CASE STUDY – ALAM MEDICO
Mr. Shiladitya Roy had recently taken over charge of a rural branch of a nationalised bank. Before the present posting, he was a field officer for a group of three adjoining branches in another district of the same state. He was happy to get full charge of a branch at a young age, and hence full of enthusiasm.
Within a few days of his taking charge, a person who identified himself as M Alam, proprietor of a small drug store approached him. He had made an application to the branch for a loan of Rs.5000 some time back. The previous manager was not willing to sanction it because many such small loans granted by the branch turned out to be bad debts. Mr. Alam said that he was not like others: he was an honest person, which the manager could easily verify from the market.
Mr. Roy found the person interesting. From the heap of pending papers, he fished out the one-page application of Mr. Alam in the bank's standard form, which is reproduced below:
Name and address
M/s Alam Medico
M. Alam, qualified pharmacist
Date of establishment
Amount of loan required
Marital status of the proprietor
Married with two children
(land, house, etc.)
Amount invested in business
Annual net profit
Rs.500 per month as part-time attendant at the Primary Health Centre.
Sources of supply
Wholesalers in the town, 20 kms. away.
Practice of sales
Mr. Aslam Chowdhury
Worth Rs 80000
(house and about 10 acres land )
Mr. Abhay Pandey
Worth Rs 75000
(house and about 7 acres land )
The next day, Mr. Roy visited the shop of Mr. Alam He found that it was situated opposite the Primary Health Centre (PHC). The proprietor had good relations with the doctor. In fact, while working as a part-time attendant at the PHC, he was encouraged by the doctor to set up this business. When he obtained his license as a pharmacist with the help of the doctor, he sold out his small piece of land and opened the shop with that money. He is still continuing with the PHC, and intends to do so in future also. The doctor was all praise for him.
There was no medicine shop nearby. The demand for medicines was good. But Mr. Alam explained that the turnover of his shop was low, because he could not keep adequate stock in his shop owing to lack of finance. Many bulk orders from the PHC had to be declined often owing to lack of finance.
The books of accounts available with the proprietor revealed that the information given in the application was more or less correct. While verifying the stocks, the bank manager observed that Mr. Alam was keeping cheaper varieties of medicines manufactured by not-so-well-known drug manufacturers, because the inhabitants of the village could not afford to pay for high-value medicines. The margin of profit in these types of medicines was high. On enquiry, the proprietor said that his price of medicines included transportation costs. He also told him that since the previous year he was having a young boy working in the shop who he paid Rs 125 per month. His other expense was Rs. 50 per month (mainly on tea).
On asking why he had applied for a loan of Rs.5000 only, Mr. Alam said diffidently that it was his fear that if he had applied for a larger amount, he would not get the loan at all. This had been the experience of others who had obtained loans from the branch in the past.
Having gathered and verified the relevant information, Mr. Roy came back to the branch and set himself to the task of making a real appraisal of the proposal. He did not agree with those fellow-managers who normally held that since the amount of loan asked for was small and well within their discretionary power, it could just be given without taking the trouble of assessing the proposal at all.
The needs of the borrower
The crucial question now was to determine the need of the prospective borrower. Mr. Roy knew from his experience as a field officer that the most important aspect of appraising the credit proposal of a person with small means was to first determine the personal need of the borrower. The need of the business must then flow from it. The approach must be quite different from that of appraising the proposal of a big business.
Mr. Alam's annual income from the business was Rs 21250, or Rs 1770 per month. Allowing for inaccuracy in accounting and being conservative, the monthly income could be taken as Rs 1500. Adding to this, his income of Rs 500 p.m. as an attendant at the PHC, the aggregate monthly income came to around Rs. 2000. The total members of his family were five, including his widowed mother, of whom three were adults, and one a school-going boy. Even assuming that the cost of living in a village was lower than it is in a town or city, it was difficult to maintain a family of this size with the bare minimum necessities of life at a monthly income of Rs 2000. But how could he maintain himself so long? And if he could do it in the past, then why could he not be able to do it in the future also? Yes, he did maintain himself in the past with such a meagre income, and he could also do it in the future, but he would continue to remain poor. A beggar also 'lives'; but it is no living, mere existence. If finance from a nationalised bank could not uplift him from his poverty level, there was no need for the bank to remain in the village. Mr. Roy firmly believed in this approach. Besides, he also believed that if a borrower were not given adequate finance to do a business that could earn for him an income sufficient to ensure a minimum livelihood, the loan itself would be wasted. The borrower would not be able to repay the loan, and the account would become bad. Before obtaining a bank loan, the poor man had been honest. The bank, by giving him a loan that was inadequate for the purpose, had put a burden on him that he could not carry. He succumbs to the pressure, defaults in repayment, and becomes dishonest.
Mr. Roy does not want to do this to Mr. Alam. So he estimates that Mr. Alam must have at least a net income of Rs 3000 per month from his business, which together with his salary of Rs 500 per month will ensure him a minimum decent living, considering the cost of living in the village. That is, his net aggregate income should not be below Rs 3500 p.m. But this is not all. He should also have another Rs. 750 p.m., partly as a saving to take care of contingencies, and partly for paying installments towards the repayment of a loan, if sanctioned by the bank.
Mr. Alam should, therefore, have Rs 3750 p.m. from the business, or Rs 45000 p.a. The gross income required should, therefore, be Rs 45000 + 2100 (wage and expenses on tea) = Rs. 47100, say Rs. 47000.
In 2006, Mr. Alam sold medicines for Rs.70300 against which his expenses were Rs 49050, leaving a profit of Rs 21250. The cost of goods sold was Rs 46950. Hence, the gross profit was Rs 70300 - Rs 46950 = Rs 23350. The return on sales (gross profit ratio), comes to about 33.33 %. Therefore, to ensure a gross return of Rs 47000, he must have sales of Rs 141000 (Rs. 47000 x100/33.33).
Next was the question of determining the investment required in stocks to ensure the required sales?
The following calculations reveal the movement of stocks of the business since its inception.
Aggregate annual expenditure
Less: other expenses
Cost of goods sold
Cost of goods available for sales
Less: cost of goods sold (as above)
Stock turnover ratio
1) Other expenses are tea, etc. @ Rs 50 p.m. and wages @ Rs 125 p.m. from 2006.
2) Stock turnover ratios are calculated on the cost of goods sold against year-end closing stock.
The level of closing stock held in the business when compared with the original amount of Rs 17500 invested by Mr. Alam indicates that he has not eaten away his capital. On the contrary, he might have brought in some small amounts here and there. (Out of the capital of Rs.17500, he must have spent about Rs 6000-7000 in furniture and fixtures for setting up his shop, with the remaining amount in stocks).
The stock turnover ratio is somewhat on the low side. Further, it has also fallen marginally in 2006. But considering that a medicine stores situated in a remote village has to keep a larger stock of a variety of medicines to service the demand of the patients and the PHC, the stock turnover ratio cannot be regarded as very low. Mr. Roy however, felt after discussion with the proprietor that the stock turnover could be increased to 3.5 by proper planning in stock holding and increasing the frequency of purchases, which, at present, is once a fortnight. He, however, decides to be conservative and take the expected stock turnover at 3.20.
The amount of investment required in the stock to ensure a sale of Rs 141000 can now be found out as below:
Cost of goods sold (for sales of Rs 141000)
Rs 94000 (Rs. 141000- Rs. 47000)
Expected stock turnover
Required stock holding
Rs 29375/, say Rs 30000 (Rs. 94000/3.20)
So, he may get a loan of Rs. 15000 from the bank, which he can repay in 3 years in equated monthly installment of Rs 500, inclusive of interest @ 12 per cent p.a.
Mr. Roy also calculated various alternative amounts of loan to see their impact on the improvement of the financial condition of the applicant. The following table narrates these alternatives.
Alternative Scenarios of Loan, Sales and Monthly Income
Alternative amount of loan
Probable incremental sales
Probable incremental profit per month
Repayment of loan per month (approx.)*
Net addition to income per month
Expected net monthly income from business**
*Equated monthly installment for 36 months @ 12% per annum.
**Col. 5 + existing income from the business of Rs.1500 p.m.
Note: Figures in brackets under column (2) denote total sales calculated with the base sales of Rs 70000 (approx.) in 2006
Looking at the table, Mr. Roy contemplates that alternatives (a) and (b) should be rejected, because these do not generate the targeted level of net monthly income of Rs 3000. The choice should be limited between alternatives (c) and (d). Personally, he prefers alternative (d), but that requires an aggregate sale of Rs 166,000 per annum. Although the proprietor says that he can increase his sales substantially if proper finance is made available, can he really make it? Alternative (c) requires annual sale of Rs 142,000. This appears to be more feasible. Here net income of Rs 3000 per month is meeting the targeted level.
Mr. Roy decides to meet the PHC doctor the next day to have an idea of the expected range and demand of medicines in the village. He would particularly examine the orders of the PHC that could not be executed by Mr. Alam the previous year for want of finance.
Case Study- Alam Medico , By: E.V.Murray