We had discussed about
the Working Capital Assessment (Working
Capital) and margin money for Non Fund Based limits (The
Essence of Margins for Non Fund Based WC Limit) in previous articles.
A company is at the
beginning stage of a business. The company needs to purchase current assets
(materials) worth INR 100 million. The suppliers are ready to supply 25% of material
at clean credit period of 90 days and balance with cash payment on delivery.
The company also needs to provide Performance Bank guarantee (PBG) of INR 100
million to some party for getting a business contract. XYZ Bank is ready to
provide PBG with 20% FDR Margin. With this information let’s assess the limit:
(A) Current Assets (CA)
- Inventory Estimate : 100
(B) Margin Money for PBG
Estimate : 20
Total Assets: 120
(C) Current Liabilities
(CL) – Sundry Creditors (excluding bank borrowing for WC) Estimate :25
Total liabilities: 25
NFB Limit (PBG)
Estimate : 100
Under the standard MPBF
assessment method, the WC gap (i.e. the difference between CA and CL (excluding
the bank finance) is considered eligible for WC finance subject to 25% of CA to
be funded by promoters.
Important point to
remember here is that WHATEVER is INCLUDED HERE IN THE CURRENT ASSETS
(AND IS HYPOTHECATED TO BANK AS PRIMARY SECURITY), IS ACCEPTED FOR FINANCING BY
WC BANK. In the above example, the BG is for performance purpose. It
does not result in materials/current assets on which bank will have
hypothecation charge. In this example, there will be fund requirement of INR 20
million (20% of PBG required) for obtaining the PBG from bank. Since the WC
banks provide finance against the hypothecation of current assets, and by
establishment of PBG there will not be any creation of CA (the primary security
for the bank against which lending is done), the bank will not consider this
margin money as part of CA. Hence MPBF will be:
(D) WC GAP : A – C = 75
(E) Less : 25% of CA
i.e. = 25
Balance eligible under
MPBF (D – E) = 50
The estimated balance
sheet will look like as following:
Current Assets
|
Current Liabilities
|
Inventory
:100
|
Sundry
Creditors : 25
|
WC
Bank Borrowing : 50
|
|
Non Current Assets
|
|
FDR
Margin : 20
|
Non Current Liability
|
Promoter’s
Contribution for CA : 25
|
|
Promoter’s
Contribution for PBG FDR Margin:20
|
|
Total : 120
|
Total: 120
|
Current Ratio (Current Assets Divided by Current
Liabilities)
|
1.33 times
|
With the above
explanation, it can be concluded that if the NFB limit does not result in
increase in equivalent CA (which are hypothecated to bank as primary security),
the FDR margin cannot be treated as part of CA for arriving at the MPBF.
Now, lets consider an
additional assumption in the above example. Suppose that the material supplier
is willing to provide 25% of the materials on 90 days credit only if equivalent
irrevocable LC is established in his favour. Bank stipulates 20% FDR margin for
LC establishment. So, now the company additionally needs 20% funds of the 25%
of the material value i.e. 100*25%*20%= INR 5 millions.
Again the question:
whether this estimated FDR margin can be included in the CA for arriving at the
MPBF? Since establishment of Usance LC will result in
increase in inventory on which WC bank will have hypothecation charge,
therefore, can this FDR margin be included in the CA while calculating the MPBF?
Here we need to look at
the Usance LC process. It may be observed that at the time of establishing the
LC, there is no current asset against this, and we have established above that WC
bank finance is provided against CA (which are stored at an identified
location). When LC will mature, the company can make payment by debiting its Fund Based A/c limit (generally Cash Credit A/c), and this utilization will be
allowed by bank since material would have arrived and will become paid stock
under the hypothecation charge of the bank. However since at the time of LC
establishment there is no CA, therefore bank will not agree to fund the margin
required for establishing the LC. This margin will have to be brought in by the
company/promoters.
(1) If we look
at the transaction from another angle, it can be also said that instead of
funding the 20% margin, the bank may very well ask company/promoters for bringing
25% FDR margin instead of 20%. Why? Because under MPBF method since bank agrees
to fund 75% of the CA and 25% is contributed by company/promoters, therefore
future expected material delivery has to be funded in the same ratio(i.e 75:25).
Hence at the time of LC establishment itself, the bank may ask for 25% margin
by promoters/company. Agreeing to a lower margin (i.e. 20%) may be only on the
following assumptions:
-
Company/Promoter’s contribution in funding the existing CA is more than 25%
resulting in Current Ratio of more than 1.33 times.
- Bank is
willing to agree to a lower contribution by promoter’s/company (i.e. bank
accepting Current Ratio less than 1.33 times)
(2) The bank may also
ask the company/promoter to bring 100% margin. Why? Because if the company is
maintaining exact 1.33 times Current Ratio
before opening of the LC, then there is no additional current asset available
as a primary security to the bank. Actually, there has to be additional current
assets (which are hypothecated to bank as primary security) equivalent
to the difference between the LC value and FDR margin provided by company. In
the absence of this validation, if the bank agrees for issuance of LC at the
stipulated FDR margin, it is done on the following strength:
(1) The bank is ready
to take non fund based unsecured exposure equivalent to the difference between
the LC amount and FDR Margin.
(2) The company has
provided sufficient collateral security which ensures that bank’s exposure is
always 100% secured.
The estimated balance
sheet will look like as following:
Current Assets
|
Current Liabilities
|
Inventory
: 100
|
Sundry
Creditors:25
|
Bank
Borrowing Inventory: 50
|
|
Non Current Assets
|
Non Current Liabilities
|
FDR
Margin for PBG: 20
|
Promoter’s
Contribution for CA : 25
|
FDR
Margin for materials LC : 5
|
Promoter’s
Contribution for FDR PBG Margin:20
|
Promoter’s
Contribution for FDR LC Margin:5
|
|
Total:
125
|
Total
: 125
|
Current Ratio (Current Assets Divided by Current Liabilities)
|
1.33 times
|
