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APROJECT REPORT
WorkingCapital
ManagementSUBMITTED BY:
Anand Bagri(MMS-Corporate Finance)
Submitted to :PROF. P.L.ARYA
THE DirectorN.L.DIMSR
UNIVERSITY OF MUMBAI(2008-2010)
NIRANJAN LAL DALMIA INSTITUTE OF MANAGEMENT
STUDIES AND REASERCH
MUMBAI- 401104
N.L. DALMIA INSTITUTE OF MANAGEMENT STUDIES AND RESEARCH
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SHRISHTI, SECTOR-1, MIRA ROAD (E)
ACKNOWLEDGEMENT
I take immense pleasure in submitting the project on
Working Capital Management .
As this project comes to an end, I would like to take the
opportunity to thank all those persons who supported me
directly or indirectly in this project.
I would like to thank project guide Prof. P.L. ARYA for the
support and guidance throughout the project.
Last but not the least I would like to thank all the students and staff
members of N.L. Dalmia Institute of Management Studies and Research
who helped me in my endeavor.
Anand Bagri
MMS (Corporate Finance)
N.L.Dalmia Institute of Management Studies and Research
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INDEX
Sr.No. Topic Page No.
1. Executive Summary 32. Objectives and Scope of the project 53. Working Capital 64. Management of Working Capital 85. Need for adequate Working Capital 106. Factors determining Working Capital 127.
Assessment of Working Capital 168. Working Capital Finance 209. Modes of Working Capital Finance 24
i. Cash Credit 25ii. Working Capital Demand Loan 29iii. Bill Discounting 31iv. Export Packing Credit 34v. Commercial Paper 40vi. Inter-Corporate Deposit 47vii.FCNR(B) Loans 50
10. Statement Of Working Capital 53
11. Inventory Management 55
12. Cash Management 6413. Receivables Management 73
14. Conclusion 79
15. Bibliography 80
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Executive summary
Working capital management refers to the administration of all aspectsof current assets, namely cash, marketable securities, debtors and stock
(inventories) and current liabilities. The financial manager must determine
levels and composition of current assets. He must see that right sources are
tapped to finance current assets, and that current liabilities are paid in time.
There are many aspects of working capital management, which
make it an important function of the financial manager:
Time : working capital management requires much of the financial
managers time. Investmen t: working capital represents a large portion of the total
investments in assets. Significance : working capital management has great significance
for all firms but it is very critical for small firms. Growth : the need for working capital is directly related to the
firms growth.
Investment in current assets represents a very significant portion of the total
investment in assets. Working capital management is critical for all firms. A
small firm may not have much investment in fixed assets, but it has to invest to
in current assets. Small firms in India face a severe problem of collecting their
debtors.
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It may, thus, be concluded that all precautions should be taken for the
effective and efficient management of working capital. The finance manager
should pay regular attention to the levels of current assets and the financing of
current assets.
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OBJECTIVES AND SCOPE OF THE PROJECT
Objectives of the Project:
To study working capital management process.
To study receivable management of the company.
To study the process of cash and inventory management.
Scope of the project:
The scope of the project includes elaborate discussion on:
Statement of working capital.
Inventory management
Cash management.
Debtors management.
The above-mentioned topics form the core part of working capital
management.
Limitations:
Not considered other current assets and their ratios, which form a part of
working capital like Stock of raw material, work in progress, outstanding
expenses, labor, etc as too many calculations may lead to confusion.
Methodology: Acquisition of primary and secondary data.Primary data: The first hand data obtained from the company
sources (E.g.; information about the company.
Secondary data: Annual reports, balance sheets, trial balance, etc.
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Working Capital
The objective of running any Company is to earn profits. A Company
will require funds to acquire Fixed Assets like Land, Building, Plant &
Machinery, Equipment, Tools, etc and also to run business viz, for its
day to day operations (working). Capital or Funds required for a
Company can therefore be bifurcated as Fixed Capital & Working
Capital.
Funds required for day to day working would be to finance production
and sales. For production, funds are needed for purchase of Raw
Materials / Stores / Fuel, for payment of Labour, Power Charges, etc, for
storing Finished Goods, and for financing the sales, by way of sundry
debtors / receivables.
Concept:
Working Capital is often defined as the excess of Current Assets over
Current Liabilities. Current Assets are those, that in the ordinary course
of business can be or will be converted into cash within one year (during
operating cycle of the industry). Current Liabilities are those liabilities
intended, at their inception, to be paid in the ordinary course of business
within a reasonably short time (normally one year) out of current assets or the income of the business.
The above definition of Working Capital, however, takes into account
only the funds available to the Company from long term sources like
capital and long-term borrowings. It does not represent the total funds
required by the Company towards Working Capital, to sustain its level
of operations. The excess of CA over CL is therefore, known in working
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parlance, as Net Working Capital (NWC) or Liquid Surplus (LS) and
represents that portion of the Working Capital, which has been provided
from the long-term sources.
N.L.Dalmia Institute of Management Studies & Research
LIABILITY ASSETS
DL
CL
C &R
CA
FA
M & NCA
ITA
L.S. (or) NWC
8
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Management of working capital
Management will use a combination of policies and techniques for the
management of working capital. These policies aim at managing the
current assets (generally cash and cash equivalents , inventories and
debtors ) and the short term financing, such that cash flows and returns are
acceptable. It simply refers to management of the working capital, or in
more precise terms, the management of current assets. A firms working
capital consist of its investment in current asset which include short term
asset such as cash and bank balance, inventories, receivables, andmarketable securities.
Cash management : Identify the cash balance which allows for the
business to meet day to day expenses, but reduces cash holding costs.
Inventory management: Identify the level of inventory which allows for uninterrupted production but reduces the investment in raw materials -
and minimizes reordering costs - and hence increases cash flow, supply
chain management ; Just In Time (JIT); Economic order quantity (EOQ);
Economic production quantity (EPQ).
Debtors management: Identify the appropriate credit policy , i.e. creditterms which will attract customers, such that any impact on cash flows
and the cash conversion cycle will be offset by increased revenue and
hence Return on Capital (or vice versa ); Discounts and allowances .
Short term financing: Identify the appropriate source of financing, given
the cash conversion cycle: the inventory is ideally financed by credit
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http://en.wikipedia.org/wiki/Asset#Current_assetshttp://en.wikipedia.org/wiki/Cashhttp://en.wikipedia.org/wiki/Cash_and_cash_equivalentshttp://en.wikipedia.org/wiki/Inventoryhttp://en.wikipedia.org/wiki/Debtorhttp://en.wikipedia.org/wiki/Cash_managementhttp://en.wikipedia.org/wiki/Just_In_Timehttp://en.wikipedia.org/wiki/Economic_order_quantityhttp://en.wikipedia.org/wiki/Economic_production_quantityhttp://en.wikipedia.org/wiki/Credit_(finance)http://en.wikipedia.org/wiki/List_of_Latin_phrases#Vhttp://en.wikipedia.org/wiki/Discounts_and_allowanceshttp://en.wikipedia.org/wiki/Asset#Current_assetshttp://en.wikipedia.org/wiki/Cashhttp://en.wikipedia.org/wiki/Cash_and_cash_equivalentshttp://en.wikipedia.org/wiki/Inventoryhttp://en.wikipedia.org/wiki/Debtorhttp://en.wikipedia.org/wiki/Cash_managementhttp://en.wikipedia.org/wiki/Just_In_Timehttp://en.wikipedia.org/wiki/Economic_order_quantityhttp://en.wikipedia.org/wiki/Economic_production_quantityhttp://en.wikipedia.org/wiki/Credit_(finance)http://en.wikipedia.org/wiki/List_of_Latin_phrases#Vhttp://en.wikipedia.org/wiki/Discounts_and_allowances8/4/2019 Anand Bagri
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granted by the supplier; however, it may be necessary to utilize a bank
loan (or overdraft), or to "convert debtors to cash" through " factoring ".
The term working capital may be used in two different ways:
1. Gross working capital: The gross working capital refers to the
firms investment in all current assets taken together.
2. Net working capital: The term net working capital may be defined
as the excess of total current assets over total current liabilities.
A firm should maintain an optimum level of gross working capital. This
will help avoiding the unnecessarily stoppage of work or liquidation due
to insufficient working capital. Effect on profitability because over
flowing working capital implies cost. Therefore, a firm should have just
adequate level of total current assets. The gross working capital alsogives an idea of total funds required for maintaining current assets.
On other hand, net working capital refers to amount of funds that must be
invested by the firm, more or less regularly in current assets. The net
working capital also denotes the net liquidity being maintained by the
firm. This also gives an idea of buffer available to the current liability.
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Need for adequate working capital
Every firm must maintain a sound working capital position otherwise; its
business activities may be adversely affected.
The excess working capital , i.e. when the investment in working capital
is more than the required level, it may result in unnecessary accumulation
of inventories resulting in waste, theft, damage etc. Delay in collection of
receivables resulting in more liberal credit terms to customers than
warranted by the market conditions. Adverse influence on the performance of the management.
On the other hand, inadequate working capital is not good for the firm.
It may result in the following:
The fixed asset may not be optimally used.Firm growth may stagnate.
Interruptions in production schedule may occur ultimately resulting
in lowering of the profit of the firm.
The firm may not be able to take benefit of an opportunity.
Firm goodwill in the market is affected if it is not in a position to
meet its liabilities on time.
Working Capital Needs:
A business need for working capital can come as a result of several
reasons that include the following:
Increasing sales growth or seasonal growth.
Customers paying slower.
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Need to increase inventory to support sales growth and/or adding
product lines.
Desire to take discounts on purchases from vendors.
Recent operating losses have reduced your cash reserves.
Increased expenses due to additional marketing efforts, new
employees, office relocation, etc.
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Factors determining working capital requirement
Though there is no set of universally applicable rules to ascertain working
capital needs, the following factors may be considered:
Nature of business:
The Working capital requirement depends upon the nature of business
carried on by the organization. In a manufacturing firm the requirement is
generally high, but it also depends on the type and nature of the product.The proportion of current asset to total assets measures the relative
requirements of working capital of various industries.
Manufacturing cycle:
Time span required for the conversion of raw materials into finished
goods is a block period. The period in reality extends a little before andafter the work-in-progress. The manufacturing cycle and the fund
requirements vary in direct proportion. The funds blocked in
manufacturing cycle vary from industry to industry. Further, even within
the same group of industries, the operating cycle may be different due to
technological considerations.
Business cycle:
Business fluctuations lead to cyclical and seasonal changes, which, in
turn, cause a shift in working capital position particularly for working
capital requirement. The variations in business conditions may be in two
directions: Upward phase when boom conditions prevail, and
Downswing phase when economic activity is marked by a decline.
During the upswing of business activity, the need for working capital is
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likely to grow and during the downswing phase the working capital
requirement is likely to be less. The decline in economy is associated
with a fall in the volume of sales, which, in turn, leads to a fall in the
level of inventories and book debts.
Seasonal variation:
Variation apart, seasonally factor creates production or even shortage
problem. This is the reason as to why manufacturing concerns producing
seasonal products purchase their raw material throughout the year and
carry on the manufacturing activity. For example woolen garments have ademand during winter. But the manufacturing operation for the same has
to be conducted during the whole year resulting in working capital
blockage during off-season.
Production policy:
While working capital requirements vary because of seasonal factors, theimpact can be minimized by suitably gearing the production schedule.
There are two choices- either the production is periodically adjusted to
meet the seasonal requirements or a steady level of production is
maintained throughout, consequently allowing the inventories to build up
in the off-season.
Scale of operations:
Operational level determines the working capital demand during a
particular period. Higher the scale, higher will be the need for working
capital. However, pace of sales turnover is another factor. Quick turnover
calls for lesser investment for inventory while low turnover rate
necessitates larger investments.
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Credit policy :
The credit policy influences the requirement of working capital in two
ways:
Through credit terms granted by the firm to its
customers/buyers of goods.
Credit terms available to the firm from its creditors.
Growth and expansion:
It is, of course difficult to determine precisely the relationship between
the growth and volume of business and the increase in working capital.
The composition of working capital also shifts with economic
circumstances and corporate practices. However, it is to be noted that the
need for increased working capital funds does not follow the growth in
business activity but precedes it.
Dividend policy:The payment of dividend consumes cash resources and, thereby, effects
working capital to that extent. However, if the firm does not pay dividend
but retains the profit, working capital increases. There are wide variations
in industry practices as regards the inter relationship between working
capital requirement and dividend payment. In some cases, shortage of
working capital is sometimes a powerful reason for reducing or evenskipping dividends in cash (resolved by payment of bonus shares).
Depreciation policy:
There is an indirect effect of depreciation policy on working capital.
Enhanced rates of depreciation lower the profits and tax liability and,
thus, more cash profits. Higher depreciation means lower disposable profits and a smaller dividend payment. Thus cash is preserved. If the
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current capital expenditure falls short of the depreciation provision, the
working capital position is strengthened and there may be no need for
short-term borrowing. If the current capital expenditure exceeds the
depreciation provision, either outside borrowing will have to be resorted
to or a restriction on dividend payment coupled with retention of profits
will have to be adopted to prevent working capital position from being
adversely affected.
Price level changes:
Rising prices necessitate the use of more funds for maintaining anexisting level of activity. However, the implications of rising price levels
on working capital position may vary from company to company
depending on the nature of its operation, its standing in the market and
other relevant considerations.
Operating efficiency:The efficient utilization of resources by eliminating waste, improved
coordination and full utilization of existing resources would increase the
operating efficiency. Efficiency of operations accelerates the pace of cash
cycle and improves the working capital turnover. It releases the pressure
on working capital by improving profitability and improving the internal
generation of funds.
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Assessment of Working Capital
Funds required to carry the required levels of current assets, to enable the
Company to carry on its operations at the expected levels uninterruptedly,
are the Working Capital Requirements. Therefore Working Capital
Requirement (WCR) is proportional to:
a. The volume of activity (i.e. level of operation )
b. The type of business carried on viz. manufacturing
process, production programme.
Though there are various methods for assessing the quantum of WCR for
an industry, the following three are commonly known and used.
1) Operating Cycle Method (for W/C limits upto
Rs.25000)
2) Usual or Traditional Method (for W/C limit upto
Rs.10 lacs)
3) Using Tandon & Chore Committee Norms (for W/C limitabove Rs.10 lacs)
1. Operating Cycle Method:
Any manufacturing activity is characterized by a cycle of operations
consisting of purchase of raw materials for cash, converting these into
FGs and realising cash by sale of these finished goods.
The cycle consists of:1) Time taken to acquire RMs &
Ave. period for which they are in
stores.
2) Conversion process time.
3) Ave. period for which finished
goods are in stores.
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O.C.
CASH
S.Dr.
F.G.
RM
SIM/WIP
17
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4) Ave. collection period of
receivable (Sundry Debtors) operating cycle is also called cash to cash
cycle & indicates how cash is converted into RM, WIP, FG & Bill
receivables and finally cash.
If length of operating cycle is, say 120 days. Then it means 365 / 120 = 3
cycles of operations in a year. This means each rupee of WCR employed
in the unit is turned over 3 times in a year. This is also known as Working
Capital Turnover Ratio.
WCR =Operating Expenses
No. of Cycles per annum
Factors, which influence WCR, are:
1) Level of operating Expense &
2) Length of operating Cycle.
2. Usual (Traditional) Method of Assessment of WCR:
The operating cycle concept serves to identify the areas requiring
improvement for the purpose of control and performance review. But
bankers require a more detailed analysis to assess the various components
of WCR viz. finance for stocks, bills, etc. Hence usual method is
different.
Bankers provide working capital finance for holding an acceptable level
of Current Assets, viz. RM, SIP, FG, and SDrs for achieving a pre-
determined level of production and sales.
Quantification of these funds, required to be blocked, in each of these
items of CA at any time is as follows:
1) R.M. requirement is generally
expressed as so many months requirement (consumption).
2) W.I.P. a rough & ready formula
for computing the requirement of funds is to find the Cost of
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Production for the period of processing. viz.( RM consumed /
month + Expenses / month) * period of processing in months.
3) F.G. the requirement of funds
against FG is expressed as so many months cost of production.
4) Sundry Debtors: WCR against
Sundry Debtors will be computed on the basis of Cost of
Production (where as the Permissible Bank Finance will be on
the basis of the sale value)
WCR is normally expressed as so many months of Cost of
Production (CoP).Working Capital of any industry can thus be summerised as:
RM Months Requirement Rs . A
WIP Weeks (CoP) Rs. B
FG Months (CoP) to be stocked Rs. C
SDrs Months (CoP) outstanding Credit Rs. D
Expenses One Month Rs. E Less: Credit received on purchases Rs. F
Less: Advance payment on received Rs. G
WCR (Rs. H ) = (A+B+C+D+E)-(F+G)
The purpose of assessing the Working Capital Requirement of the
company is to determine how the total requirement of funds will be met.
The two resources are: 1) Long term Borrowing and Capital2) Short term Bank Borrowing.
3. Method using Tandon / Chore Committee Norms:
The Reserve Bank of India constituted study groups in 1974 and 1979
viz. Tandon Committee and Chore Committee to frame suitable
guidelines for Working Capital Finance. The recommendations of
Tandon / Chore Committee relate to:
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Norms for Inventory and Receivables
a. Approach to Lending
b. Follow-up, Supervision & Control of Advances
The Tandon Committee prescribed definitive norms as to the reasonable
level of inventory and the receivables the unit should carry and the extent
to which the total Current Assets are supported by long-term funds.
The lending norms comprise of three methods as under:
1st method : The quantum of the banks short-term advances
will be restricted to 75% of the Working Capital gap; remaining25% is to be met from NWC.
2nd method : NWC should be atleast be equal to 25% of the
total value of acceptable current assets. The remaining 75% should
first be financed by other CL and then the banker may finance the
balance of the requirement.
3 rd method : Borrower should provide for entire core CA and
25% of the CA over the core CA. RBI has not implemented this
method.
All the units with Fund Based Working Capital limits of Rs.50 lacs and
over should be straightaway placed under 2 nd method of lending.
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Working Capital Finance
Banks normally provide Working Capital Finance by way of advances
against stocks and sundry debtors. Banks do not finance the full amount
of the funds required for carrying inventories and receivables. Bank
finance is normally restricted to the amount of funds locked up less a
certain percentage of margins. Margins are imposed with a view to have
adequate stake of the promoter in the business both to ensure his adequate
interest in the business and to act as a bulwark against any shocks that the
business may sustain. The margins stipulated will depend on various
factors like saleability, whether imported or indigenous, quality
durability, price fluctuations in the market for commodity. Taking into
account the total WCR as assessed earlier, the permissible limit upto,
which the bank finance can be granted, is arrived at as shown below:
Permissible Limit
Raw Materials Rs.
Less: % margin Rs.
_____________
___________________ P
Stocks-in-Process Rs.
Less: % margin Rs.
_____________ ___________________ Q
Finished Goods Rs.
Less: % margin Rs.
_____________
___________________ R
Sundry Debtors Rs.
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Less: % margin Rs.
_____________
___________________ S
Total Permissible Limit ( P+Q+R+S )
___________________ T
(P+Q+R ) indicates the total limit against stocks and S indicates the limit
against sundry debtors. The difference between the working capital
requirement ( H ) and the total permissible bank borrowing ( T ) is the
Long-Term Working Capital and should be met from the Net Working
Capital. When the NWC is not sufficient to meet the Long Term WCRs,there will be a deficit in the WCR. It will be necessary for the Company
to either arrange to meet the funds from borrowings or arrange for more
Short-Term funds from bank, by reduction in margins temporarily or
granting separate advances to be repaid out of the units future profits.
The Computation of Bank finance is facilitated by the new set of formsintroduced by RBI commonly known as CMA format. The format
provides, a fund of information/data to the Banker in respect of the past,
present and future financial position of borrower. Complete and prompt
submission of data by the borrower is a sine-qua non for speedy credit
decisions by Banks.
CMA Format:
For appraising the Working Capital requirement the borrower has to
submit the financial data to the Bank in the prescribed format. This is
known as the CMA format (Credit Monitoring Arrangement).
There are total six forms to be filled up according to the CMA format.
These forms give the following details:
FORM I:
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Computation of Maximum Permissible Bank Finance for Working
Capital Requirement for 3 years. Audited figs. for the last year,
estimated figs. for the current year & projected figs. for the next year.
Other than sick/weak units, the computation is done as per II nd method
of lending.
In case of I st method of lending specific reasons thereof are furnished.
FORM VI:
Details of funds flow statement for 3 years. Audited figs. for the last
year and projected figs. for the current and the next year.
In case increase in inventory, decrease in CL or WC gap is
disproportionate with % change in sales, the same is given in details
separately.
Along with the above forms a statement of Analytical and Comparative
Ratios is also submitted. These data are also for 3 years as mentioned
above. The various ratios include current ratio, Debt/Equity ratio, Bank borrowing/Total outside liabilities, net sales/Total tangible assets,etc.
Also stock of raw material in terms of No. of months consumption, WIP
in terms of No. of months cost of production, FG in terms of No. of
months cost of sales, Sundry debtors in terms of No. of months sales are
also given.
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Modes of Working Capital Finance
The bank can provide the Working Capital Finances in different ways.Basically these are of two types: a) Fund Based Working Capital Finance
and b) Non Fund based Working Capital Finance.
The scope of this project is restricted to the Fund Based Finance only.
The Fund Based Finances can be availed in many ways. Different
facilities and instruments are made available to the borrower to avail the
finances. In the following pages an attempt has been made to explainsome of them in brief. These are as follows:
Cash Credit
1. Working Capital demand Loan
2. Bill Discounting
3. Export Packing Credit
4. Commercial Paper
5. Inter-Corporate Deposit
6. FCNR(B) Loans
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Cash Credit
Cash Credit is the part of fund based facility given by the Bank to the
company. With this the company, which is the customer to the bank, can
draw amounts upto pre-defined limits specified by the bank. The
company can use this money to fulfill its every day working capital
needs. As and when the company receives the sales proceeds, it can
deposit the same to its cash credit account with the Bank. These
payments can be in parts or in full depending upon the sales receipts. The
company can issue cheques to its suppliers as well as deposit the
cheques given by its customers. This form of advance is highly attractive
from the borrowers point of view because while the borrower has the
freedom of drawing the amount in installments as and when required,
interest is payable only on the amount actually outstanding.
Availment of Cash Credit Facility:
For availing the cash credit facility, the company or the borrower has to
make an application to the consortium of banks or a particular bank as the
case may be. The application should be accompanied with the financial
statement for the current year (estimated figs) and projected figs for the
next year. Along with this one copy of audited financial statement of the
last year is also to be submitted. These will also give the working capitalneeds of the company. These statements should be given in the proper
CMA format only.
Where there is consortium, the lead bank shall do the assessment of credit
requirement. It is based on the following parameters:
1. Past performance as evidenced by audited Financial Statement.
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2. Present performance indicated by current statement of stocks, sales,
proforma, Balance sheet, etc.
3. Future performance indicated by projected Balance Sheet, Cash flow,
etc.
Where there is no consortium the concerned bank does the assessment
and sanctions the credit limits.
Once the facility is made available to the company or the borrower, then
the borrower can draw as much as needed and as and when needed, to the
extent that the amounts outstanding in the account does not cross theDrawing Power limits specified / sanctioned to it. There is no restriction
on the amount of transactions, involving deposits and withdrawals, which
can be done during a day.
Drawing Power limits:
The Drawing Power for the company is calculated on the monthly basis.It is changes every month. The companys utilization of working capital
limits can not cross the Drawing Power limits. These limits can be equal
to or less than the total sanctioned limits for a particular year. But it can
not be more than that.
The Drawing Power is calculated on the basis of the stocks and debtors of
the company, for the previous month. The borrower has to submit astatement, giving the stock and debtor position, at the end of every
month. These are hypothecated with the bank against which the bank
provides the credit. The stock includes Raw Materials, intermediate
stocks and Finished Goods. To compute the Drawing Power, 75% of total
stocks (reduced by amount payable for Letter of Credit creditors) and
60% of debtors outstanding for a period of less than six months are
considered. Then Drawing Power is divided, on prorata basis, among all
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the banks in the consortium. It may happen that the amount, so calculated
above, will exceed the total sanctioned limits for the company. In such
cases, the sanctioned limits will be the ceiling for the Drawing Power.
Hence in any case the Drawing Power can not exceed the sanctioned
limits.
Further more, if the borrower is enjoying, Bill Discounting, EPC or
WCDL facilities, then the Drawing Power will be blocked by that amount
for the period till such facilities are enjoyed. Generally all banks divide
the Drawing Power limit into two parts. 50% each for Cash Credit and
WCDL.
Interest rate:
The borrower has to pay the interest on the limit utilisation at the day end
and not on the entire amount of sanctioned limit. This is where the cash
credit account comes in very handy for the borrower, as he has to pay the
interest only for the amount he has utilised.The interest rate is negotiable. It depends upon the borrower and the
bank, which is giving the facility. The interest is calculated on daily basis,
but charged to the account on a monthly basis. The closing balance, for
the day, is liable for the interest charges.
The borrower will not be paid any interest if he has any surplus amount in
his account. A minimum charge may be payable, irrespective of the levelof borrowing, for availing this facility. This is to make sure that the bank
is not at a loss.
Duration of the facility:
Normally such facilities are given for a period of one year. After one year
the bank does the review. This is to find out, upto what extent the
borrower is using the facility given to him. Is he making the maximum
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possible use of the facility provided? Depending on the review, the bank
may lower the sanctioned limits. If every thing is in place then the
agreement is automatically renewed for the next year.
Changes in the sanctioned limits for the subsequent Year:
For every subsequent Year, the company or the borrower has to submit to
the bank the CMA data, as mentioned earlier, in the proper CMA format
giving the details. The details contain the estimated financial statements
for the subsequent Year and projected financial statements for the next
year henceforth. These details will also give the working capitalrequirement for the subsequent Year. Then the bank will renew the terms,
for giving the Cash Credit / Overdraft facility. If there is any
increase/decrease in the working capital requirement, then accordingly,
the changes are made to the sanctioned limits.
If, in the review of the current year, the bank finds that the borrower is
not using the facility then the bank may even refuse to renew the facility,in the subsequent Year. Depending on the financial position of the
borrower the bank can even increase / decrease the interest rate.
In case of consortium of banks, as said earlier, the lead bank decides on
the cash credit limit for the borrower or the company. Then this limit is
divided among number banks, in the consortium, depending upon their capacity to give the facility.
Hence, the borrower can have cash credit account with different banks.
But while doing this, it is made sure that the total limit, taken together, is
within the sanctioned limits.
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Working Capital Demand Loan
Working Capital Demand Loan (WCDL) is also a fund-based facility
given by the bank to the company. These loans are linked with the cash
credit account of the company with the bank. They are given at the same
interest rate as that of the cash credit account. The loans are supported by
a demand promissory note executed by the borrower. There is often a
possibility of renewing the loan.
Availment of Working Capital Demand Loan:
This facility comes with the cash credit facility. These loans are available
on demand and hence are called Working Capital Demand Loans. For
getting the loan the company or the borrower has to apply for it. This
application has to be made 2 to 3 days in advance. This application
doesnt, normally, involve a lengthy procedure. A mere request, for the
same, is enough for getting the loan, provided sanction is available.
As explained earlier, the Drawing Power of the borrower is divided
between Cash Credit and WCDL equally, if the borrower enjoys no other
facility. But if the borrower is enjoying other facilities, like Bill
Discounting and EPC, then he can request to the bank to block the
WCDL facility for the said facilities. The borrower then can not get the
WCDL, if the Drawing Power, against WCDL, is exhausted due to theavailment of the said facilities. When the amounts, raised against these
facilities, are fully repaid, then the blocked part is released and the
borrower can get the WCDL to its full extent.
For example,
If the Drawing Power limit of a company for a month is, say Rs.100
Crores. Then Company can avail WCDL of Rs.50 Crores. Now, if the
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company avails an EPC of say Rs. 40 Crores and requests the bank to
block its WCDL facility for that much amount, then the company can get
WCDL upto Rs. 10 Crores only. And can only enjoy the entire WCDL
limit only when it repays the EPC.
Duration of the loan:
The WCDLs are given for some minimum period. This period varies
from bank to bank and for customer to customer. It can be negotiated.
Generally this period varies between 15 days to one month. One can not
repay the loan before this period, even if he is capable of paying.
Interest rate and method of payment:
As mentioned earlier, the interest rate is same as it is for the Cash Credit.
Only difference is in calculating and charging the interest. Here the
interest is to be paid on the month end or on repayment of WCDL
whichever is earlier. The interest is calculated on the entire loan amount,for the period for which the loan was used. Interest, from the date on
which the loan was given to the end of that month, is charged at the end
of that month. The balance interest is charged on the end of the next
month. The payment of the principal amount can be made on any date
after the minimum period is over. As mentioned above the principal can
not be repaid before this period. If one pays before this period then hewill be penalised for that. In this case he has pay additional 2% interest
over and above the agreed interest rate for the period the loan is used. In
most cases, these loans are renewed.
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Bill Discounting
Bill discounting is one of the facilities for supporting the working capital
requirements.
In bill discounting facility generally three parties are involved, which are
the drawer (seller), drawee (buyer), and the bank.
The seller sells the products to the customer and raises an invoice against
it. Then on the basis of this invoice, the seller will make a Bill of
Exchange. The B/E contains the details like the invoice date, name of the
bank to whom the payment has to be made, the due date of payment and
the amount to be paid. The B/E and the invoice are send to the buyer for
his acceptance. After the acceptance by the buyer, the same are returned
to the drawer.
The drawer then submits the invoice and the B/E, along with the covering
letter, to the bank. The bank, after receiving these documents, credits the
B/E amount, less the discount charges (i.e. interest), immediately to the
drawers account. The entire procedure takes 3 to 4 days.
The drawee shall make the payment of the B/E amount to the bank on the
due date.
If the drawee fails to make the payment on the due date then the bank
takes the necessary action, according to the terms and conditions
mentioned in the Bill Discounting Agreement/Sanction Letter. The bank,in this case may, register a protest, for the dishonor of the bill, with a
notary public. On the dishonor of the bill, the bank intimates the drawer
of the bill, about the fact of dishonor, and requests the drawer to make the
payment on the bill with the additional interest on the delayed payment
and other expenses that the bank has incurred for the recovery of the bill
amount.
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Discounting Rate:
The discounting rates differ from bank to bank and from customer to
customer. It mainly depends upon the credit rating of the borrower,
drawee of the bill (B/E drawn on reputed drawees attract lower rate of
interests), tenure of the bill and also whether the bill is with recourse or
without recourse. Hence the discount rates are negotiated. The discount
rate varies between 9.25 to 10.5%. The bank generally gives the discount
rate 1 to 2%below their PLR.
Bill discounting is cheaper as compared to cash credit and working
capital demand loan.
Bill Discounting Agreement:
At the request of the company the bank has granted the company bill
discounting facility by way of discounting of sales bills raised by the
company on customers, with certain overall limit (termed as the
facility) on terms and conditions mutually agreed.
On presentation of the documents the bank shall discount the
documents for an amount equivalent to 100% of the value of the bill
and pay to the company/credit to the companys account with the bank
the discounted value of the bill. Provided that the bank may at its
entire discretion refuse to entertain the companys request to discount
any bill, without being obliged to assign any reason therefore. Each bill presented to the bank for discounting shall be made payable
not later than 90days from the date of the bill and shall have been duly
accepted by the customer and endorsed in favour of the bank
In respect of each bill discounted by the bank the company shall be
liable to pay to the bank the interest at the rate specified by the bank in
its sole discretion from time to time from the date on which the bill
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has been discounted upon the date on which the payment is received
from the customer.
On maturity of the discounted bill the bank shall cause the said bill to
be presented to the customer for payment.
In the event of any of the bill drawn on any customer remaining over
due for more than 15 days the bank may at its entire discretion
discontinue discounting of any bills drawn on such customer until the
overdue payment is fully regularised. Even after such regularisation
the bank may delete the name of such customer from the schedule and
refuse to discount bills drawn on such customers. In the event of any of the discounted bill remaining unpaid for a
period of the 30 days from the due date the bank shall be entitled to
initiate proceedings against the defaulting customer and all cost,
charges and expenses incurred by the bank for recovery of such
outstanding bill amount shall be to the account of the company.
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Export Packing Credit
Exports:
Exports have come to be regarded as an engine of economic growth in thewake of liberalization and structural reforms in the economy. A sustained
growth in exports is, however, not possible in the absence of proper and
adequate infrastructure, as adequate and reliable infrastructure is essential
to facilitate unhindered production, cut down the cost of production and
make our exports internationally competitive.
Various export-financing facilities are available with the exporters.Export Packing Credit is one of them.
The banks give Export Packing Credit (EPC) to the exporter for
encouraging the exports and allow more foreign currency to come into
the country. These are of two types:
1. Pre-shipment Export Packing Credit
Post-shipment Export Packing Credit
The Export Packing Credit can be availed in both Indian Currency as well
as in Foreign Currency.
Pre-Shipment EPC:
Pre-shipment EPC is extended prior to shipment for the purchase of raw
materials, processing, packing, transportation, warehousing, etc of goods
meant for exports. Pre-shipment EPC is extended in both Indian Currency
as well as Foreign Currency. Pre-shipment Rupee Credit is extended to
finance temporary funding requirement of export contracts. This facility
enables provision of rupee mobilisation expenses for construction/
turnkey projects. Exporters could also avail of pre-shipment credit in
foreign currency (PCFC) to finance cost of imported inputs for
manufacture of export products to be supplied under the projects.
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Exporters with a good track record are allowed a running account facility
with the bank for PCFC. The specified eligibility factor is that the
export's overdues should not exceed 5% of the average annual export
realizations during the preceding three calendar years. Commercial banks
also extend this facility for definite periods.
Post-shipment EPC:
Post-shipment is extended after shipment, to bridge the time lag between
the shipment of goods and the realization of proceeds. Exporter can avail
this facility in both Rupee as well as Foreign Currency. In case of ForeignCurrency, no Foreign Currency loan is granted. Loan is given in rupees
but the liability is in dollars. The loan is to be liquidated from the export
proceeds. This scheme is optional for Banks. RBI declares the rate of
interest on such loans.
In this case, the interest amount in US $ is deducted from the amount of
the bill. Only the net amount will be converted into rupees and credited toexporters account.
Availment of Facility: For availing such credits, the exporter has to make an application to the
bank for granting the export credit facility. The documents attached with
the application are the Letter of Credit (LC)/ Contracts/ confirmed ordersalong with a covering letter, furnishing therein an undertaking that the
relative export bills will be negotiated with the bank. Further that, the
finance granted against such LC/s Contracts/ orders will be liquidated
within a period of 180 days from the date of availment of the advances or
within the prescribed time limit as per the directives issued by RBI from
time to time.
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Exporters with firm export orders or confirmed letters of credit are
eligible for the EPC, provided they satisfy the other credit norms. The
credit will be available for maximum period of 180 days from the date of
first disbursement. In some cases, the credit can also be extended for a
period of 270 days with a higher rate of interest. Moreover a corporate
can also book forward contract in respect of future export credit drawls.
In case LC/ Contract/ confirmed order is expected in the near future, the
relevant evidence which may be in the form of a cable / telex is also
applicable, subject to the condition that such communication contains at
least the following information:1. Name of the buyer
2. Value of the order
3. Quantity and particulars of the
goods to be exported
4. Date of shipment
5. Terms of paymentFinal LC/ contract should be produced at a later stage, as and when
available.
For getting the credit, the exporter has to submit the following documents
to the concerned bank in case of pre-shipment EPC.
1. Exporters tender document
2. Offer confirmed order document.In case of postshipment EPC one extra document, that is required to be
attached along with the above two, is the Bill of Lading.
In case of Rupee denominated EPC, the tender amount is converted into
Indian Currency. This application contains the tender amount in Indian
Currency and the unit Rate of the material in $/unit. Where as in foreign
Currency denominated EPC no such conversion is done.
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After approving such application, the bank immediately credits the entire
amount to the exporters account / makes the payment. This may be in
Indian Currency or Foreign Currency as the case may be. For example, at
SBI, Pre-shipment EPC in Foreign Currency can be availed in US Dollar,
Pound, Sterling, Euro and the Japanese Yen. At the same time, the bank
blocks the CC / WCDL account for an amount equivalent to the tender or
credited amount. This is done to make sure that exporters withdrawal
does not cross the sanctioned limits. Generally, the pre-shipment advance
granted to the exporter does not exceed FOB value of the goods or
domestic market value of the goods, whichever is less.
Repayment:
On realization of the proceeds from the export, the exporter has to repay
to the bank on or before the due date. Such credits are to be repaid only
with the proceeds of the export bill tendered, under the export bill
rediscounting scheme, and not with foreign exchange acquired from anyother source.
Interest rate:
The rate of interest on the EPC differs from bank to bank and for exporter
to exporter, depending on the credit rating of the exporter. Hence these
are negotiable. But it is always lower than the banks PLR. The interestrate for the EPC in Indian Currency and EPC in Foreign Currency is
different. Interest rate is generally between 8 to 10% for the Indian
Currency EPC, where as it is LIBOR+ some spread for Foreign Currency
EPC, which works out to around 3%. The interest rate on EPC is lower
than CC / WCDL rate. This is to encourage the exports.
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The amount recovered through such export trade should be equal to or
greater than the EPC availed, to make sure that more foreign currency
comes in. If the exporter fails to achieve this, then he is penalized. In such
cases, he has to pay the interest at a rate applicable for CC / WCDL, for
the under recovered amount.
If the exporter fails to pay on the due date, then an extra interest of 2% is
charged over and above the CC / WCDL rate as applicable.
Regulatory Aspects of Export Credits:
While extending such facilities banks are mainly governed by theguidelines issued by the Reserve Bank of India under the Export Credit
(Interest Subsidy) Scheme 1968. It is necessary that the exporter applies
for and obtains sanction of limits suitable and according to his needs. At
the pre-safe stage bifurcation of working capital limits for domestic and
export purposes is essential so that the quantum of packing credit advance
could be determined. At the post stage, quantum of post-shipment creditfacilities would be based on export sales and export receivables.
Export Credit (Interest Subsidy) scheme 1968:
In order to maintain the cost of export credit at a reasonably low level, the
RBI prescribed in August 1967, a ceiling on the rates of interest that
could be charged by banks on export credit. The ceiling rates, which weresubsequently replaced, by fixed rates were lower than the rates of interest
charged for other commercial advances.
Operational Features:
The factors taken into consideration by banks before disbursal of export
credit facilities are
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1. Banks adopt a flexible attitude with regard to debt / equity ratio,
margin and security but there could be no compromise in respect of
viability of the proposal and the integrity of the borrower.
2. Exporters should be able to satisfy their bankers about their capacity
to execute the orders within the stipulated time and to manage the
export business.
3. The quantum of finance sought for should be commensurate with the
expected export turnover and the needs of the exporter.
4. Banks would need to be satisfied about the standing of the credit
opening banks.5. Banks would also look into, the political and financial conditions of
the importers country.
6. In working out the need-based requirements of the exporter, the banks
keep in view the past performance, orders on hand etc.
7. The terms and conditions of the credit facilities are advised by banks
to the exporter by an arrangement letter.
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Commercial Paper
Introduction:
Commercial Paper (CP) is an unsecured money market instrument issued
in the form of a promissory note. CP, as a privately placed instrument,
was introduced in India in 1990 with a view to enabling highly rated
corporate borrowers to diversify their sources of short-term borrowings
and to provide an additional instrument to investors. Subsequently,
primary dealers and satellite dealers were also permitted to issue CP to
enable them to meet their short-term funding requirements for their
operations.
Terms and conditions for issuing CP like eligibility, modes of issue,
maturity periods, denominations and issuance procedure, etc., are
stipulated by the Reserve Bank of India. There are no interest rate
restrictions on CP.
Eligibility for issue of CP:
Corporates, Primary Dealers (PDs) and Satellite Dealers (SDs), and the
all-India Financial Institutions (FIs) that have been permitted to raise
short-term resources under the umbrella limit fixed by Reserve Bank of
India are eligible to issue CP.
A Corporate would be eligible to issue CP provided it satisfies thefollowing requirements:
1. Tangible net worth of the company, as per the latest audited Balance
Sheet, is not less than Rs. 4 Crores.
2. Working Capital (fund based) limits of the company, sanctioned by
bank/s or all-India Financial Institution/s, is not less than Rs. 4 Crores.
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3. The company should obtain the specified credit rating from an agency
approved by RBI, for the purpose, from time to time.
4. The borrowal account of the company is classified as a Standard Asset
by the financing bank/s/ institution/s.
Rating Requirement:
All eligible participants shall obtain the credit rating for issuance of
Commercial Paper from either the Credit Rating Information Services of
India Ltd. (CRISIL) or the Investment Information and Credit Rating
Agency of India Ltd. (ICRA) or the Credit Analysis and Research Ltd.(CARE) or the FITCH Ratings India Pvt. Ltd. or such other credit rating
agency (CRA) as may be specified by the Reserve Bank of India from
time to time, for the purpose. The minimum credit rating shall be P-2 of
CRISIL or such equivalent rating by other agencies. The issuers shall
ensure at the time of issuance of CP that the rating so obtained is current
and has not fallen due for review.
Denomination and minimum size of CP:
CP can be issued in denominations of Rs.5 lacs or multiples thereof.
Amount invested by single investor should not be less than Rs.5 lacs
(face value).
Minimum and Maximum Period of CP:
CP can be issued for maturities between a minimum of 15 days and a
maximum upto one year from the date of issue. The maturity date of the
CP should not go beyond the date up to which the credit rating of the
issuer is valid. There shall be no grace period of payment of CP. If the
maturity date happens to be a holiday, the company shall be liable to
make payment on the immediate preceding working day.
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Limits and the Amount of Issue of CP:
The aggregate amount to be raised by issuance of CP by a corporate
should not exceed the working capital (fund-based) limit sanctioned to it
by bank/banks. Corporates can automatically raise CP to the extent of
50% of working capital limits without prior clearance from the bank/s.
(The 50% limit would also be inclusive of any outstanding CP).
However, companies intending to issue CP in excess of 50% of working
capital limits can do so after getting prior clearance from bank/s.
The total amount of CP proposed to be issued should be raised within a
period of two weeks from the date on which the issuer opens the issue for subscription. CP may be issued on a single date or in parts on different
dates provided that in the latter case, each CP shall have the same
maturity date.
Every CP issue should be reported to the Chief General Manager,
Industrial and Export Credit Department (IECD), Reserve Bank of India,
Central Office, Mumbai through the Issuing and Paying Agent (IPA)within three days from the date of completion of the issue.
Investment in CP:
CP may be issued to and held by individuals, banking companies, other
corporate bodies registered or incorporated in India and unincorporated
bodies, Non-Resident Indians (NRIs) and Foreign Institutional Investors(FIIs). However, investment by FIIs would be within the limits set for
their investments by Securities and Exchange Board of India (SEBI).
A CP shall be issued to a non-resident Indian (NRI) only on conditions
that (1) the proceeds will be non-repatriable and (2) the CP shall not be
transferable.
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Mode of issue:
CP can be issued either in the form of a promissory note or in a
dematerialised form through any of the depositories approved by and
registered with SEBI. As regards the existing stock of CP, the same can
continue to be held either in physical form or can be dematerialised, if
both the issuer and the investor agree for the same.
CP will be issued at a discount to face value as may be determined by the
issuer. CP can be issued as Front Ended or Rear Ended, depending upon
the terms agreed upon between the borrower and investor.
No issuer shall have the issue of Commercial Paper underwritten or co-accepted.
Payment of CP:
The initial investor in CP shall pay the discounted value of the CP by
means of a crossed account payee cheque to the account of the issuer
through IPA. On maturity of CP, when the CP is held in physical form,the holder of the CP shall present the instrument for payment to the issuer
through the IPA. However, when the CP is held in Demat form, the
holder of the CP will have to get it redeemed through the depository and
receive payment from the IPA.
Standby facility with banking companies:A company issuing CP may request the sole bank / the consortium leader
to provide standby facility for an amount not exceeding, the amount of
issue, for meeting the liability of CP on maturity. In view of CP being a
stand alone product, it would not be obligatory in any manner on the
part of bank to provide stand-by facility to the issuers of CP. Where
standby facility has been arranged for, such company may fall back on
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the working capital (fund based) limit with the sole bank / consortium
banks, if there is no Roll Over of commercial paper.
Procedure for Issuance:
1. A resolution, for the proposed CP program, shall be passed in the
Board Meeting.
2. Any company proposing to issue CP should submit a proposal
incorporating details in the form, as modified from time to time by the
Reserve Bank of India, to the financing banking company together
with the certificate issued by the credit rating agency. The financing banking company, on receipt of the proposal for issuance of CP, shall
scrutinise the same and on being satisfied shall take the proposal on
record.
3. A Company proposing to issue CP upto 50 per cent of working capital
limits may, after submitting the proposal as stated above, open the
issue for subscription.4. However, a company proposing to issue CP in excess of 50 per cent of
working capital limits can open the issue for subscription only after
the proposal has been taken on record by the financing banking
company.
5. Companies must ensure that the proposed issue of CP is complete
within the period of two weeks from the date of opening of the issuefor subscription.
6. After the exchange of deal confirmation between the investor and the
issuer, issuing company shall issue physical certificates to the investor
or arrange for crediting the CP to the investor's account with
depository. Investors shall be given a copy of IPA agreement, copy of
IPA certificate to the effect that documents are in order and a
statement of account from depository (in case of Demat form).
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7. The initial investor in CP shall pay the discounted value of the CP by
means of a crossed account payee cheque to the account of the issuing
company with the financing banking company only.
8. The working capital (fund-based) limit of every company issuing the
CP shall be correspondingly reduced by the financing banking
company, once the CP is issued and the financing banking company
shall make necessary adjustments in the account of such company
respectively, with the banking company/the other member banking
companies.
9. Every company issuing CP shall within three days from the date of completion of issue, advise the Reserve Bank of India {Industrial and
Export Credit Department, Central Office, Mumbai (IECD)}, through
the financing banking company, the amount of CP actually issued.
Documents for issue of CP:
The following are the documents relating to issue of CP:1. Incumbency certificate to be issued by the company issuing CP
2. Certificate issued by the Credit Rating Agency.
3. Issuing and Paying Agency Agreement to be signed by A Scheduled
Bank and the CP issuing company and
4. Standby Agreement to be signed by Standby Bank and the CP issuing
company.
Issue Expenses:
A Company issuing CP shall bear the expenses of the issue including
dealers fees, rating agency fee. The charges by the banking company for
providing standby facilities and of IPA commission. Also stamping duty
at the rate of 0.05% is to be paid for the Stamp Office Agreement.
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Issuing and Paying Agency:
At the request of the issuer, the Issuing and Paying Agent (IPA), agrees to
act as the IPA in respect of all the CPs to be issued by the issuer during
the validity of the IPA agreement, as per the terms and conditions
mentioned. Only a scheduled bank can act as an IPA for issuance of CP.
As and when the Issuer proposes to issue the CPs, the IPA allows the
issuer to withdraw such number of blank forms of CPs from its safe
custody sufficient to meet the requirement of the issuer for issuing the
CPs. Then, on the receipt of the duly filled CPs from the issuer, the IPA
intimates the Dealer that the CPs along with the Certificate of IPA areready for delivery and delivers them to the dealer for distributing to the
investors. After receiving the discounted face value of the CPs, the IPA
credits the account of the investor.
On maturity of the CP, the holder presents the document to the IPA at the
place and office as indicated in the CP for payment. The IPA may pay the
amount thereafter depending upon the availability of the funds in theissuers account.
IPA will get a commission, at a rate as may be mutually agreed between
the Issuer and the IPA, from time to time, within the overall limit
prescribed by the RBI, for the services of handling the receipt and
payment of the CPs and for monitoring the Account of the issuer with the
IPA in connection therewith and for maintenance of Registers andRecords therefore.
Conclusion:
The average discount rate of the CP in India, is around 7 to 9%, which is
less than the usual CC / WCDL interest rate, which is close to 14 to 15%.
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Inter-Corporate Deposits
Apart from CPs, corporates also have access to another market called theInter Corporate Deposits (ICD) market. An ICD is an unsecured loan
extended by one corporate to another. This market allows funds surplus
corporates to lend to other corporates. Also the better-rated corporates
can borrow from the banking system and lend in this market. As the cost
of funds for a corporate is much higher than a bank, the rates in this
market are higher than those in the other markets.ICDs are unsecured, and hence the risk inherent in high. The ICD market
is not well organised with very little information available publicly about
transaction details. The instrument is non negotiable and hence is not
transferable or tradable.
ICDs are given outside the working Capital limits, unlike CPs. But there
is limit on the outstanding amount.
Interest rate:
The instrument carries a coupon rate, which is market determined.
It depends on:
Prevailing market rate, call money rate, Bank rate, etc.
Financial strength and credit rating of borrower.
The coupon rate mostly remains fixed upto the maturity.
Issuance:
These are issued at the face value. The issue can be single or in parts,
which depends upon the size of the issue. If the issue size is big and there
is no single investor interested in investing for the entire amount, then the
issue can be divided into small parts and issued to number of investors.
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Such issues can be made at different coupon rates depending upon the
negotiations with different investors.
Transaction size is mostly in the region of Rs.1 Crore to Rs. 5 Crores. the
transactions are mostly routed through financial intermediary. i.e.
Brokerage House.
Duration:
These are generally for a period of 90 days. However one may also have
money invested for even short term of 3 to 5 days on call. Rate of interest
is generally low compared to interest on higher tenure.
Types of Deposits:
Such deposits are usually of Fixed Period ICDs, Pure Call ICDs and a
combination of both. These are as follows:
1. Call Deposits:
These deposits carry a call option. The lender on notice can terminatethese. The maturity period can be as short as one day, to as long as one
year. For example, 5 days and call, which means, the lender can call
back the deposit on any day after the 5 th day.
In theory, a call deposit is withdrawable by the lender on a days
notice. However, in practice, the lender has to give 1 to 2 days notice.
2. Three Months Deposits:These are more popular in practice. These deposits are taken by
borrowers to fulfill the short-term cash inadequacy. There will not be
any call option. The maturity period is fixed at 3 months.
3. Six Months deposits:
Normally lending companies do not extend deposits beyond this time
frame. Such deposits are usually made with first class borrowers. The
maturity period is fixed at 6 months.
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Payment:
The payment of such deposits is to be done on maturity. The interest is
also payable on maturity. In case of the Call Deposits the payment is to
made when the notice from the lender is received. In case of default in
payment, there will be some penalty payable, as per the terms agreed
upon in the agreement.
Characteristics of ICD Market:
Following are some of the characteristics of the ICD market.
1. Lack of regulation:The lack of legal hassles and bureaucratic red tape makes an ICD
transaction very convenient. In a business environment otherwise
characterised by a plethora of rules and regulations, the evolution of
the ICD market is an example of the ability of the corporate sector to
organise itself in a reasonably orderly manner.
2. Secrecy:ICD market is shrouded in secrecy. Brokers regard their lists of
borrowers and lenders as guarded secrets. Tightlipped and
circumspect, they are somewhat reluctant to talk about their business.
Such disclosures they apprehend would result in unwelcome
competition and undercutting of rates.
3. Importance of Personal Contacts:Brokers and lenders argue that they are guided by a reasonably
objective analysis of the financial situation of the borrowers. However
the truth is that lending decisions in the ICD markets are based on
personal contacts and market information which may lack reliability.
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FCNR(B) Loans
FCNR(B) stands for Foreign Currency Non-Residence (Borrowings).
FCNR(B) loans are given by the banks to the borrowers from the
FCNR(B) deposits. FCNR(B) deposits are the deposits kept by NRI in
foreign currencies. Bank provides loan in foreign currency out of dollar
deposit of NRI available with them. These loans are generally provided
out of the Working Capital limit sanctioned to the company.
Availment of FCNR(B) loans:
The corporate needing funds make an application to the bank having the
FCNR(B) deposit account. The bank after scrutinising such application to
their satisfaction extends the loan to the company. The bank provides
dollars to the borrower or the company, the company utilises the dollar
either to meet its immediate requirement of dollar payment either
towards imports or other foreign currency payments. However, generally
the dollars provided by the bank are sold back to the bank at the
prevailing exchange rate and rupee amount is credited to the companys
account. It may be noted that the liability of the company is always in
foreign currency.
Duration:
Depending upon the type of loan the tenure is determined. These loansare given for a short duration. Since banks lend foreign currency loans
out of their FCNR(B) deposits, which typically span over 6-12 months
period, they cannot lend FCNR(B) loans for periods of more than one
year. Normally such loans are given for a period of 90-180 days.
Interest Rate:
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Interest is charged by applying a spread over LIBOR (London Inter-Bank
Offer Rate). The spread can be in range of 50-300 basis points (0.50% -
3.00%) over the LIBOR. Currently the 6 month LIBOR is around 2.00%
p.a. The spread is levied by the bank depending upon the credit rating of
company, prevailing market condition, etc.
The currency risk is borne by company. However company by booking a
forward contract, upto maturity of loan, can limit any adverse movement
in currency rates. Also the effective rate of interest can be determined.
Assuming premium rate to be 5.50% and that the rate of interest quoted
by bank is LIBOR + 1% p.a., the effective cost will be 8.50% p.a.The mechanism provides for cheaper financing. Even after taking forward
cover the effective cost is much less than the rate levied by the bank on
Working Capital funds in Rupees.
Further in case company does not take a forward cover and the rate of
depreciation is less than the premium payable on booking of forward
contract, the effective cost can still be cheaper. Assuming that thecompany had not covered the exposure and in case the rupee depreciates
only, by say 2% p.a. vis--vis the premium of 5.50% p.a. the effective
cost will come to 5% p.a. only.
Repayment:
As mentioned earlier, the liability of the company remains in foreigncurrency only. The interest is calculated on the foreign currency. The
repayment of the principal amount, along with the interest thereon, is to
be made on maturity.
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Characteristics of FCNR(B) loans:
1. With the interest rate on these loans linked to the dollar exchange rate
and rates prevailing in the international market, these loans work out
to be cheaper than rupee credit.
2. The RBI has allowed banks lend at sub-PLR rates in its recent credit
policy, which has made this avenue very attractive in recent months.
3. For banks, too, FCNR(B) loans is a profitable avenue of business as
the cost of funds here are cheaper than rupee funds. This helps banks
manage their spreads better as cost of funds and loans linked to
FCNR(B) move with international benchmarks and Libor.4. The abolishing of incremental CRR on FCNR(B) loans has further
helped in reducing cost of funds for banks.
Conclusion:
Corporates and banks are suddenly discovering the benefits of foreign
currency loans that are available from the FCNR(B) deposits banks.However, the availability of FCNR(B) funds for lending purposes is very
limited. The funds requirement of corporates, however, is many times
higher. Besides, this special source of funds is concentrated mostly in
three public sector banks SBI, BoB and Bank of India. Also, corporates
still feel there are problems on the FCNR(B) loan front. For one, these
funds are unable to meet their entire credit needs. Second, they aretypically of six months to one-year duration.
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STATEMENT OF WORKING CAPITAL
PARTICUL
ARS
For the year ended
Changes In W-cap
Increase Decrease2004 2005 2006 2004-05 2005-06 2004-05 2004-05
CurrentAssetsInventories 29490.66 28756.59 31904 .16 3147.57 734.07
Sundry Debtors 24614.52 22627.67 24846.74 2219.07 1986.85
Cash and Bank 2675.92 1324.83 2503.17 1178.34 1351.09
Other Current
Assets 1887.79 2277.723315.06
389.93 1037.34
Loans and
Advances12122.14 12206.35 14442.06 84.21 2235.71
Total CurrentAssets
70791.03 67193.16 77011.19 9818.03 3597.87
CurrentLiabilities
Acceptances 89.75 42.17 45.09 2.92 47.58
Sundry
Creditors10491.99 11009.37 16427.41 517.38 5418.04
Advances
against sales449.05 459.52 560.35 10.47 100.83
Due to
Subsidiary Cos137.82 207.25 177.84 69.43 29.41
Deposits from
Dealers and
Agents
4874.25 5134.95 5318.21 260.7 183.26
Overdrawn
Bank Balances 186.60 484.16 1125.67 297.56 641.61
Other liabilities 1491.91 1689.99 2044.72 198.08 354.73
Interest accrued
but not due 315.87 477.20528.05 161.33
50.85
Provisions 8373.15 5605.17 6770.84 1165.67 2767.98
Total CurrentLiabilities
26410.39 25109.78 26227.34 1117.56 1300.61
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Net
Working
Capital
(CA CL)
44380.64 42083.38 50783.858700.47
2297.26
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INVENTORY MANAGEMENT
Inventory refers to the stock of products a firm is offering for sale and thecomponents that make up the product. It includes raw materials; work in
process (semi-finished goods). Managing inventory is a juggling act.
Excessive stocks can place a heavy burden on the cash resources of a
business. Insufficient stocks can result in lost sales, delays for customers
etc. The key is to know how quickly the overall stock is moving or, put
another way, how long each item of stock sit on shelves before being
sold. Obviously, average stock-holding periods will be influenced by the
nature of the business.
Inventory Financing:
As with accounts receivable loans, inventory financing is a secured loan,
in this case with inventory as collateral. However, inventory financing is
more difficult to secure since inventory is riskier collateral than accounts
receivable. Some inventory becomes obsolete and looses value quickly,
and other types of inventory, like partially manufactured goods, have
little or no resale value.
Firms with an inventory of standardized goods with predictable prices,
such as automobiles or appliances, will be more successful at securing
inventory financing than businesses with a large amount of work in
process or highly seasonal or perishable goods. Loan amounts also vary
with the quality of the inventory pledged as collateral, usually ranging
from 50% to 80%. For most businesses, inventory loans yield loan
proceeds at a lower share of pledged assets than accounts receivable
financing. When inventory is a large share of a firms current assets,
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however, inventory financing is a critical option to finance working
capital.
Lenders need to control the inventory pledged as collateral to ensure that
it is not sold before their loan is repaid. Two primary methods are used to
obtain this control: (1) warehouse storage; and (2) direct assignment by
product serial or identification numbers. Under one warehouse
arrangement pledged inventory is stored in a public warehouse and
controlled by an independent party (the warehouse operator).
A warehouse receipt is issued when the inventory is stored, and the goods
are released only upon the instructions of the receipt-holder. When the
inventory is pledged, the lender has control of the receipt and can prevent
release of the goods until the loan is repaid. Since public warehouse
storage is inconvenient for firms that need on-site access to their
inventory, an alternative arrangement, known as a field warehouse, can be established.
Here, an independent public warehouse company assumes control over
the pledged inventory at the firms site. In effect, the firm leases space to
the warehouse operator rather than transferring goods to an off-site
location. As with a public warehouse, the lender controls the warehousereceipt and will not release the inventory until the loan is repaid.
Direct assignment by serial number is a simpler method to control
inventory used for manufactured goods that are tagged with a unique
serial number. The lender receives an assignment or trust receipt for the
pledged inventory that lists all serial numbers for the collateral. The
company houses and controls its inventory and can arrange for product
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sales. However, a release of the assignment or return of the trust receipt is
required before the collateral is delivered and ownership transferred to the
buyer.
This release occurs with partial or full loan repayment. While inventory
financing involves higher transaction and administrative costs than other
loan instruments, it is an important financing tool for companies with
large inventory assets. When a company has limited accounts receivable
and lacks the financial position to obtain a line of credit, inventory
financing may be the only available type of working capital debt.Moreover, this form of financing can be cost effective when inventory
quality is high and yields a good loan-to-value ratio and interest rate.
Factors to be considered when determining optimum stock levels
include:
What are the projected sales of each product?How widely available are raw materials, components etc.?
How long does it take for delivery by suppliers?
Can the company remove slow movers from their product range
without compromising best sellers?
It should be noted that stock sitting on shelves for long periods of timeties up money, which is not working.
For better stock control, the following may be considered:
Review the effectiveness of existing purchasing and inventory
systems.
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Know the stock turn for all major items of inventory.
Apply tight controls to the significant few items and simplify
controls for the trivial many.
Sell off outdated or slow moving merchandise - it gets more
difficult to sell the longer the company keeps it.
Consider having part of the companys product outsourced to
another manufacturer rather than make it yourself.
Review your security procedures to ensure that no stock is going
out the back door!
Higher than necessary stock levels tie up cash and cost m
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