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Working Capital

  • Working Capital represents liquidity available with the company for managing its day-to-day operations.

 

  • Net Working Capital is Current Assets minus Current Liabilities. Current Assets here refers to cash, inventory, raw material, and account receivables. Current Liabilities include account payable. Lenders always consider Net Working Capital prior to extending working capital facilities.

 

  • Company aims for a positive working capital (current assets > current liabilities), as it reflects upon its ability to meet its short-term requirements and have an edge in the market.

 

  • Working capital financing is utilised to finance Company’s investments in short-term assets i.e., accounts receivable and inventory, and fund its day-to-day operations including salaries, overheads, and other expenses.

 

  • Working Capital Facilities are provided by Banks across multiple financial products to best suit company’s  business requirements. The best fit for your company will depend on its industry, business model, stage of development, and the current assets on its balance sheet.

 

Overdraft

 

  • Overdraft facility is utilised to meet with day to day working capital requirements of a Company.

  • The Facility utilisation is to meet with day-to-day expenses, salary payments and other general corporate expenses.

  • Facility can be settled in full anytime and can be redrawn fully up to its sanctioned limit.

  • Overdraft facility is typically set-up in the checking account of Company.

  • Banks typically monitor the aggregate annual debits and credits routed thru the account with the overdraft  facility

 

 

Typical terms of Overdraft

 

  1. Overdraft facility is typically sanctioned for a period of a year and renewed thereafter

  2. Overdraft is extended on a secured as well on an unsecured basis

  3. Overdraft is settled by the general revenue stream of the Company

  4. Interest rate charged is same as charged on the other short-term working capital requirements.

  5. Overdraft facility is extended on a general basis as well as for a specific project or a specific purpose.

 

 

Short-Term Loan

 

  • Short Term Loan facility is utilised to meet with day to day working capital requirements of a Company.

  • The Facility utilisation is to meet with day-to-day expenses, salary payments and other general corporate expenses.

  • Short Term Loans drawn within the Facility are repaid by either the general revenue stream or a specific assigned revenue of Company

 

 

Typical terms of Short-Term Loan

 

  1. Short Term Loan facility is typically sanctioned for a period of a year and renewed thereafter

  2. The Short-Term Loan Facility is typically drawn in 2 to 3 short term loans or more depending on the Facility size

  3. Tenor of individual short-term loan is typically 30 days to 90 days. At maturity, the short term is repaid along with the interest. The short-term loan can also be redrawn immediately or after a cooling period of say 1 to 2 days.

  4. The Facility is extended on a secured as well on an unsecured basis

  5. Interest rate charged is same as charged on the other short-term working capital requirements

  6. The facility is extended on a general basis as well as for a specific project or a specific purpose

 

Loan Against Trust Receipts (LATR)

 

  • Loan Against Trust Receipt (LATR) is an advance for a pre-agreed tenure for the sole purpose of financing payments to be made by the customer covering purchase of goods either under a Letter of Credit (LC) established through the bank or by way of documents received on collection without a letter of credit.

  • Trust receipt is a legal document between a bank and customer, stating that the bank will give goods to the Customer however the bank will still retain the title to the goods and can repossess it if the Customer does not uphold the terms decided upon in the trust receipt.

  • Trust Receipt is a deferred payment facility from the Bank under a LC or otherwise. Customer can defer his payment obligation to the Bank, however, is able to get the goods that has already been ordered under an LC or otherwise.

  • The customer simply submits a TR Letter which basically contains a statement of receiving the goods on Bank’s behalf and promising to pay the Bank with deferred payment that includes the total cost along with the interest.

  • Financing by way of trust receipts does not amount to secured financing. However, it does create certain rights and obligations that put the Bank in a better position than most other unsecured lenders.

 

Typical Terms of Loan Against Trust Receipts

 

  1. Purpose is to meet with the working capital requirements of a Company by financing their purchases.

  2. Typical tenor of LATR ranges from 45 days to 180 days

  3. LATR is settled by the realization of the sales proceeds by Company.

  4. Interest rate charged is same as charged on the other short-term working capital products.

  5. LATR facility is extended on a general basis as well as for a specific project or a purpose.

 

 

Invoice/Bill Discounting

 

  • Bill Discounting is a trade transaction in which a Company’s unpaid invoices/ bills which are due to be paid at a future date are sold to a Bank/lender.

  • Bill discounting involves a Company  discounting outstanding invoices with a Bank/lender to gain access to short-term financing to strengthen its working capital position. 

  • Bill discounting is a form of loan that is available to the beneficiary of the invoices and has to be repaid if the bank or the lender does not realize the amount of the bill when presented to the buyer at the time of maturity or at the end of the credit period.

  • The discounting provides upfront funds to the Company rather than waiting for the complete credit period extended by them to the buyers. Discounting shortens the working capital cycle of companies as they realise the funds immediately thereby improving upon their liquidity position.

  • Companies can complete multiple cycles because of shortened working capital cycle thereby enhancing their revenue and in turn strengthening profitability.

 

 

Typical Terms of Invoice/Bill Discounting

 

  1. Purpose is to meet with the working capital requirements of a Company by financing their sales.

  2. Typical tenor of Bill/Invoice ranges from 60 days to 180 days

  3. Bill/Invoice discounting is settled by the realisation of the sales proceeds at the end of the credit period.

  4. Interest rate charged is same as charged on the other short-term working capital requirements.

  5. Bill/Invoice discounting facility is extended on a general basis as well as for a specific project or a purpose.

 

 

Cheque Discounting

 

  • The discounting of post-dated cheques is for Companies which accept post-dated cheques from their clients to realise sale proceeds for products or services offered by them.

  • Cheque discounting improves the liquidity position of a Company by shortening its cash conversion cycle.

  • The cheque discounting provides upfront funds to the Company rather than waiting for the complete credit period extended by them to the buyers.

  • Banks accept cheques which are drawn on  acceptable companies  with no record of past unpaid cheques from the drawer.

 

 

Typical Terms of Cheque Discounting

 

  1. Purpose is to meet with the working capital requirements of a Company by financing their sales.

  2. Typical tenor of Cheque discounting ranges from 60 days to 180 days

  3. Cheque discounting is settled by the realisation of the cheque proceeds

  4. Personal cheques, related entity cheques and foreign currency cheques do not qualify for discounting

  5. Typically, Company must have received cheques from the same drawer before and the account must be reasonably active for at least six months to qualify for discounting

  6. Cheque discounting facility is extended on a general basis as well as for a specific project or a purpose.

 

Letter of Credit

 

 

  • Letter of Credit also known as a documentary credit, is a payment mechanism used in trade to provide guarantee from a Bank to a seller of goods.

  • If a buyer fails to pay a seller, the bank that issued a letter of credit must pay the seller if the seller meets all the requirements in the letter of credit. A letter of credit provides protection for sellers. 

  • A letter of credit is essentially a financial contract between a bank, a bank's customer, and a beneficiary. Generally issued by an importer’s bank, the letter of credit guarantees the beneficiary will be paid once the conditions of the letter of credit have been met.

  • Letters of credit are used to minimize risk in international trade transactions where the buyer and the seller may not know one another.

  • The letter of credit outlines the conditions under which payment will be made to an exporter. The issuing bank will generally act on behalf of its client (the buyer) to ensure that all conditions have been met before the funds of the letter of credit are released.

 

 

Parties involved in a Letter of Credit

 

Applicant: An applicant (buyer of goods) requests bank to issue a Letter of Credit

 

Beneficiary:  Seller who receives his payment under the Letter of Credit

 

Issuing Bank:  Bank issuing the Letter of Credit at the request of the buyer

 

Advising bank:  Bank that’s responsible for the transfer of documents to the Issuing Bank on behalf of the exporter and is generally located in the country of the exporter

 

Confirming Bank: Provides an additional guarantee to the undertaking of the Issuing Bank. It comes into the scene when the exporter is not satisfied with the assurance of the Issuing Bank

 

Negotiating Bank: Bank that negotiates the documents related to the LC submitted by the exporter. It makes payments to the exporter, subject to the completeness of the documents, and claims reimbursement under the credit

 

Reimbursing Bank: Bank where the paying account is set up by the Issuing Bank

 

Process Flow of LC

 

Step 1: Agreement between Buyer and Seller wherein the Buyer agrees to purchase goods from Seller.

 

Step 2: Buyer applies for a LC with his Bank (LC Issuing Bank)

 

Step 3: LC Issuing Bank opens and sends the LC to the Seller

 

Step 4: Based on the LC, Seller ships/transports the goods to the Buyer

 

Step 5: Seller prepares and presents the documents required under the LC to the LC Issuing Bank

 

Step 6: LC Issuing Bank vets the documents and makes payment if the presented documents are in compliance with the LC

 

Step 7: LC Issuing Bank seeks payment and shares documents with the Buyer (LC applicant)

 

Step 8: Buyer receives goods from the carrier based on  the documents

 

 

 

Bank Guarantee

 

  • Bank Guarantee is a promise made by the bank to any third person to undertake the payment risk on behalf of its customers. Bank guarantee is given on a contractual obligation between the bank and its customers.

  • The value of guarantee is called the 'guarantee amount'. The 'issuing bank' will pay the guarantee amount to the 'beneficiary' of the guarantee upon receipt of the 'claim' from the beneficiary. This results in 'invocation' of the Bank Guarantee.

  • The bank guarantee serves as a risk management for the beneficiary, as the bank assumes liability for completion of the contract should the buyer default on their debt or obligation.

  • Bank guarantees serve the purpose of facilitating business in situations that would otherwise be too risky for the beneficiary to engage.

  • A Guarantee is a simple and practical way of ensuring that a business – or its trading partner – receives compensation in the event of a breach of contract. It’s a formal assurance that a borrower will be able to pay its counterparty, irrespective of any financial circumstances.

  • The underlying contract for a Bank Guarantee can be financial or performance based.

Parties to a Guarantee

 

 

Applicant:       The party requesting the Guarantee

Guarantor:      The bank that guarantees the agreed compensation amount to be paid in the event of a failure to meet                                        contractual obligations

 

Beneficiary:      The party for whom the Guarantee is issued

 

 

 

Types of Bank Guarantee

 

Some of the types of guarantees issued by the Banks are as below:

 

  1. Bid Bond Guarantee

  2. Advance Payment Guarantee

  3. Payment Guarantee

  4. Performance Guarantee

  5. Retention Guarantee

  6. Deferred payment Guarantee

  7. Shipping Guarantee

  8. Standby LC

 

 

Foreign Exchange (FX) Limits

 

Foreign Exchange Limits are extended by Banks at the request of their Customer/Companies to hedge currency risk and interest rate risk faced by the Companies in their normal business operations. The FX limits are required by the Companies to hedge the risks.

 

Currency Risk Hedging Limit:

Companies with foreign currency exposure i.e., sales is in other currencies or raw material purchases in other currencies tend to hedge their foreign exchange currency exposure with a Bank to minimize the loss due to fluctuation in foreign currency. Bank offers Foreign Exchange limits at the request of their customers to hedge the currency risk.

 

Interest Rate Risk Hedging Limit:

Companies tend to hedge the interest rate risk on their borrowings by either converting their fixed rate borrowings to floating rate borrowings or converting their floating rate borrowing to fixed rate borrowing. Banks offer Interest Rate Swap Facility to the Companies to hedge the interest rate risk. 

Working Capital
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