Bank Management

EPAF
IIMC
Aug- Nov 2024
Praloy Majumder
1
Evaluation of borrowers

2
 Designing immediate solutions

Company Name
Working Capital Assessment

4
Risk Management of
Banks

5
Credit Risk Framework

6
 Credit Risk Measurement

Expected Loss Un Expected Loss

Before lending , bank would calculated the Expected Loss associated with
lending
From Expected Loss , bank would calculate the unexpected loss . Bank
has to maintain capital on this unexpected loss .
Bank would charge interest rate in such way that it recovers expected loss
through pricing . Besides desired return on equity would have to collected
through pricing . This pricing is called risk based pricing
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Risk Based Pricing
 Bank wants to give a loan of Rs 100 lacs to borrower .
 Bank would first calculate the expected loss . Suppose the
expected loss amount calculated is 0.50% of the loan amount
( we shall discuss calculation in later slides )
 Once bank calculates expected loss , it would calculate
unexpected loss from expected loss by using certain process
( this part would be covered in credit risk measurement classes
later part of the course ) . For the time being , let us assume
that Unexpected Loss calculated is 8% of the loan amount .
 Once bank estimates , Expected Loss and Unexpected Loss , it
would now calculate the financing structure . The financing
structure is shown in the next slide .
Risk Based Pricing : Loan funding
structure
Risk Based Pricing : Cost associated with
the loan
 Required return on Equity : 15% p.a.
 Cost of deposit : 7% p.a.
 Operation cost : 0.25% p.a. of loan amount
Risk Based Pricing : Interest rate
determination
Expected Loss
Expected Loss
Probability of Default
Financial Statement
Analysis

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Financial Statement
Analysis

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Financial Statement
Analysis

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Financial Statement
Analysis

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Financial Statement
Analysis

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Financial Statement
Analysis

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Important formulae

Serial No Particulars Component

1 Net Sales Gross Sale – Excise
2 Cost of Production Consumption + Power and Fuel + Salary and
Wages + Other Manufacturing Expenses+
Depreciation + Opening Work-in- Progress –
Closing Work-in- progress
3 Cost of Sales Cost of Production + Opening Finished Goods –
Closing Finished Goods
4 Current Asset Accountant Current Asset – Loans and advances
to group companies – Receivable of more than
180 days – Investment in capital market
5 Total Outside Liability Total Term Liability + Total Current Liability +
Selected contingent liability
6 Adjusted Tangible Net Equity + Reserves – Revaluation Reserves –
Worth Intangible Asset – Investment in group
companies- Loans and advances to group
companies

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Important formulae

Serial No Particulars Component

7 Net Profit Margin Net Profit / Net Sales
8 EBITDA Margin = [ Profit After Tax- Other Income + Depreciation
+ Taxes + Interest + Amortisation ] / Net Sales
9 Debt Service Coverage = [Profit After Tax + Depreciation + Interest
Ratio ]/[Principle repayment commitment + Interest
repayment commitment ]
10 Leverage Ratio =Total Outside Liability / Adjusted Tangible Net
Worth
11 Current Ratio = Current Asset / Current Liability
12 Return on Equity = Profit After Tax / Net Worth

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Important formulae

Serial No Particulars Component

13 Raw Material Cycle = [Raw Material / Consumption] *12

14 Work in Progress Cycle = [Work in Progress / Cost of Production ] * 12

15 Finished Goods Cycle = [Finished Goods/ Cost of Sales ]*12

16 Receivable Cycle =[ Receivable /Gross Sales ] *12

17 Creditor Cycle = [ Creditor / Purchase ] *12

18 Operating Cycle = 13+14+15+16

19 Cash Cycle =18-17

20 Purchase = Consumption + Closing stock of Raw Material –

Opening Stock of Raw Material

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 Cash Flow Analysis
Cash Flow from Operation (CFO) formula:
Profit After Depreciatio Finance Other
Tax n Charges Income

Current Assets, Cash and Bank

Loans and Balance
Advances

Current
Liability and Borrowing
Provisions

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 Cash Flow Analysis

Component A Component B Component C

The lower the
The higher the The lower the The
component lower
C per unit of the
The higher the The lower the
component A per unit of component B per unit of sales it is the best. Inof
component C per unit
component
sales, A per
the better unit of
it is. component
sales, B per
the better unit of
it is. salesthe
it is the best. isIn
case component
sales, the better it is. sales, the better it is. case the component
increasing, if it isis
happening with reducingis
increasing, if it
happening
creditor dayswith
and reducing
age of
creditor days and
creditor break up then age itof
iscreditor break up then it
acceptable.
www.disseminare.com is acceptable.

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 Cash Flow Analysis
Cash Flow from Financing (CFF) formula:
Profit of the Dividend for
Reserves & current the current
Equity
Surplus financial financial
year year

Finance
Current
Long Term Cost on
Maturity of
Liability Long Term
Term Loan
Liability

Finance Cost
Bank
Finance Cost on Bank
Short term Borrowing
on Short Borrowing
liability for Working
Term Loan for Working
Capital
Capital
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 Cash Flow Analysis
Cash Flow from Investment (CFI) formula:

Other
Income

Investment
Gross Fixed normal
Asset course of
business

Speculative
Asset

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Discussion on techniques to be used to capture all possible
cash flow analysis of a Customer
Creation of risk grid based on cash
flows
P&L Item Change in Change in Risk Grading
Current Other
Asset Current
Liability
Cash flow from Positive Negative with Negative with Lowest
Operation +ve lower lower creditor
operating cycle
cycle
Cash flow from Positive Positive with Positive with Moderate to
Operation +ve higher higher creditor high
operating cycle
cycle
Cash flow from Negative Negative with Positive with Moderate to
operation +ve lower higher creditor high
operating cycle
cycle
Cash flow from Negative Positive with Positive with Highest
operation -ve higher higher
operating operating
cycle cycle
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Creation of risk grid based on cash
flows
Equity Long term Short term Risk Grading
Component debt debt
component component
Cash flow from Positive Negative with Negative with Lowest
Financing +ve lower cash cycle lower cash
cycle
Cash flow from Positive Positive with Positive with Moderate to
Financing +ve higher cash higher cash high
cycle cycle
Cash flow from Negative Positive with Positive with Moderate to
Financing +ve lower cash cycle lower cash high
cycle
Cash flow from Negative Positive with Positive with Highest
Financing -ve higher cash higher cash
cycle cycle

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Creation of risk grid based on cash
flows
Gross Fixed Other Non Risk Grading
Asset Current Asset
Component Component
Cash flow from Positive with Negative with Lowest
Investment -ve lower cash cycle lower cash cycle
Cash flow from Positive with Positive with Moderate to
Investment -ve higher cash higher cash high
cycle cycle
Cash flow from Negative Positive with Moderate to
Investment -ve lower cash cycle high
Cash flow from Negative Positive with Highest
Investment -ve higher cash
cycle

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Working capital facility

Net
worth Non
Current
Asset
Liability

BB CA

OCL

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Fund Based Working Capital
Assessment
 Rules of financial
Step projections Rules
Activity
No
1 Estimate / Project sales Sales should not increase more
than the sales /GDP multiple of
the industry
2 Estimate / Project non Non current asset should not be
current asset projected at higher than the
industry level sales / non current
asset ratio
3 Estimate the financing The targeted debt to equity ratio
pattern of incremental should not be more than the
non current asset if industry average
required
4 Estimate the debt Targeted debt amount should
amount not be more than the industry
5 Estimate the equity Clearly identify the sources of
amount equity
6 Estimate all expenses Expenses to sales ratio should34
except interest , not go down from the industry
 Rules of financial
Step No
projections
Activity Rules
7 Estimate current
assets
Inventory a. Raw Material Holding level of Raw Material
should not go up in terms of
months of consumption
b. WIP Holding level of WIP should not go
up in terms of months of cost of
production

c. Finished Goods Holding level of FG should not go

up in terms of months of cost of
sales
d. Spares Holding level of FG should not go
up in terms of months of
consumption of spares
Receivab Receivable Holding level of receivable should
35
le not go up in term of gross sales
Rules of financial
projections

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 Rules of financial
projections
Step Activity Rules
No
18 Estimate TAX Based on long term taxation
policy of the country
19 Estimate PAT Use the formula PBT- Taxes
20 Estimate dividend As per dividend policy
21 Estimate retained Use formula = PAT – Dividend
earning
22 Transfer the
retained earning
into the reserves

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Fund Based Working Capital ( FBWC) assessment method

FBWC

Domestic Import Export

Fund Based Working Capital ( FBWC) assessment method

Domestic

Turn over Operating MPBF Cash Budget

method Cycle method method method
Fund Based Working Capital ( FBWC) assessment method

Turn over method Assessment

Estimated Projected
date

1st July 2022 2022-23 2023-24

Step 1 Estimate the turnover of estimated year Rs 500 lacs

Step 2 Cash cycle from past data ( OC- CC ) ( days) 75 -105

Step 3 FBWC requirement ( 25% of Est. sales ) Rs 125 lacs

Step 4 Minimum Margin Money for Working Rs 25 lacs

Capital ( 5% of Est. Sales )

Step 5 Estimated Margin Money for Working Capital Rs 30 lacs

Step 6 Actual Margin Money for Working Capital as Rs 25 lacs

On March 31st , 2022
Step 7 Fund Based Working Capital Limit as per Rs 95 lacs

Turn over method

Is DP statement
TO method applicable for Is Net Working Capital mandatory for TO method
every entity ? relevant in TO method ? ?
Fund Based Working Capital ( FBWC)
assessment method: Case 1

Actual sales for the FY 2020-21 : Rs 600 lacs

Actual sales for the FY 2021-22 : Rs 900 lacs

Estimated sales for the FY 2022-23 : Rs 1100 lacs

Followings are details of Inventory , Receivable and Creditor amount ( Rs lacs )
As on March 31st , 2022 :
Raw Material : Rs 50 lacs ; WIP : Rs 10 lacs ; FG : Rs 100 lacs ;
Receivable : Rs 100 lacs ; Creditor : Rs 50 lacs
Cash Credit Outstanding as on March 31, 2022 was Rs 130 lacs
What would be the fund based working capital limit for FY 2022- 23 under
Turn over method ?
Fund Based Working Capital ( FBWC) assessment method

Operating cycle method 2020-21

Step 1 Estimate the RM Cycle , WIP Cycle , FG Cycle and Receivable Cycle ( months )
RM 1 WIP 0
FG 1
. Recv.
. . 2
Cycle 0 Cycle 5 Cycle 5 Cycle

Step 2 Estimate appropriate monthly cost ( Rs lacs )

Consu 1
mptio COP
1 1 Gross 1
0 2 COS 4 8
n sales

Step 3 Estimate amount of Working Capital Required ( Rs lacs )

1 2 3
RM 0 WIP 6 FG 1 Recv. 6
73

Step 4 Estimate margin money for each category of Current Asset ( % and Rs lacs )
2 1
RM . WIP FG 5.2 Recv. 14. 23.65
.
(25%) 5 (25%) 5 (25%) 5 (40%) 4

Step 5 Estimate Creditor cycle and amount

Per month 15
1 No of
Creditor purchase month 1
5
( Rs lacs ) LIMIT
( Rs 34.35

lacs )
 Fund Based Working Capital ( FBWC)
assessment method: Case 2

Actual sales for the FY 2020-21 : Rs 600 lacs

Actual sales for the FY 2021-22 Rs 800 lacs
Estimated sales for the FY 2022-23 : Rs 10 00 lacs
Followings are estimates of Inventory , Receivable and Creditor amount ( Rs lacs )
As on March 31st , 2023 :
Raw Material : Rs 60 lacs ; WIP : Rs 10 lacs ; FG : Rs 90 lacs ;
Receivable : Rs 100 lacs ; Creditor : Rs 70 lacs

Margin for Inventory is 25% and Receivable is 40% .

What would be the fund based working capital limit for FY 2022-23 under
Operating Cycle method ?
Fund Based Working Capital ( FBWC)
assessment method: MPBF

Form III
Estimated Current Asset ( CA) ( Rs lacs ) of CMA Prepare estimates in the CMA Form II and III
Form

Form III Sales Cost HL

Estimated Other Current Liability ( OCL)
of CMA
( Rs lacs )
Form
CA ,
Estimated Working Capital Gap ( WCG) Form V
OCL
( Rs lacs ) of CMA
Form

Minimum Net Working Capital ( 25% of Form V

CA or 25% of WCG) ( Rs lacs ) of CMA
Form

Estimated Net Working Capital MPBF Limit

Form V of
( Rs lacs ) CMA Form
Fund Based Working Capital ( FBWC)
assessment method: MPBF

Prepare estimates in the CMA Form II and III

Actual Estimate
Form III RM 15 20
Rs lacs
Estimated Current Asset ( CA) ( Rs lacs ) of CMA Months
1.5 2

Form

Form III
Estimated Other Current Liability ( OCL)
of CMA
( Rs lacs )
Form

Estimated Working Capital Gap ( WCG) Form V

( Rs lacs ) of CMA
Form

Minimum Net Working Capital ( 25% of Form V

CA or 25% of WCG) ( Rs lacs ) of CMA
Form

Estimated Net Working Capital Form V of

( Rs lacs ) CMA Form
Fund Based Working Capital Assessment : MPBF Method

March 31st , March 31st , Comments

2022 2023
Raw Material ( Rs 20 30
lacs )
HL ( months of 1 2 Justification
consumption ) required
WIP ( Rs lacs ) 5 5
HL ( months of COP) 0.25 0.50 Justification
required

FG ( Rs lacs ) 30 35
HL ( months of COS) 1.10 1.00
Receivable ( Rs 50 60
lacs )
HL ( months of sales 2 3 Justification
) required
OCA ( Rs lacs ) 5 7
HL ( % of Total 4.54% 5.10% Justification
Current Asset ) required
Total Current Asset 110 137
( Rs lacs )
Fund Based Working Capital Assessment : MPBF Method

March 31st , March 31st , Comments

2022 2023
Creditor ( Rs 20 30
lacs )
HL ( months of 1.10 2.11
purchase )
Other other 10 15
current liability
( Rs lacs ) NWC = LTS- LTU
HL ( % of Other 33.33% 33.33%
Current
Liability )
Other Current 30 45
Liability ( Rs
lacs ) ( 2)
Working Capital 80 92
Gap ( 3) ( Rs
lacs )
Min NWC 27.50 34.25
( MPBF II) ( Rs
lacs )
Actual 30.00 38.00 Sources of
/Estimated Estimated
NWC ( Rs lacs) NWC
MPBF ( Rs lacs ) 50.00 54.00
 Problem on Fund Based Working Capital
Assessment
• The estimated current asset of a company as on March 31 st 2023 is Rs 300 crores. Out
of this total current assets , receivable of more than 6 months is Rs 20 crores and loans
to group companies is Rs 20 crores. The estimated other current liability as on the same
date is Rs 60 crores out of which term loan installment payable within 1 year is Rs 20
crores.
• The fund based working capital assessment would be carried out under MPBF method
II . The estimated net working capital would be 20% more than the minimum net
working capital .
• Find out the MPBF Limit :
• Estimate current asset = Rs 260 crores ;
• Estimate other current liability = Rs 40 crores;
• Estimate working capital gap = Rs 260 crores – Rs 40 crores = Rs 220 crores
• Minimum NWC = Rs 260 crores * 25% = Rs 65 crores
• Estimated NWC = Rs 65 crores * 1.20 = Rs 78 crores
• Fund Based Working Capital Limit = Minimum of [ 220 – 65 , 220- 78 ] = Rs 142 crores
Fund Based Working Capital Assessment : Cash budget method

Rs lacs
Qtr 1 Qtr 2 Qtr 3 Qtr 4

Receipt on account of
Cash sales 3 2 4 1
0 0 0 0 Most scientific
Realisation of 6 4 8 3
Receivable 0 0 0 0
6 2 3 4
Other income
96 62 123 44
Total Revenue Receipt
Payment on account of Better end use
Cash payment 2 1 2 5 monitoring
Creditor and exp 0 0 0
8 9 5 2
Payment 0 0 0 0
4 6 4 3
Interest and taxes
Total Revenue Payment 104 106 74 28

Revenue surplus /deficit () (8) (44) 49 16

DP statement required
Capital account surplus
(2) 10 (8) 6
/deficit ()
Overall surplus
(10) (34) 41 22
/deficit ()
Opening CC balance (20) (30) (64) (23)
Seasonality captured
Closing CC balance (30) (64) (23) (1)