TYPE OF RISKS, CREDIT RISK MEASUREMENT ASSESSMENT & CREDIT RISK MITIGATION

TYPE OF RISKS, CREDIT RISK MEASUREMENT ASSESSMENT & CREDIT RISK
MITIGATION

Risk is inherent in banking business, but the question before us is how we will
define risk and to identify what types of risk is being faced by banks.
Risk can be defined is the likelihood of an adverse deviation of the actual
result from an expected result. Banks that run on the principle of avoiding risks
cannot meet the legitimate credit requirements of the economy or the
shareholders’ expectations of reasonable, normal and adequate profits. On the
other hand, a bank that takes excessive risks is likely to run into difficulty .So a
balanced approach is required to be taken , where a calculative risk is required
to be taken by the banks.

Types of Risks faced by Banks
Banks face a number of risks in different areas of their operations, some of the
prominent risks faced by them are Credit Risk, market Risk, Operational Risk,
Liquidity Risk etc. One by one ,we will discuss some of the prominent risks faced
by the banks.
Credit Risk has been defined as “The possibility of losses associated with
diminution in the credit quality of borrowers or counterparties. In a bank’s
portfolio, losses stem from outright default due to inability or unwillingness of a
customer or counterparty to meet commitments in relation to lending, trading,
settlement and other financial transactions. Alternatively, losses result from
reduction in portfolio value arising from actual or perceived deterioration in
credit quality.”
Credit risk is the most common & predominant risk in banking and possibly the
most important in terms of potential losses. This risk relates to the possibility
that loans will not be paid or that investments will deteriorate in quality or go
into default resulting into potential loss for the bank. Credit risk is not confined
to the risk that borrowers are unable to pay; it also includes the risk of
payments of the bills being delayed beyond the maturity time, which can also
cause problems for the bank. some of the related risks to credit risk are
Counterparty Default Risk: This refers to the possibility that the other party
in an agreement will default.
Securitization Risk: Securitization is a process of distributing risk by
aggregating debt instruments in a pool and then issuing new securities backed
by the pool. There are two types of securities, viz. traditional and synthetic
securitizations. A traditional securitization is one in which an originating bank
transfers a pool of assets that it owns to an arm’s length special purpose
vehicle. A synthetic securitization is one in which an originating bank transfers
only the credit risk associated with the underlying pool of assets through the use
of credit-linked notes or credit derivatives while retaining legal ownership of
the pool of assets.
Concentration Risk: A concentration risk is any single exposure or group of
exposures with the potential to produce losses large enough (relative to a bank’s
capital, total assets, or overall risk level) to threaten a bank’s health or ability
to maintain its core operations.
Market Risk: Market risk generally refers to risks which result from changes in
market variable viz. price changes in the currency, money and capital markets
etc. Market risk also results from sensitivity to foreign exchange fluctuations
due to open foreign exchange positions and (in the broadest sense) open term
positions.
Interest Rate Risk (IRR): Interest rate risk (IRR) is defined as the change in
investors’ portfolio value due to interest rate fluctuations. The IRR
management system is concerned with measurement and control of risk
exposures, both in trading book (i.e. assets that are regularly traded and are
liquid in nature) and in banking book (i.e., assets that are usually held till
maturity and rarely traded).
Equity Price Risk: This risk arises due to fluctuations in market prices of equity
due to general market-related factors.
Foreign Exchange Risk: This risk arises due to fluctuations in exchange rates.
Operational Risk: The risk of loss resulting from inadequate or failed internal
processes, people and systems or from external events is called Operational
Risk. This definition includes legal risks, but excludes strategic and reputation
risk.
Compliance / Legal Risk: Compliance/Legal risk includes, but is not limited to,
exposure to fines, penalties or punitive damages resulting from supervisory
actions, as well as private settlements. Legal/compliance risk arises from an
institution’s failure to enact appropriate policies, procedures, or controls to
ensure it conforms to laws, regulations, contractual arrangements, and other
legally binding agreements and requirements.
Documentation Risk: The unpredictability and uncertainty arising out of
improper or insufficient documentation which gives rise to ambiguity regarding
the characteristics of the financial contract is referred to as documentation risk.
Liquidity Risk: Liquidity risks arise from a bank’s inability to meet its
obligations when they fall due, and refer to situations in which a party is willing
but unable to find counterparty to trade an asset.
Term Liquidity Risk: The risk arises due to an unexpected prolongation of the
capital commitment period in lending transactions (unexpected delays in
repayments).
Withdrawal / Call Risk: The risk that more credit lines will be drawn or more
deposits withdrawn than expected is referred to as withdrawal or call risk. This
brings about the risk that the bank will no longer be able to meet its payment
obligations without constraints.
Structural Liquidity Risk: This risk arises when the necessary funding
transactions cannot be carried out (or can be carried only on less favourable
terms). This risk is sometimes also called funding liquidity risk.
Contingent Liquidity Risk: Contingent liquidity risk is the risk associated with
finding additional funds or replacing maturing liabilities under potential, future
stressed market conditions.
Market Liquidity Risk: This risk arises when positions cannot be sold within a
desired time period or can be sold only at a discount (market impact). This is
especially the case with securities/derivatives in illiquid markets, or when a
bank holds such large positions that they cannot be sold easily. These market
liquidity risks can be accounted for by extending the holding period in risk
measurements (e.g. the holding period for VaR) or by applying expected values
derived from experience.
Other Risks
Strategic Risk: Strategic risk refers to negative effects on capital and earnings
due to business policy decisions, changes in the economic environment,
deficient or insufficient implementation of decisions, or a failure to adapt to
changes in the economic environment.
Reputation Risk: Reputation risk refers to the potential adverse effects which
can arise from bank’s reputation deviating negatively from its expected level. A
bank’s reputation refers to its image in the eyes of the interested public
(investors/lenders, employees, customers, etc.) with regard to competence,
integrity and reliability).
Capital Risk: Capital risk results from an imbalanced internal capital structure
in relation to the nature and size of the bank, or from difficulties associated
with raising additional risk coverage capital quickly, if necessary.
Earning Risk: Earning risk arises due to inadequate diversification of a bank’s
earnings structure or its inability to attain a sufficient and lasting level of
profitability.
Outsourcing Risk: While there are many ways to categorize outsourcing risk,
four of the most convenient are operational disruption risk, data risk, quality
risk and reputation risk.
Though lot number of risks is faced by banks, but Basel Committee on Banking
Supervision (BCBS) in their Basel II accord has elaborated three types of risks
viz. Credit Risk, Operational Risk and Market Risk, under Pillar 1 (component on
Minimum Capital Requirements). However, their Pillar 2 (component on
Supervisory Review Process) involves bank management to develop systems that
support the internal capital assessment process and it should also allow for
setting targets for capital that are commensurate with the Bank’s particular risk
profile and control environment.
Risk Management today is more than Compliance of Regulatory Guidelines. It is
about building value by optimizing, rather than minimizing risk. Risk
management is not about avoiding risk. It helps banks to be aware of the risks
inherent in the business and take advantage of this knowledge to gain a
competitive edge and enhance shareholders value.
Risk creates opportunity >>> Opportunity creates value >>> Value creates
stakeholders’ wealth.

Assessment of Working Capital Limit, Assessment of NFB limits

Assessment of Working Capital Limit
Under Assessment of WC limits, give comments on holding levels of Inventory, receivables, sundry creditors and OCA by comparing the same with last year estimates and actuals. Give comments on the reasons for variation, if any between the estimates and actuals. Further, also explain the reasons for the current year estimates like change in - order book position, capacity utilization etc. Similarly, give comments on funding pattern of TCA by NWC, SC, BF etc. Ideally see that contribution by BF not to exceed 50% and NWC with a minimum of 25% while funding TCA.
Any increase/ decrease in operating cycle has a cascading effect on the performance of the unit too. Hence, analyse the reasons like variation in sales, inventory, receivables vis-à-vis utilization of WC limits in the last as well as current year.
Always remember that whatever enhancement in CC limits is proposed to be recommended, it should have proportionate increase in sales. For example, in the last year, if the unit has achieved Rs 10 cr of sales with a CC limit of Rs 1 cr and now requested for Rs 2 cr of CC limit for achieving an estimated turnover of Rs 15 cr…there is no proportionate jump in sales when compared with the limits. This aspect has to be looked into critically.
Assessment of Term Loan
If any project report is available, ensure that the report is prepared by any of our empaneled agencies. Always ensure stipulated DE (Debt/ Equity), DSCR, various statutory approvals required for establishing the unit starting from Municipality approvals to PCB/ Coastal regulatory clearances if any for all the projects which we are going to finance.
DSCR: While structuring instalments, stipulate repayment as per cash flows during a year. See that DSCR always stands above 1.50 in all the years of repayment.

Assessment of NFB limits
Bank Guarantee:
1. In respect of BG limits, apart from qualitative data, focus on giving certain qualitative information on:
(a) Unit’s track record of executing the works timely.
(b) Position of invocation of BG’s, if any during previous years.
(c) Analyse the reasons for previous extensions, if any by putting focus on delay in release of drawings by clients, delay in handing over the sites, delay in environmental clearances, frequent revision in work scope, delay in release of funds causing execution delays etc.
2. Further, if any enhancement is proposed, write comments on:
✓ Orders bagged/ expected to be bagged by the unit during the current year.
✓ Success rate of the unit in the tenders participated during the previous years and arrive at the average strike rate.
Letter of Credit:
Understand the purpose for which the LC is proposed to be opened. In majority of the cases, it is for the purpose of procurement of raw material. If LC is requested for CAPEX purposes, invariably recommend for term loan too.
User has to be careful here, if the unit is also enjoying CC limit, so that double financing in the form of LC/ CC needs to be avoided.
Usance period: Always, ensure that usance period should not be more than the operating cycle of the unit, which may lead to diversion of funds.
In respect of LC’s, have the position of devolvement of LC’s, if any during previous years in order to understand the ability of the unit to pay bills on time.

Balance Sheet

Balance Sheet


Liabilities                                      Assets
Share Capital                               Fixed Assets
Reserves & Surplus                      Investments
Secured Loans                              Current Assets, Loans &Advances
Unsecured Loans                           Miscellaneous Expenditure
Current Liabilities & Provisions   Profit & Loss A/c (Dr balance,if any)



A. LIABILITIES
(a) Share Capital
Capital is the amount contributed by the promoters to
the business. As the firm is seen as different from its
promoters, capital becomes a part of the firm’s ‘liability’
to the promoters.
For a company, the capital has a few stages:
• Authorized capital: the maximum amount which can
be raised by way of capital.
• Issued capital: the amount of authorized capital
which has been offered to shareholders.
• Subscribed capital: the amount of issued capital
which has been subscribed by the shareholders.
• Paid up capital: the amount of subscribed capital
which has actually been paid up (balance is unpaid).
(b) Reserves & Surpluses
Reserves are the earnings kept aside for a specific
purpose. Surpluses are the earnings not so earmarked.
The components of Reserves are:
• Capital Reserve: It includes
o Capital Redemption Reserve: for payment of
preference shares.
o Revaluation Reserve: as market value of fixed
assets.
o Debenture Redemption Reserve: for repayment
of debentures.
o Subsidy Reserves: subsidy held for use in a project.
(d) Unsecured Loans
Unsecured loans are the loans raised without offering
security. These loans include:
• Fixed deposits
• Loans & advances from subsidiaries
• Short term loans and advances from banks and
others
• Other loans and advances.
(e) Current Liabilities & Provisions
These are the liabilities which are payable within 1 year
from the date of balance sheet. Major components of
current liabilities are:
• Acceptances, i.e. the bills accepted for payment
• Sundry Creditors, i.e. the trade creditors against
receipt of materials and other creditors towards
expenses incurred
• Advance payments received- from dealers,
customers etc
• Unclaimed Dividends, i.e. the dividends declared
which are yet to be paid off
• Interest Accrued but not Due, which can arise in
respect of all loans and deposits
• Other liabilities, if any, which are payable within 1 year.
Major components of Provisions are:
• Provisions for Taxation, which are kept aside from
profit for eventual payment to income tax authorities

• Proposed Dividends, i.e. the amount provided for
pending declaration of dividends
• Other Provisions, viz, for contingencies, for provident
fund etc.



B. ASSETS


(a) Fixed Assets
Fixed assets are those assets which are held for use in
production or for providing goods and services over a
long run. In other words, fixed assets facilitate the
production process although these assets do not directly
go into the process of production.
A list of fixed assets appears in Sch VI of the Companies
Act. The fixed assets include land and building, plant and
machinery, furniture and fittings, patents, goodwill etc.
Fixed assets are presented as Gross Block and Net Block.
Gross Block represents the original cost of the fixed assets
and Net Block is the book value of the fixed assets which
is calculated as the original cost less accumulated
depreciation of each category of assets.
(b) Investments
Investments generally refer to the money deployed in
securities or assets which are not directly related to the
main activities of the company. A firm having surplus
cash invests the same in securities to earn returns instead
of holding the idle cash with it. A firm may also have
investments in real estates, subsidiary companies etc.
(c) Current Assets, Loans & Advances
Current assets are the assets which can be turned over
into cash within the operating cycle, maximum 1 year
The following types of current assets find mention in the
Sch VI of the Companies Act:
- Interest accrued on investments - Stores and spares
- Loose tools - Stock-in-trade
- Work-in-progress - Sundry debtors
- Cash balance on hand and Bank balances
Loans and advances are in the nature of short term
advances generally given in course of the business.
Examples of loans and advances are:
• Advances recoverable in cash or kind or for value to
be received
• Bill of exchange
• Balances with customs, port trusts etc
• Advances and loans to subsidiaries/ partnership firms
(d) Miscellaneous Expenditure
Miscellaneous Expenditure is the expenditure against
which the firm does not hold any tangible asset and,
hence, Miscellaneous Expenditure is also called ‘Intangible
Assets’. Such expenditure needs to be written off over a
period of time. Miscellaneous Expenditure which is not
written off appears on the asset side of the balance sheet.
Examples of the miscellaneous expenditure are:
• Preliminary expenses
• Exchange, commission, brokerage and other expenses
incurred or discount allowed on underwriting or
subscription of shares/debentures
• Interest paid out of capital during construction
period.
Balance in Profit and Loss Account
It represents the loss of the firm carried forward. While
the profit carried forward appears on the liability/credit side,
the loss carried forward appears on the asset/debit side. The
firm may adjust the loss against the uncommitted reserves,
if any, and carry forward the balance amount of loss in asset
side.
Banker’s Approach to Analysis of Balance Sheet
The balance sheets of the companies are drawn from
the point of view of their shareholders who are interested in
‘solvency’ of the business. However, the lending banker’s
approach to balance sheet is mainly a study in ‘liquidity’ of
the firm. The lending banker, therefore, re-classifies the
Balance Sheet with emphasis on proper identification of
current assets and current liabilities. The banker identifies
the ‘eligible current assets’ which can be financed. All
other items of “Current assets, Loans and Advances” in the
balance sheet are placed in CMA format as ‘non-current
assets’. Similarly, the banker identifies all current liabilities
payable within current year. In the process, some part of
term liabilities of the balance sheet is shown as current liability
in CMA format.
The guidelines for re-classification of current assets and
current liabilities are as under:
i. Cash margin for LCs and guarantees relating to working
capital can be taken as current assets.
ii. Fixed deposits in banks and trustee securities are to be
classified as current assets. Temporary investment of
surplus liquidity in MF, money market instruments
(CD, MMME etc) can be taken as current assets. All other
investments, like ICDs, investments in shares and bonds
etc will be excluded from current assets.
iii. Slow moving/obsolete inventory and overdue receivables
(say over 6 months) are to be removed from current assets
iv. Stores and spares should bear a relation to the
consumption of the unit (max 12 months consumption
taken as current assets for imported spares and 9 months
consumption for domestic spares)
v. Advances paid to employees, suppliers for raw materials
etc can be taken as current assets only for the amount
as realizable within 1 year.
vi. Investment in shares, advance to companies etc not
connected with business of the unit should be excluded.
Advance to interconnected companies can be taken as
current asset only if these are on market terms and at
reasonable level/period.
vii. Security deposits (for electricity, customs etc)/tender
deposits are to be excluded from current assets.
viii. Outstanding advance payments received from customers
are to be taken as current liability (unless specifically
payable after 1 year). Advance payments received against
works in progress are to be netted off.
ix. Deposits received from dealers are to be treated as
current liabilities unless payable on termination of
dealership.
x. Current liabilities would include: bank borrowings, usance
bills discounted, short term borrowings from banks/friend
and relatives, sundry creditors for materials and
expenses, interest accrued but not due, dividend and
other expenses payable. The instalment on term loan,
public deposits etc payable within 1year is classified as a
current liability.
xi. Provision for taxation should be netted off against the
Adavance Tax Paid for all years.
xii. Provision for disputed liabilities (e.g. excise duty, sales
tax etc) should be treated as current liability unless these
are payable in instalments as per the written orders of
the concerned authorities. If the amount is invested in
fixed deposits, the same should be netted off.
xiii. Provisions for all known/accrued liabilities should be
made, including those for prior period, events after
balance sheet date etc. If some known liabilities may be
payable eventually from general reserves in future, an
estimated amount should be taken as current liabilities.
xiv. ICDs taken will be shown as current liability/short
term borrowing (and also under additional information
in Form III)
xv. Bills negotiated under LCs: The facility of purchase of
demand and usance bills under LCs is provided outside
assessed bank finance (ABF). Therefore, receivables
under sale bills drawn under LCs (inland/export) will not
be included in current assets in Form III and bank
borrowings under LC Bills Purchase limit will be excluded
from projected bank finance under current liabilities.
However, the same will be shown as contingent liability
under ‘Additional Information’.
Above re-classification would give the lending banker a
true and fair view of the liquidity position of the firm and
helps him proper assessment of working capital requirement.

FINANCIAL STATEMENT ANALYSIS.Very Useful

FINANCIAL STATEMENT ANALYSIS

Financial statements are the statements that convey
information about the firm in financial terms. All the activities
of the firm (including HR, production, marketing etc) have
financial implications which are captured and presented
through financial statements.
IMPORTANT FINANCIAL STATEMENTS
Two commonly used financial statements are Profit and
Loss Account and Balance Sheet. Other financial statements,
which have specific uses, are the Funds Flow Statement and
Cash Flow Statement. In case of the companies, the audited
financial statements are supported by Schedules, Notes to
Accounts, Director’s Report, Auditor’s Report etc. Various
aspects of the financial statements are presented below mainly
from banker’s point of view.
1. PROFIT & LOSS ACCOUNT
Profit & Loss Account (P&L Account) presents the net
result of operations of the firm over a period of time. It is,
therefore, called the Operating Statement or Income
Statement.
A. Features of P&L Account:
(i) It is prepared for an accounting period, which is
normally one year. (i.e. accounting period concept).
However, the companies may prepare their financial
statements for an accounting period of maximum
15 months (or 18 months with approval of Registrar
of Companies).
(ii) Income is captured in P&L Account on accrual basis
(i.e. accrual concept) - hence, income is different
from cash.
(iii) For any income, the matching expense needs to be
accounted for (i.e matching concept)
(iv) Income is to be reckoned only if it is reasonably
certain whereas expense is to be provided if it is
reasonably possible (i.e. prudence concept)
(v) It records only revenue receipts and revenue
expenditure (and not capital receipts/expenses)
pertaining to the period.
B. Components of P&L Account
P&L Account can be studied broadly at 4 stages:
(i) Net Sales (i.e. revenue generated)
(ii) Cost of Sales (i.e. manufacturing cost of goods sold)
(iii) Operating Profit (i.e. income from main operations)
and
(iv) Net Profit (i.e. net result available for shareholders).
i. Net Sales:
It is computed as Gross Sales less Excide Duty and
adjusted for Sales Returns, Discounts etc.
Gross Sales: It is the number of units sold multiplied
by the average unit price. ‘Gross Sales’ is also adjusted for
Sales Returns and Discounts. Sales Returns represent goods
sold but subsequently returned. Thus, ‘Sales Returns’ reduce
the ‘quantity sold’. Discounts (which are given for bulk
purchase, timely payment, cash purchase etc) represent the
reduction in ‘unit price’. Thus, both Sales Returns and
Discounts effectively lower the sales figure during the period
and, hence, should be reduced from Gross Sales.
Excise Duty: It is deducted from Gross Sales because
excise duty is applicable as soon as the manufacturing process
is completed to make the product saleable (in other words,
excise duty is linked to production and precedes sale). Excise
duty is also collected for the government and, hence, does
not constitute a part of revenue of the firm. Moreover the
rate of excise duty may differ from year to year, which may
mislead while comparing sales over consecutive years.
For above reasons, ‘net sales’ is a more meaningful
parameter for analysis than ‘Gross Sales’.
ii. Cost of Sales
It is also called the Cost of Goods Sold. It is computed in
two stages, namely (a) Cost of Production and (b) Cost of
Sales.
(a) Cost of Production: It includes only those expenses
which directly go into producing the goods during the
period (regardless of whether the goods are sold or not).
These expenses, called direct expenses, include:
(a) raw materials and stores & spares consumed
(b) direct labour (i.e wages of manpower engaged in
production)
(c) power & fuel (on factory side)
(d) other manufacturing expenses (e.g. repairs &
maintenance)
(e) depreciation of fixed assets and
(f) adjustments for semi-finished goods or Stocks-In-
Process (i.e. add opening SIP and subtract closing
SIP)
‘Raw materials consumed’ is the value of raw materials
which go into production. It is different from raw materials
purchased as under
Raw materials consumed =
Raw materials purchased + Opening Stock - Closing Stock
of raw materials
Similar method is used for calculation of stores and spares
consumed during the accounting period.
Direct Labour and Power & Fuel: Only those expenses
which pertain to the manufacturing side are taken here. For
example, the direct wages and the salaries of the production
staff form a part of direct labour whereas the salary of
administrative staff is excluded.
Depreciation: It is a notional charge towards wear and
tear of the fixed assets through use or efflux of time or
obsolescence. It needs to be fully provided for replacement
of fixed assets in future. (In fact, companies are not
permitted to pay dividends or managerial remuneration before
providing for dividend in full). Being notional, it is a non-cash
expense.
Calculation of depreciation is based on three factors: (a)
the original cost of fixed asset (b) its estimated scrap value
and (c) its useful life. The original cost less scrap value is
depreciated over the useful life of the asset.
Two commonly used methods of depreciation (which are
also recognized by the Companies Act 1956) are the Straight
Line Method and Written Down Value Method.
In Straight Line Method(SLM), the depreciable value of
the fixed asset is divided equally over the number of years of
its useful life:
Annual Depreciation = (Original Cost - Scrap Value)/
Useful Life
Thus, in SLM, the depreciation is a constant amount every
year.
In Written Down Value (WDV) Method, the depreciation
is calculated with reference to the book value of the asset
(and not the original cost). Here, the applicable rate of
depreciation is first determined (based either on useful life
or as given in statutes) and then the book value is multiplied
by the rate of depreciation. Since the book value is more in
initial years, the amount of depreciation is more in initial
years than in later years.
A comparison of SLM and WDV methods of depreciation
would show the following:
• The amount of depreciation is constant in SLM whereas
it is progressively reducing in WDV method. It is less in
SLM than in WDV method in initial years and more in
later years
• The resultant net profit of the firm with SLM will be more
in initial years (as depreciation expense is less under
SLM) than with WDV method.
Accounting Standard (AS-6) permits change in method
of depreciation in case of (a) change in statute (b) change in
accounting standard or (c) to present information in a more
appropriate manner. Many companies change the method of
depreciation to suit their needs and the financial analyst needs
to probe into the same.
Stock-In- Process (SIP): The manufacturing expenses
are adjusted for the SIP consumed in production. For the
purpose, the opening SIP is added (as it is used in production
in current period) and the closing SIP is subtracted (as it is
not used in current period).
Above expenses added together give the Cost of
Production (COP) of goods.
(b) Cost of Sales: It is the Cost of Production adjusted for
the stock of finished goods. The opening stock of finished
goods is added to COP and the closing stock of finished
goods is subtracted to ascertain the Cost of Sales
(because the opening stock of finished goods has gone
into sales whereas the closing stock is still left out).
iii. Operating Profit
Operating Profit is profit generated from operations. It is
ascertained at three stages (a) Gross Profit (b) Operating
Profit before Interest and (c) Operating Profit after Interest.
(a) Gross Profit: It is computed as Net Sales – Cost of
Sales. It is the net amount that the production process
has given to the firm to sell the goods and make profits.
It is a measure of business risk (i.e. more gross profit
means lower risk in business).
(b) Operating Profit Before Interest: It is calculated as
the amount of Gross Profit less Selling, General and
Administrative (SGA) expenses. SGA expenses include
the staff salaries, bonus, marketing expenses,
administrative expenses and all non-manufacturing
expenses (except interest cost).
Operating Profit Before Interest is also called the Earnings
Before Interest & Tax (EBIT). It measures the operating
efficiency of the firm (prior to financing charges/interest)
(c) Operating Profit After Interest: It is calculated as
the amount of Operating Profit before Interest less
Interest expenses.
Interest expense: It is the amount of financing cost of
the firm, i.e. its expense towards borrowed funds. The
borrowings can be by way of loan from banks, public deposits,
debentures etc. Interest cost should bear a relationship to
the outstanding borrowing amount and the applicable rate of
interest. Other expenses like discounts, ancillary costs,
financial charges, exchange differences etc should be
segregated.
Operating Profit After Interest shows the overall operating
efficiency of the firm.
iv. Net Profit
This is the amount of profit available to the shareholders.
It is calculated in 2 stages: (a) Profit Before Tax (PBT) and
(b) Profit After Tax (PAT).
(a) Profit Before Tax: It is the profit earned by the
firm after all operating, financing and non-operating
expenses are accounted for. PBT is, therefore,
calculated as Operating Profit (after Interest) plus
net non-operating income. The non-operating
income (Other Income) and non-operating expenses
(Other Expenses) are kept ‘below the line’ of
operating profit for financial statement analysis as
they do not accrue from core operations.
(b) Profit After Tax: It is calculated as the PBT less
Provision for Tax. Net Profit is the net amount
available to the firm (and its shareholders) after all
expenses are paid for.
In case of companies, dividend, if declared, is paid out
of the net profit. In such a case, the balance amount is called
the Retained Profit, which is transferred to Reserves & Surplus
Account of Balance Sheet.
Banker’s Approach to Analysis of P&L Account
The approach of bankers to analysis of P&L account
differs from that of the shareholders mainly in following
respects:
(i) Bankers break down the income and expenses into
operating and non-operating items in their CMA format
as they are interested in operating efficiency of the firm.
(In contrast, companies present the P&L Account as
Income & Expenditure Statement, where the Total
Income and Total Expenditure are given over major
heads). Bankers also segregate the revenue of core
operations from non-core operations (e.g. trading profit)
(ii) Secondly, bankers look for full provision of various
expenses in the P&L account (e.g. depreciation, prior
period expenses, events after balance sheet date etc).
(iii) Thirdly, they ignore pure accounting transactions like
revaluation of fixed assets, deferred tax accounting etc.
(iv) Fourthly, they look for consistency in presentation of
various components of P&L account for inter-year
comparison of efficiency of operation.
The resultant profitability will show a reasonably correct
picture of viability of operations.

CHECKLIST FOR INSPECTION OF UNITS

CHECKLIST FOR INSPECTION OF UNITS
1 Take a copy of the latest Stock Statement of the Unit & also the immediate previous
stock statement.
2 Ensure that If limits granted on the basis of book debts, then list of Debtors (classified
age-wise / country-wise)
3 Make a Note of the details viz.
a) The Latest Limit
b) Drawing power
c) Outstanding
d) Notes on the promises made during last visit & notings made during the last
inspection
e) Average Sales (Monthly) as per “projections’ given
f) No. of Shifts / Average employees during each shift
g) Average Creditor and Debtor Level
h) Rejection Level / Sales Returns data
4 Observe & make a note of the present ‘Activity level” at the Unit (No. of shifts worked,
Avg. No. of employees, Sales, Creditor elves, Debtor level) & compared with the
previous levels
5 Ensure that all the machineries are in effective use.
6 a
6 b
Ascertain any machinery discarded if so How the Sale Proceeds were utilized
Similarly ascertain if any machinery has been purchased new – if so what was the
source of funds for the purchase.
7 Observe about the labour situation and also make casual but purposive enquiries
thereon.
8 Notice the Key change in Management Positions within the Unit.
9 Observe the Production levels & make a critical comparison with the “Projections”. If
substantial variance observed, then reasons for the shortfall ascertained and made
note of.
10 Note the quantity of Rejections / Sales returns, ascertain reasons, compare with data
for the previous month / quarter.
11 Notice the Average Sales levels and make a critical comparison with the ‘Projections’ /
check for the reasons.
12 Conduct a random check of the stocks with focus on
a) The present levels of stocks - should commensurate with production cycles
b) Quantity of slow-moving items - should be minimum or nil
c) Inclusion of obsolete items as part of stocks – should not be done
d) Sudden but phenomenal increase / decrease in stocks in comparison to those
as per latest stock statement – the reasons should be clarified with the
borrower
13 Ensure that the ‘Statutory Dues” like PF, ESI, Sales Tax, Income Tax, Property Tax,
EB dues etc have been paid and are evidenced by presence of receipts thereof on
record.
14 Observe that books of accounts are written-up, up to date.
15 If accounts remain irregular, then a meaningful discussion on regularization of
accounts to be held with borrower / executives.
16 Make a note of any difficulty in verifying stocks / book debts or in carrying out
inspection at the Unit.
17 Ensure that The commitments given during last inspection have been met or
acceptable reasons for not meeting the commitments given.
18 Ensure that the suggestions given by the Bank during last inspections have been
implemented.
19 Record any positive / negative developments that are likely to befall the Unit.
20 Discuss the adverse features observed during Inspection with the borrower /
executives of the Unit.
21 Submit the observations regarding the inspections holistically to the next higher
authority in the prescribed format and in time.
22 Ensure to record the visit in the Inspection Register maintained at the Bank as well as
in the Unit Inspection Register at the Unit and NOT in any other forms / registers of the
Unit thereat.