WORKING CAPITAL

(NON FUND BASED) AND

WORKING CAPITAL FOR
CONTRACTORS
&
SEASONAL INDUSTRIES
BY
R.K.GUPTA
B. Com (Hons); CAIIB; AIB (LONDON); L.L.B; MBA (Finance)
22-11-2014

Copyright 2009-2010 R.K.Gupta.

WHY THIS PROGRAMME?

a. To provide opportunity to all the employees to improve
their knowledge
b. Improvement of knowledge creates confidence
c. Knowledge and confidence enhances efficiency and
productivity and on the other side it reduces the risk
d. Efficiency and productivity enhances wealth of the
share holders and the employees also.
e. RISK
Risk can be defined as the combination of the probability of
an event and its consequences.

f. Probability
g. Accountability
h. So mitigation through:
a. Integrity
b. System and procedure
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TOPICS FOR DISCUSSION IN

(NFB) WORKING CAPITAL
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
l.

Definition
Over /under financing
Why non fund based limits preferred
Types of non fund based products
Factors determining Non Fund Based Working Capital
Types of Bank guarantees and its essentials
How to work out the Limits for Bank Guarantee
What is letter of credit and its types and essentials
Parties to the letter of credit
How to work out the Limits for Letter of Credit
Devolvement of letter of credit
In what circumstances the limit can be sanctioned in
isolation
m. Value and evaluation of DP through stock statement
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DEFINITION (NFB) AND IMPORTANCE OF

ADEQUACY OF WORKING CAPITAL
a.
b.
c.
d.
e.

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Where the funds are not required but

Funds are required on the event of failure of
commitment by the borrower/ Applicant of the Non
fund Based Limit
It is a contingent liability.
CASE OF UNDER FINANCING
(liquidity crunch)
CASE OF OVER FINANCING
(Over Trading OR diversion of funds )

WHY NON FUND BASED LIMITS PREFERRED?

a. Can be used to reduce cost of borrowed funds
b. Banks charge a small commission on Non fund
based products as compared to interest on
Fund based products
BUT
a. Usage of these tools is subject to a mutual
understanding between the buyer and the
supplier
b. Credibility of the borrower and seller,
beneficiary & bank is the cause of such
instruments

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NON FUNDS PRODUCTS

A. BANK GUARANTEES

Bank guarantee is issued by the bank undertaking the liability of

applicant in case of his default. Guarantees may broadly be divided
in two categories as under:
i. Financial guarantees:
Guarantee to discharge financial
obligation of the applicant
ii. Performance guarantees: Guarantee for due performance of a
contract by the applicant
iii. Deferred Payment Guarantee: Generally in case of Purchase of
Heavy Machineries
B. LETTER OF CREDIT
Domestic LC
Foreign LC
a. Documentary Letter of Credit
b. Usance Letter of Credit
i.
Revolving Letter of Credit
ii. Irrevocable letter of Credit
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NON FUNDS PRODUCTS

FINANCIAL GUARANTEES:
Financial guarantees are direct credit substitutes wherein a bank irrevocably
undertakes to guarantee the repayment of a contractual financial obligation.
Financial guarantees essentially carry the same credit risk as a direct extension of
credit i.e., the risk of loss is directly linked to the creditworthiness of the counterparty
against whom a potential claim is acquired. An indicative list of financial guarantees,
attracting a CCF of 100 per cent is as under:
a. Guarantees for credit facilities;
b. Guarantees in lieu of repayment of financial securities;
c. Guarantees in lieu of margin requirements of exchanges;
d. Guarantees for mobilisation advance, advance money before the
commencement of a project and for money to be received in various stages
of project implementation;
e. Guarantees towards revenue dues, taxes, duties, levies etc. in favour of
Tax/ Customs / Port / Excise Authorities and for disputed liabilities for
litigation pending at courts;
f. Credit Enhancements;
g. Liquidity facilities for securitisation transactions;
h. Acceptances (including endorsements with the character of acceptance);
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i. Deferred payment guarantees.

NON FUNDS PRODUCTS

PERFORMANCE GUARANTEE
Performance guarantees are essentially transaction-related
contingencies that involve an irrevocable undertaking to pay a third party
in the event the counterparty fails to fulfil or perform a contractual nonfinancial obligation.
In such transactions, the risk of loss depends on the event which need not
necessarily be related to the creditworthiness of the counterparty involved.
An indicative list of performance guarantees, attracting a CCF of 50 per
cent is as under:
a.Bid bonds;
b.Performance bonds and export performance guarantees;
c.Guarantees in lieu of security deposits / earnest money deposits (EMD)
for participating in tenders;
d.Retention money guarantees;
e.Warranties, indemnities and standby letters of credit related to particular
transaction.
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FACTORS DETERMINING WORKING CAPITAL (NFB)

BANK GUARANTEE:
a.
Amount of contract in hand
b.
Amount of Bank Guarantee already in force
c.
Amount of Contracts to be procured during the year
d.
Amount of Contracts to be completed during the year
LETTER OF CREDIT:
a.
Total Costs incurred on materials purchased on credit
b.
The length of time which is taken for getting the goods from the
seller to the place of the buyer.
c.
Time taken from arrival of the goods to send the goods to the
buyer through sale on credit or cash.
DEFERRED PAYMENT GUARANTEE:
a.
What is the period of Deferred Payment.
b.
Amount and tenure of Term Loan in case of Deferred Payment
Guarantee.
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IMPORTANT FACTORS (BG)

a.
b.
c.
d.
e.
f.
g.
h.
i.

Approved draft matter of Bank Guarantee.

Name of the Applicant
Name of the beneficiary
Amount of guarantee
Date of operation of guarantee
Date of expiry of guarantee
Period of operation
Commission on Bank guarantee
Signatories to the Guarantees
i. Who should sign?
ii. Importance of sending the intimation to RO for
issuance of each guarantee?
iii. Importance of seeking the confirmation by
beneficiary

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IMPORTANT FACTORS (BG)

j.
k.
l.
m.
n.
o.
p.
q.
r.

Expired guarantees
Repercussion of expired guarantees
Reversal of guarantees
Notice to the beneficiary
Renewal of bank guarantees
Guarantees for unlimited period
RBI guidelines for invocation of guarantees
Monitoring of performance guarantee.
Monitoring of financial guarantee

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WORKING OUT THE LIMIT FOR BG

Amount of contracts in hand at the opening of the quarter

+Amount of contracts expected to be procured during the

quarter

-Amount of contracts to be completed during the quarter

Balance of amount of contracts in hand at the close of the

quarter

A+B-C

Amount of BG outstanding on account of amount A

Amount of BG outstanding on account of amount B

Amount of BG outstanding on account of amount C which

are expected to be reversed

Amount of BG limit for consideration

D+E-F

Margin in shape of Cash/ Term Deposit

0-100%

Collateral Security amount

0-100%

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Working capital in case of construction

contractors & seasonal Industries
a. What is the nature of stock?
b. What is the nature of security in case of working capital
finance
c. Requirement of funds depends on:
i. Period of completion of the project
ii. Period of book debt realization
iii. Neither MPBF nor Turnover method is applicable in
such like cases
iv. Cash Budget method is the only alternate.
v. But again the question is what is the principal
security to the Bank.
d. What steps a Bank should take to mitigate its risk.
e. Assignment of debts if so
i. How in case of firm and
ii. How in case of company.
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Working capital in case of seasonal Industries

a. What is the meaning of seasonal industries ?
i. Rice Sheller
ii. Food processing units
iii. Sugar industries
b. Requirement of funds depends on:
i. Period of availability of raw material.
ii. In such like cases, the date of expiry of the product is
most important.
iii. The goods manufactured be sold before the next
season arrived to have safety from price fluctuation.
iv. Cash Budget method is the best method for the
purpose.
v. How the cash budget method is applied.
vi. DP is to be worked out on the basis of stock
available.
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NON FUND PRDUCTS

LETTER OF CREDIT
A document issued by a financial institution which
provides an irrevocable payment undertaking to a
beneficiary against complying documents as stated in
the credit.
i. Documentation
ii. All documentation should be in accordance with the
instructions of the applicant and any deviation may place
the bank at default/risk
iii. Goods are on Trust as such documentation for Loan
against Trust Receipt to be got executed
iv. Revolving Letter of Credit.
v. Stipulation of reinstatement of LC.
vi. Limits of Cash Credit (Hyp) or (Pledge)
vii.Stock Statement to be examined for Drawing Power.
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OTHER IMPORTANT POINTS

APPLICANT:
The buyer /importer of goods: This person has to make
payment of letter of credit to the issuing bank if the
documents are in accordance with the terms and
conditions of LC.
ISSUING BANK:
Importers or buyers bank who lends its name or credit
is issuing Bank. It is liable for payment of LC in case the
documents are received by it from the nominated or
negotiating bank and the documents are in terms of
letter of credit. This bank gets 5 days to check the
documents.
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OTHER IMPORTANT POINTS

Advising Bank
Issuing bank branch or correspondent in exporter
country to whom the letter of credit is sent for onward
transmission to the seller or beneficiary, after
authentication of genuineness of the credit.
Where it is unable to verify the authenticity, it can seek
instructions from the opening bank or can advise the LC
to the beneficiary, without any liability on its part. This
bank has no obligation to negotiate the document.
Beneficiary:
The party to whom the credit is addressed i.e. seller or
the exporter or the supplier of the goods. It gets payment
against documents as per LC from the nominated bank
within validity period of negotiation maximum 21 days
from date of shipment.
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OTHER IMPORTANT POINTS

Negotiating bank:
The bank to whom the beneficiary presents the documents for
negotiation. It claims payment from the reimbursing bank or opening
bank and gets 5 banking days to check the documents.
Reimbursing Bank:
Third bank which repays, settle or funds the negotiating bank at the
request of its principal, the issuing bank .
Confirming Bank:
The bank adding confirmation to the credit, which undertakes the
responsibility of payment by the issuing bank and on his failure to
pay the confirmation, is added on request of the opening bank.

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OTHER IMPORTANT POINTS

Red clause LC:
PCL to exporter on guarantee of issuing bank of importer.
Green clause of LC:
Permit the storage of goods to be exported in warehouse
in addition to PCL under red clause LC.
Revolving letter of credit:
Reinstatement clause.

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Assessing Limit for Working Capital under L/C

L/C facility can be assessed in the following manner:
Rs. (In Lacs)
Total purchases
1000
Purchase under L/C (say 60%)
600
Period under L/C (days)
90
Lead time under L/C (days)
(Only in case of Offsite)
30
L/C Requirement (600 x (90 + 30)/365)
197.26

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OTHER IMPORTANT POINTS

a. No LC be opened in name of sister/allied/group
concern/frontal firms or companies floated in name of
employees of the promoters.
b. No LC be opened to facilitate the accommodation bills
c. Limit should not be opened in isolation.
d. In what circumstances the limit can be sanctioned in isolation
e. LC sanctioned for WC should not be used for LC for capital
goods.
f. LC for capital goods be backed by TL whereas LC for WC be
backed by working capital limits.
g. LC should be in consonance with the goods dealt with by the
buyer and seller.
h. Contract in respect of type, quantity, value, payment terms,
mode of transport be examined before opening LC as LC is to
be opened in accordance with the terms of contract-------22-11-2014

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OTHER IMPORTANT POINTS

i.

Frequent LC in name of one personKYC, CR, CIBIL

report, nature and type of business, constitution and
relation with LC opening firm be examined to avoid
kite flying/accommodation bills
j. Liquidity aspect at the time of payment be thoroughly
examined.
k. It may be at one time of building margin slowly to
ensure honour the LC on due date.
l. Value and evaluation of DP through stock statement
m. When L/C is to be treated as devolved?
n. Steps to be taken at the time of devolvement of LC
Notice
Drawing power
Penal interest
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THANK YOU
R.K.GUPTA
www.rkguptafinance.in
rkgupta1949@hotmail.com
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