Appraising a Rice Mill: DSCR and Drawing Power
Mahendra Sahu runs a rice mill at Bargarh as a proprietorship. He seeks a cash credit limit of ₹25 lakh and a term loan of ₹40 lakh for a dryer. The branch's appraisal shows profit after tax of ₹9.60 lakh, depreciation of ₹6.40 lakh, interest on the proposed term loan of ₹4.80 lakh, and annual repayment of term loan instalments of ₹12.00 lakh. Closing stock is ₹48 lakh, sundry debtors ₹22 lakh and sundry creditors ₹6 lakh. The bank's norms allow 75% of stock and 60% of debtors as drawing power, after deducting creditors. The account with another bank was overdue by 45 days on two occasions in the last year, and the mill's stock statement shows that 30% of the stock is slow-moving. The branch manager must recommend the proposal with conditions, or reject it, giving reasons.
1. Calculate and interpret the Debt Service Coverage Ratio (DSCR) for the term loan.
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Formula: DSCR = (PAT + depreciation + interest on term loan) ÷ (interest on term loan + term loan instalments).
Computation:
- Numerator = 9.60 + 6.40 + 4.80 = ₹20.80 lakh
- Denominator = 4.80 + 12.00 = ₹16.80 lakh
- DSCR = 20.80 ÷ 16.80 = 1.24
Interpretation: for every ₹1 of debt service, the unit generates ₹1.24. That is a cushion of only 24% - below the 1.50–2.00 that banks normally want for a term loan, and below what is needed to absorb a bad procurement season or a delayed rice levy payment. The ratio is also computed on projected figures; the two 45-day overdues on the existing account show that cash flows have already slipped once.
Use in the decision: DSCR 1.24 does not by itself make the loan unviable, but it justifies a shorter risk appetite - a smaller term loan, a longer repayment tenor (which reduces the annual instalment and raises DSCR), a moratorium linked to the dryer's commissioning, and a higher margin. Simply accepting the proposal as submitted would be weak appraisal.
2. Compute the permissible drawing power and comment on whether the ₹25 lakh cash credit limit is fully covered.
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Step 1 - eligible current assets:
- Stock: 48.00 × 75% = ₹36.00 lakh
- Debtors: 22.00 × 60% = ₹13.20 lakh
- Gross DP = 49.20 lakh
- Less sundry creditors ₹6.00 lakh → DP = ₹43.20 lakh
So the ₹25 lakh limit is covered about 1.7 times.
Step 2 - test the quality of the stock. If 30% of stock is slow-moving, it should be excluded before applying the margin: 48.00 × 70% = 33.60; 33.60 × 75% = 25.20; plus 13.20 = 38.40; less 6.00 = ₹32.40 lakh. The limit is still covered, but the cushion shrinks sharply and the DP will fall if the slow-moving pile is not sold.
Conclusion: the limit is adequately secured by current assets, but the branch should (i) value stock net of the slow-moving portion, (ii) obtain stock and debtor statements monthly, (iii) stipulate a margin of 25% at all times and (iv) mark the account for closer monitoring. DP is a ceiling on drawings, not a sanction; a limit above DP would allow over-drawing.
3. Given the overdues and slow-moving stock, what should the branch manager recommend and on what conditions?
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Recommend conditional sanction, not outright rejection, but with the risk priced and the structure tightened.
Reasons: DSCR 1.24 is thin; two 45-day overdues place the account in SMA-1 territory (overdue 31–60 days), which is a conduct red flag, not yet an NPA. The unit is viable but weakly cushioned.
Conditions to impose:
- Reduce the term loan to about ₹30 lakh or extend the tenor so that DSCR moves towards 1.50; keep a moratorium of 3–6 months till the dryer is commissioned.
- Charge the stock and book debts by hypothecation, with a first charge, and obtain collateral (mortgage of the mill property) to cover the gap.
- Route all sale proceeds through an escrow/trust account with the branch; obtain monthly stock, debtor and creditor statements and inspect the godown quarterly.
- Fresh sanction only after the existing bank's dues are cleared and a no-dues/NOC is obtained; check CIBIL/CRILC status of the proprietor.
- Cap the cash credit at ₹25 lakh but restrict drawings to DP based on stock excluding slow-moving items; review the limit annually.
If the promoter refuses escrow or collateral, reject. Record the SMA history and the reasons in the appraisal note.