PROJECTED SALES AMOUNT – THE MOST IMPORTANT ITEM IN CMA DATA
The main job of a credit officer is to appraise the limits requirement of the company. As you may have experienced in your day to day work, companies tend to project a higher requirement than actually needed. This may be because they feel that if they apply for a limit of Rs. 5 crore, then atleast bank may sanction Rs. 3 crore incase there are some problems with the proposal. So even if the company actually needs Rs. 3 crore, it will prepare projected financials in such a way that they need Rs. 5 crore. Another reason could be the company plans to divert the funds to another activity such as sister firm or real estate, etc. Whatever be the reason, your job as a credit officer is to arrive at the reasonable quantum of credit requirement for the applicant company. To do this, you need to be aware of the common gimmicks companies employ to project a higher credit requirement.
Unless it is a very big company with a professional setup, the usual sequence of events when a company requires fresh limit or enhancement in limit will be as follows. Let us suppose that the company is presently availing working capital limit of Rs. 200 lakh. The proprietor or promoters now feel that they require Rs. 400 lakh. This is not based on any objective assessment. They usually do not undertake an assessment of the funds required. Instead, what happens usually is that they arrive at an estimate of the funds required based on various factors such as :
- is the present limit sufficient? Were we able to manage with the present limit last year? Were there instances in the last year where we felt that the limit was inadequate
- what are our growth plans for this year? How much turnover is expected to increase this year and to achieve that level of growth, how much funds do we require
- what is the attitude of the bank? Are the branch manager, Circle Office staff and Executives, Head Office Executives positive in their thinking? Based on our past experience with them, is it likely that they sanction the limit we apply or will they sanction only, say Rs. 300 lakh instead of the Rs. 400 lakh we require. In that case, let us apply for Rs. 500 lakh
- Our sister firm needs funds and the banker of the sister firm is not positive in sanctioning additional limit. We need to add that requirement also in the present proposal
- The real estate market is good this year. If we can divert some amount into real estate, we will get good returns
So based on reasoning such as above and business judgement, the promoter arrives at the likely funds requirement. Please remember that in most cases, this figure is arrived at based on pure judgement. There will be no assessment that is carried out. The promoter will think “last year we had working capital limit of Rs. 200 lakh and achieved turnover of Rs. 1200 lakh. This year I am planning to increase turnover to Rs. 2000 lakh, so I would require working capital limit of Rs. 400 lakh.” This is how he would think. It is just a judgement without actual assessment.
The promoter then directs his staff looking after Accounts and Finance to apply to the Bank for enhancement of the limit from Rs. 200 lakh to Rs. 400 lakh. So the staff already have the figure in hand. They do not need to work out the actual requirement. The reality might be that only Rs. 300 lakh is sufficient for reaching the targeted turnover but that is immaterial. The boss has given the figure of Rs. 400 lakh. what the finance people will now do is play around with the projected figures to arrive at funds requirement of Rs. 400 lakh. This is the most important point you have to be aware as a credit officer. When you receive CMA data and go through it, you should not study it as if it was some authoritative figure had prepared the projections. The figures are twisted to arrive the required amount. So you should be aware of what are the common gimmicks companies employ to arrive at the required funds amount.
The number one item that is manipulated in the above context is projected sales turnover. The subject and concepts in this regard cannot be mentioned here for lack of space. Please refer any good book on the subject of credit appraisal if you are interested in details. Here, I will briefly list the main points.
- Projected sales turnover is the single most important figure you need to watch out for. Let us assume for simplicity that your bank feels that 20% of the projected turnover is a reasonable way to arrive at the funds requirement of companies in this particular industry. So if the projected turnover is Rs. 500 lakh, the reasonable working capital limit required will be Rs. 100 lakh while for a company whose projected turnover is Rs. 1000 lakh, the reasonable limit is Rs. 200 lakh. So if the company we are taking as example wants to apply for limit of Rs. 400 lakh, it will simply project a turnover of Rs. 2000 lakh. If another company wants a limit of Rs. 800 lakh, it will project a turnover of Rs. 4000 lakh.
- When credit officers scrutinise the CMA data, many make the mistake of going straight to the MPBF assessment. There, they will check holding levels of raw material, work-in-process, finished goods, debtors, creditors and satisfy themselves that the holding levels are reasonable. Therefore they conclude that the applied limits are reasonable. This is a wrong approach.
- How do you judge whether the projected debtors figure is reasonable. Let us say the projected sales is Rs. 4800 lakh. The reasonable credit period offered by the companies in this industry to their customers is 45 days i.e. 1.5 months. So a reasonable figure for the projected debtors figure is (4800/12) x 1.5 = 600 lakh. But note that the credit officer does not scrutinise this Rs. 600 lakh figure. Instead, he judges the 1.5 months figure and feels it is a reasonable figure. Now, let us assume another scenario where the projected sales is Rs. 6000 lakh. In this case, for the same debtor period of 1.5 months, the projected debtors amount would be Rs. 750 lakh.
| Projected sales of Rs. 4800 lakh | Projected sales of Rs. 6000 lakh | |
| Debtors amount | 600 lakh | 750 lakh |
| Debtors in months of sales | 1.5 | 1.5 |
- As you may observe from the above table, if you focus on the holding level alone, you will miss the bigger picture. Now see the following table where we have provided figures for all current assets.
| Projected sales of Rs.4800 lakh | Projected sales of Rs.6000 lakh | |
| I. Current assets and liabilities (in Rs. lakh) : | ||
| Raw material inventory stock projected | 520.00 | 650.00 |
| Work-in-process inventory stock projected | 160.40 | 188.51 |
| Finished goods inventory stock projected | 478.21 | 555.98 |
| Stores and spares stock projected | 78.00 | 97.50 |
| Debtors amount projected | 400.00 | 500.00 |
| Creditors amount projected | 195.00 | 243.75 |
| II. Holding levels (in months): | ||
| Raw material stock in months of raw material consumption | 2.00 | 2.00 |
| Work-in-process stock in months of cost of production | 0.50 | 0.50 |
| Finished goods stock in months of cost of sales | 1.50 | 1.50 |
| Stores and spares stock in months of consumption | 3.00 | 3.00 |
| Debtors in months of sales | 1.00 | 1.00 |
| Creditors in months of purchases | 0.75 | 0.75 |
- The above table gives both amount figure and holding levels. If the credit officer focuses only on holding levels, he will find that both the above cases are reasonable. This is because the holding levels are exactly same in both the cases.
- However holding levels alone is misleading. Let us calculate the MPBF in both the above cases.
| Projected sales of Rs.4800 lakh | Projected sales of Rs.6000 lakh | |
| Current assets** (a) | 1641.61 | 1996.99 |
| Current liabilities** (b) | 206.00 | 243.75 |
| Working capital gap (a-b) = (c) | 1435.01 | 1753.24 |
| Minimum stipulated NWC (25% of current assets) (d) | 410.40 | 499.25 |
| Projected NWC (e) | 475.01 | 553.24 |
| c-d | 1024.61 | 1253.99 |
| c-e | 960.00 | 1200.00 |
| MPBF (lower of c-d and c-e) | 960.00 | 1200.00 |
** the figures of current assets and current liabilities are different from the totals in the first table due to other items
- So even though both the cases had exactly the same holding levels, the MPBF is different. This is because the projected sales is different in each case. The holding levels can always be made to appear reasonable by suitably increasing projected sales figure. In the above example, maybe the first case is true. The projected sales that can be achieved even if the company goes very aggressively is Rs. 4800 lakh. Accordingly, MPBF will be assessed at Rs. 960 lakh. But suppose that the company wants to apply for Rs. 1200 lakh. Then what it will do is project a higher sales figure i.e. Rs. 6000 lakh and accordingly arrive at funds requirement of Rs. 1200 lakh. This is the reason why the projected sales figure should be the first item you should see in the CMA data
- Always ask yourself : is the projected sales level achievable. You may use the following points as guides :
- what is the turnover last year? Is the projected turnover more than 10% to 15% growth. You can assume a projected growth of 10-15% as normal growth. But if it above that, say 20 or 25% or more, you need to get further details from the company as to how the projected sales will be achieved. Is there any expansion in capacity? Is the credit offered to customers proposed to be increased to attract them? How will the projected sales be achieved?
- see the trend of sales growth for last 3-5 years. You will get an idea of the average growth rate. The projected sales should be in line with this growth rate (unless there are other factors like increase in capacity etc.) If you are comfortable with the concept of CAGR (compounded annual growth rate), check out the 3 year or 5 year CAGR also
- are there months when sales peak. For example, a jewellery showroom will have sales peak during festival season of third quarter i.e. October – December. In such cases, it is better to sanction adhoc limit during such period instead of taking total sales for the year and assessing limit for the whole year
- Remember that sales value is equal to product of sale quantity and price per unit. So a sales value of Rs. 500 lakh may be due to proposed sale quantity of 50,000 units at assumed sale price of Rs. 1000/- per unit. You need to check this price assumption. Sometimes companies take higher sale price per unit in the assumptions thereby resulting in higher sale value. You can judge whether the sale price is really Rs. 1000/- or not. Maybe the prevailing price is only Rs. 800/- per unit. You can do this by making discreet enquiries with other borrowers engaged in same industry, trade journals, industry reports, Crisil analysis reports, etc.
So the next time you receive CMA data, make sure your attention goes first to the projected sales value!
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