1. Analysis of Credit
Worthiness in Working
Capital
By
Vidish Tantia
Bachelors of Science in Mathematics,
Statistics and Economics
University Of California Los Angeles

2. ACKNOWLEDGEMENTS
This Project is a result of my experience with the credit department
at Kotak Mahindra Bank Limited. I am most grateful for the
experience and the opportunity to interact and learn.
Mr Kanishk Bhalla has been an integral part of my experience at the
Kotak Mahindra Bank. His constant support and his willingness to
share his knowledge on various practical and academic issues related
to the credit department has allowed me to finish the project.
My sincere gratitude goes to Mr Atul Bansal for assigning me the
project and advising me on various aspects of the project.
Mr Sumit Ahuja for his constant support and encouragement that
made my experience at Kotak Mahindra Bank Memorable.

3. Company Profile
THE BANKING HISTORY
Established in 1985, The Kotak Mahindra group has long been one of
India's most reputed financial organizations. In February 2006, Kotak
Mahindra Finance Ltd, the group's flagship company was given the
license to carry on banking business by the Reserve Bank of India
(RBI). This approval creates banking history since Kotak Mahindra
Finance Ltd. is the first company in India to convert to a bank.
The Complete Bank
At Kotak Mahindra Bank, we address the entire spectrum of financial
needs for individuals and corporate. We have the products, the
experience, the infrastructure and most importantly the
commitment to deliver pragmatic, end-to-end solutions that really
work.
* A license authorizing the bank to carry on banking business has
been obtained from the Reserve Bank of India in terms of Section 22
if the Banking Regulation Act, 1949. It must be distinctly understood,
however, that in issuing the license, the Reserve Bank of India does
not undertake any responsibility for the financial soundness of the

4. bank or the correctness of any of the statements made or opinion
expressed in this connection.
The Kotak Mahindra Group
Kotak Mahindra is one of India's leading financial conglomerates,
offering complete financial solutions that encompass every sphere of
life. From commercial banking, to stock broking, to mutual funds, to
life insurance, to investment banking, the group caters to the
financial needs of individuals and corporate.
The group has a net worth of over Rs. 3,200 crore, employs around
10,800 people in its various businesses and has a distribution
network of branches, franchisees, representative offices and satellite
offices across 300 cities and towns in India and offices in New York,
London, Dubai, Mauritius and Singapore. The Group services around
2.6 million customer accounts.

5. Analysis of Credit Worthiness in
Working Capital
WORKING CAPITAL - OVERALL VIEW
Working Capital management is the management of assets that are
current in nature. Current assets, by accounting definition are the
assets normally converted in to cash in a period of one year. Hence
working capital management can be considered as the management
of cash, market securities receivable, inventories and current
liabilities. In fact, the management of current assets is similar to that
of fixed assets the sense that is both in cases the firm analyses their
effect on its profitability and risk factors, hence they differ on three
major aspects:
1. In managing fixed assets, time is an important factor
discounting and compounding aspects of time play an
important role in capital budgeting and a minor part in the
management of current assets.
2. The large holdings of current assets, especially cash, may
strengthen the firm’s liquidity position, but is bound to reduce
profitability of the firm as ideal car yield nothing.
3. The level of fixed assets as well as current assets depends upon

6. the expected sales, but it is only current assets that add
fluctuation in the short run to a business.
To understand working capital better we should have basic
knowledge about the various aspects of working capital. To start
with, there are two concepts of working capital:
 Gross Working Capital
 Net working Capital
Gross Working Capital: Gross working capital, which is also simply
known as working capital, refers to the firm’s investment in current
assets: Another aspect of gross working capital points out the need
of arranging funds to finance the current assets. The gross working
capital concept focuses attention on two aspects of current assets
management, firstly optimum investment in current assets and
secondly in financing the current assets. These two aspects will help
in remaining away from the two danger points of excessive or
inadequate investment in current assets. Whenever a need of
working capital funds arises due to increase in level of business
activity or for any other reason the arrangement should be made
quickly, and similarly if some surpluses are available, they should not
be allowed to lie ideal but should be put to some effective use.

7. Net Working Capital: The term net working capital refers to the
difference between the current assets and current liabilities. Net
working capital can be positive as well as negative. Positive working
capital refers to the situation where current assets exceed current
liabilities and negative working capital refers to the situation where
current liabilities exceed current assets. The net working capital
helps in comparing the liquidity of the same firm over time. For
purposes of the working capital management, therefore Working
Capital can be said to measure the liquidity of the firm. In other
words, the goal of working capital management is to manage the
current assets and liabilities in such a way that a acceptable level of
net working capital is maintained.

8. Determinants of Working Capital
There is no specific method to determine working capital
requirement for a business. There are a number of factors affecting
the working capital requirement. These factors have different
importance in different businesses and at different times. So a
thorough analysis of all these factors should be made before trying
to estimate the amount of working capital needed. Some of the
different factors are mentioned here below:-
1. Nature of business: The nature and the working capital
requirements of an enterprise are interlinked. While a
manufacturing industry has a long cycle of operation of the
working capital, the same would be short in an enterprise
involved in providing services. The amount required also varies
as per the nature; an enterprise involved in production would
require more working capital than a service sector enterprise.
2. Size of business: It is another important factor in determining
the working capital requirements of a business. Size is usually
measured in terms of scale of operating cycle. The amount of
working capital needed is directly proportional to the scale of
operating cycle i.e. the larger the scale of operating cycle the

9. large will be the amount working capital and vice versa.
3. Market Condition: If there is high competition in the chosen
product category, then one shall need to offer sops like credit,
immediate delivery of goods etc. for which the working capital
requirement will be high. Otherwise, if there is no competition
or less competition in the market then the working capital
requirements will be low.
4. Operations: The requirement of working capital fluctuates for
seasonal business. The working capital needs of such
businesses may increase considerably during the busy season
and decrease during the slack season. Ice creams and cold
drinks have a great demand during summers, while in winters
the sales are negligible.
5. Firm’s Credit Policy: The credit policy of a firm affects working
capital by influencing the level of book debts. The credit term is
fairly constant in an industry but individuals also have their role
in framing their credit policy. A liberal credit policy will lead to
more amount being committed to working capital
requirements whereas a stern credit policy may decrease the
amount of working capital requirement appreciably but the
repercussions of the two are not simple. Hence a firm should
always frame a rational credit policy based on the credit
worthiness of the customer.
6. Availability of Raw Material: If raw material is readily available

10. then one need not maintain a large stock of the same, thereby
reducing the working capital investment in raw material stock.
On the other hand, if raw material is not readily available then
a large
7. Availability of Credit: The terms on which a company is able to
avail credit from its suppliers of goods and devices credit/also
affects the working capital requirement. If a company in a
position to get credit on liberal terms and in a short span of
time then it will be in a position to work with less amount of
working capital. Hence the amount of working capital needed
will depend upon the terms a firm is granted credit by its
creditors.
8. Growth and Expansion activities: The working capital needs of
a firm increases as it grows in term of sale or fixed assets. There
is no precise way to determine the relation between the
amount of sales and working capital requirement but one thing
is sure that an increase in sales never precedes the increase in
working capital but it is always the other way round. So in case
of growth or expansion the aspect of working capital needs to
be planned in advance.
9. Price Level Changes: Generally, rising price level requires a
higher investment in the working capital. With increasing
prices, the same level of current assets needs enhanced
investment.

11. The Products Of Working Capital
 Cash Credit/Overdraft
Cash Credit
A type of facility provided by the bank or financial institution in
which, a company can withdraw an amount more than what he holds
to his credit against the security of stock.
Overdraft
A facility, in which the bank permits the customer to debit his current
account below zero but only up to a specified limit. After a complete
research, a compilation of difference between cash credit and
overdraft is made considering various criterion.
 Working Capital Loan
A working capital loan is a loan that has the purpose of financing the
everyday operations of a company. Working capital loans are not
used to buy long-term assets or investments and are instead used to
cover accounts payable, wages, etc. Companies that have
high seasonality or cyclical sales cycles usually rely on working capital
loans to help with periods of reduced business activity.
The Benefits of a Working Capital Loan

12. The immediate benefit of a working capital loan is that it's quick and
lets business owners efficiently cover any gaps in working capital
expenditures. In addition to the speed, the other noticeable benefit
is that it's debt financing and does not require an equity transaction,
meaning that a business owner maintains full control of his company,
even if the financing need is dire.
Some working capital loans are unsecured. If this is the case, it
means that a company is not required to put down any collateral to
secure the loan. However, only companies or business owners with a
high credit rating are eligible for an unsecured loan. Businesses with
little to no credit have to securitize the loan.
Potential Drawbacks of a Working Capital Loan
A collateralized working capital loan that needs asset collateral can
be a drawback to the loan process. However, there are other
potential drawbacks to this type of working capital loan. Interest
rates are high to compensate the lending institution for risk. Further,
working capital loans are often tied to a business owner's personal
credit, and any missed payments or defaults will hurt his credit score.
 Letter of Credit (LC)
A letter of credit is a letter from a bank guaranteeing that a buyer's
payment to a seller will be received on time and for the correct

13. amount. In the event that the buyer is unable to make payment on
the purchase, the bank will be required to cover the full or remaining
amount of the purchase. Due to the nature of international dealings,
including factors such as distance, differing laws in each country, and
difficulty in knowing each party personally, the use of letters of credit
has become a very important aspect of international trade.
Types of Letters of Credit
A commercial letter of credit is a direct payment method in which the
issuing bank makes the payments to the beneficiary. In contrast, a
standby letter of credit is a secondary payment method in which the
bank pays the beneficiary only when the holder cannot.
A revolving letter of credit lets the customer make any number of
draws within a certain limit during a specific time period. A traveler’s
letter of credit guarantees the issuing banks will honor drafts made
at certain foreign banks.
A confirmed letter of credit involves a bank other than the issuing
bank guaranteeing the letter of credit. The second bank is the
confirming bank, typically the seller’s bank. The confirming bank
ensures payment under the letter of credit if the holder and the
issuing bank default. The issuing bank in international transactions
typically requests this arrangement.

14.  Bank Guarantee (BG)
This is a surety that is provided by a bank or a financial institution
that they will pay off the debts and liabilities incurred by an
individual or a business entity in case they are unable to do so.
This enables a business to grow and expand by deferring payment of
goods and services they are utilizing now to a later date. This helps a
business to invest on a larger scale than would have been possible
without the bank guarantee.
A financial institution can provide many different types of bank
guarantees. These include the following:
 Performance Guarantee (or Performance Bond) – these are
bonds that act as collateral for any loss suffered by the buyer
in case the performance of the seller is below par.
 Advance Payment Guarantee – this is to ensure the safety of
any advance payment made by the buyers to the seller. In
case the seller is unable to deliver the service or the goods,
then the buyer can get his money back.
 Payment Guarantee – this guarantee is provided to the seller,
ensuring payment by a predetermined date.

15.  Conditional Payment Undertaking – This is an instruction to
the bank from an account holder to pay a sum of money to a
creditor on completion of certain conditions. This bond is a
post contract instrument that is used to pay off agents and
contractor on completion of a project.
 Guarantee Securing Credit Line – This surety is given to a
creditor on claims against the debtor in case a loan is not
repaid as per the terms of the agreement.
 Order and Counter Guarantee – This is a surety given by the
debtor to the creditor, to protect against the failure to fulfill
an obligation as contracted. In case of default, the creditor can
demand the payment back.
 Packing Credit (PC)
Packing credit is basically a loan provided to exporters or sellers to
finance the goods’ procurement before shipment. The bank will
make the funds available to a letter of credit issued favoring the
seller and a confirmed order for selling the goods or services. The
advance is provided to purchase raw materials, process,
manufacture, pack, market and transport the required goods and
services.
 Post Shipment Finance

16. Post-shipment finance is a credit or advance given by the banks or
financial institution to exporter against the shipment that has already
been made but the realisation of export proceeds is still pending. The
credit period usually ranges between 30 days and 120 days Bill of
Lading (B/L) or Drawdown (DD).
Types of Post-Shipment Finance
 Export Bills purchased/discounted: Export (Non-LC) bills is
either discounted or purchased by the bank and the proper
limit is sanctioned to the exporter for purchase or discounted
of export bill.
 Export Bills negotiated: Export bills are negotiated when the
export documents are backed with LC. This is the most secure
mode of payment on exporter’s point of view as bank is bound
to pay if the documents are non-discrepant. However, from the
bank’s point of view, bank faces the risk of non-payment and
documentary risk.
 Advance against export bills sent on collection basis: Exporters
can also seek advance against export bills sent on collection
basis. Sometimes export documents drawn under LC are sent
on collection basis if the documents contain some
discrepancies.
 Advance against export on consignment basis: Bank may also
provide advance on export bills sent on consignment basis. This

17. means documents are sent on the risk of exporter for sale and
eventual payment of sale proceeds to him by the consignee.
 Advance against undrawn balance on exports: Sometimes, in
export, small parts are left undrawn for payment after
adjustment due to difference in rates, weight, quality etc.
Banks provide advances against undrawn balance as well
subject to the undrawn balance are maximum upto 10% of the
export value.
 Advance against claims of Duty Drawback: Duty Drawback is a
type of discount given to the exporter in his own country. This
discount is given only, if the inhouse cost of production is
higher in relation to international price. This type of financial
support helps the exporter to fight successfully in the
international markets. In such a situation, banks grants
advances to exporters at lower rate of interest for a maximum
period of 90 days. These are granted only if other types of
export finance are also extended to the exporter by the same
bank. After the shipment, the exporters lodge their claims,
supported by the relevant documents to the relevant
government authorities. These claims are processed and
eligible amount is disbursed after making sure that the bank is
authorized to receive the claim amount directly from the
concerned government authorities.

18.  Invoice Discounting
Invoice discounting can be technically defined as the selling of bill to
invoice discounting company before the due date of payment at a
value which is less than the invoice amount. The difference between
the bill amount and the amount paid is the fee of the invoice
discounting company. The fee will depend on the period left before
payment date and the perceived risk.
The bills or invoices under bill discounting are legally the ‘bill of
exchange’. A bill of exchange is a negotiable instrument which is
negotiable mere by endorsing the name. Our currency is a bill of
exchange for example. Currency provides value written over it to the
bearer of the instrument. In the case of bill discounting, such bills can
be either payable to the bearer or payable to order. Therefore, after
discounting a bill, a bank can further get the bill rediscounted from
other banks in case of cash flow requirements.

19. CONSEQUENCES OF UNDER ASSESSMENT OF
WORKING CAPITAL
 Growth may be stunted. It may become difficult for the
enterprise to undertake profitable projects due to non-
availability of working capital.
 Implementation of operating plans may become difficult and
consequently the profit goals may not be achieved.
 Cash crisis may emerge due to paucity of working funds.
 Optimum capacity utilisation of fixed assets may not be
achieved due to non-availability of the working capital.
 The business may fail to honour its commitment in time,
thereby adversely affecting its credibility. This situation may
lead to business closure.
 The business may be compelled to buy raw materials on credit
and sell finished goods on cash. In the process it may end up
with increasing cost of purchases and reducing selling prices by
offering discounts. Both these situations would affect
profitability adversely.
 Non-availability of stocks due to non-availability of funds may
result in production stoppage.

20.  While underassessment of working capital has disastrous
implications on business, over assessment of working capital
also has its own dangers.

21. CONSEQUENCES OF OVER ASSESSMENT OF
WORKING CAPITAL
 Excess of working capital may result in unnecessary
accumulation of inventories.
 It may lead to offer too liberal credit terms to buyers and very
poor recovery system and cash management.
 It may make management complacent leading to its
inefficiency.
 Over-investment in working capital makes capital less
productive and may reduce return on investment.

22. FINANCING WORKING CAPITAL
Supplier’s Credit
At times, business gets raw material on credit from the suppliers.
The cost of raw material is paid after some time, i.e. upon
completion of the credit period. Thus, without having an outflow of
cash the business is in a position to use raw material and continue
the activities. The credit given by the suppliers of raw materials is for
a short period and is considered current liabilities. These funds
should be used for creating current assets like stock of raw material,
work in process, finished goods, etc.
Bank Loan for Working Capital
This is a major source for raising short-term funds. Banks extend
loans to businesses to help them create necessary current assets so
as to achieve the required business level. The loans are available for
creating the following current assets:
Stock of Raw Materials
Stock of Work in Process
Stock of Finished Goods
Debtors

23. Banks give short-term loans against these assets, keeping some
security margin. The advances given by banks against current assets
are short-term in nature and banks have the right to ask for
immediate repayment if they consider doing so. Thus bank loans for
creation of current assets are also current liabilities.
Promoter’s Fund
It is advisable to finance a portion of current assets from the
promoter’s funds. They are long-term funds and, therefore do not
require immediate repayment. These funds increase the liquidity of
the business.

24. Appendix ‘A’
Working Capital Ratios-
1. Working capital ratio- It is the relative proportion of an
entity's current assets to its current liabilities, and is
intended to show the ability of a business to pay for its
current liabilities with its current assets.
2. Inventory conversion period- is the time required to
obtain materials for a product, manufacture it, and sell it.
The inventory conversion period is essentially the
time period during which a company must invest cash
while it converts materials into a sale. The calculation is:
Inventory. Cost of sales / 365
3. Debtor collection period- ratio is calculated by dividing
the amount owed by trade debtors by the annual sales on
credit and multiplying by 365.
4. Day’s payable outstanding- tells how long it takes a
company to pay its invoices from trade creditors, such as
suppliers. DPO is typically looked at either quarterly or
yearly.
5. Working capital cycle (WCC) is the amount of time it
takes to turn the net current assets and current liabilities
into cash. The longer the cycle is, the longer a business is

25. tying up capital in its working capital without earning a
return on it.

26. Appendix ‘B’
CRISIL (Credit Rating Information Services of India Limited) is a global
analytical company driven by its mission of making markets function
better.
It is India's foremost provider of ratings, data and research, analytics
and solutions, with a strong track record of growth and innovation.
CRISIL delivers independent opinions, actionable insights, policy
advisory and efficient solutions to over 100,000 customers across 86
industries. CRISIL's businesses operate from 8 countries including
USA, Argentina, Poland, UK, India, China, Hong Kong and Singapore.
CRISIL’s Revised Rating Symbols and Definitions:
Long-Term Debt Instruments
CRISIL
AAA
(Highest
Safety)
Instruments with this rating are considered to have the
highest degree of safety regarding timely servicing of
financial obligations. Such instruments carry lowest
credit risk.
Revised
Rating
symbol
Revised rating definition as stipulated by SEBI in its
Circular No. CIR/MIRSD/4/2011 dated June 15, 2011
CRISIL AA
(High
Instruments with this rating are considered to have high
degree of safety regarding timely servicing of financial

27. Safety) obligations. Such instruments carry very low credit risk.
CRISIL A
(Adequate
Safety)
Instruments with this rating are considered to have
adequate degree of safety regarding timely servicing of
financial obligations. Such instruments carry low credit
risk.
CRISIL BBB
(Moderate
Safety)
Instruments with this rating are considered to have
moderate degree of safety regarding timely servicing of
financial obligations. Such instruments carry moderate
credit risk.
CRISIL BB
(Moderate
Risk)
Instruments with this rating are considered to have
moderate risk of default regarding timely servicing of
financial obligations
CRISIL B
(High Risk)
Instruments with this rating are considered to have high
risk of default regarding timely servicing of financial
obligations.
CRISIL C
(Very High
Risk)
Instruments with this rating are considered to have very
high risk of default regarding timely servicing of financial
obligations.
CRISIL D
(Default)
Instruments with this rating are in default or are
expected to be in default soon.
Note : 1) CRISIL may apply '+' (plus) or '-' (minus) signs for
ratings from 'CRISIL AA' to 'CRISIL C' to reflect
comparative standing within the category. 2) CRISIL may

28. assign rating outlooks for ratings from 'CRISIL AAA' to
'CRISIL B'. Ratings on Rating Watch will not carry
outlooks. A rating outlook indicates the direction in
which a rating may move over a medium-term horizon
of one to two years. A rating outlook can be 'Positive',
'Stable', or 'Negative'. A 'Positive' or 'Negative' rating
outlook is not necessarily a precursor of a rating change.
3) A suffix of 'r' indicates investments carrying non-credit
risk. The 'r' suffix indicates that payments on the rated
instrument have significant risks other than credit risk.
The terms of the instrument specify that the payments
to investors will not be fixed, and could be linked to one
or more external variables such as commodity prices,
equity indices, or foreign exchange rates. This could
result in variability in payments, including possible
material loss of principal, because of adverse movement
in value of the external variables. The risk of such
adverse movement in price/value is not addressed by
the rating. 4) CRISIL may assign a rating of 'NM' (Not
Meaningful) to instruments that have factors present in
them, which render the outstanding rating meaningless.
These include reorganisation or liquidation of the issuer,
the obligation being under dispute in a court of law or

29. before a statutory authority.