Importance of Stock Audit for Working Capital Lender

The working capital finance is extended to a company/corporate borrower based on various projections about the operations/business performance. The fund based and non fund based limits are provided to the borrower for procuring raw materials required in the production process. The fund based limits are released to the borrower depending upon the Drawing Power (DP) arrived based on

Stock Statement. The non fund based limits are utilized by the borrower in the form of Letter of Credit(LC)/Buyer’s Credit (BC) for procurement of stocks. The banker understands the financial performance of the corporate borrower based on financial reports and various other statements submitted by borrower. However, since monitoring is the most critical part of working capital lending management, the bank needs to undertake assessment of the position of operations at the factories of the borrower to know about the position of stocks and receivables which are primary security to the working capital lender and appropriate safety measures and valuation of the same is of prime importance for the WC lender.

The Stock Audit report is prepared by a Chartered Account (CA) firm empanelled with the lender, and at the cost of borrower. It is preferred to conduct at least two stock audits in a financial year. The periodicity may depend upon the size of operations of the company/borrower as well their financial health/reputation deciding the criticalness of the stock audit. Sometimes, when the factories of the borrower are spread across several locations, it becomes tedious to conduct multiple stock audits. Similarly, for small companies also multiple stock audits may put burden on their budget as well as time & resources.

Stock Audit report of company is like an X-Ray Report for a Working Capital lender. It provides details of important inside information about the stocks and operations at the factories of the borrower which are generally situated at far-away locations and it is not possible for the banker to undertake regular and exhaustive inspections. The stock audit supports in fulfilling this requirement. The report covers many important details viz installed capacities, major stock items, method of inventory management/control at factory, no. of days for which stock is stored, proper preservation/handling of stocks, identification of movement of stocks, age-wise examination of receivables,  stock valuation methods adopted by borrower, adequacy of insurance coverage, job work received/outsourced, details of slow moving stocks, obsolete stocks, auditors views on marketability of stock, ownership of stock with borrower, demand/supply conditions, stock being commensurate with production or not, no. of workers, any abnormal consequence occurred at factory, data/record management, receivable collection system, quality of stock and receivables, auditors suggestion on any improvement required etc.

The fund based limits are released to the borrower based on drawing power(DP) worked out and DP depends on the stock and receivable statement. Under the stock audit, the auditor physically checks the stock position of raw materials, work in progress and sales registers at the factories. The auditor checks the production and despatch of goods through Excise Register, Purchase Invoices, Sales Bills etc. The stock auditor compares his calculations of drawing power based on his physical verification of stock & receivable position at the factory, with the calculation submitted by the borrower to the lender. Any difference in calculation is reported in the audit report, based on which the borrower is required to submit clarifications to the lender or take corrective measures.

From the above, it can be understood that stock audit is a critical tool which helps the working capital banker to understand the actual positions of the raw materials and production funded by the limits released by the lender. The audit helps to ensure that the bank funds are properly utilized without diversion. Considering, the working capital lending relationships to be long term in nature, and for the growing companies whose working capital need increase year on year, the stock audit helps in understanding the growing requirements. Stock Audit ensures proper valuation of stocks and receivables and measures for safety of stocks. In light of the above, it is of utmost importance for the banker to timely get the stock audits conducted, thoroughly analyze the stock audit report, and also take up any issue mentioned in the report with the borrower.

What’s Exchange Earner’s Foreign Currency Account?

Over the years Exports from India have been increasing owing to an unprecedented growth in sectors like software, jewellery, textiles, biotechnology, gems, etc. This has resulted in substantial increase in the inward remittances. In order to protect the companies engaged in regular export and import from the exchange rate fluctuations, Reserve Bank of India (RBI) has allowed parking of foreign currency by exporters in an account designated as Exchange Earners Foreign Currency Account (EEFC).

Reserve Bank of India defines Exchange Earners' Foreign Currency Account (EEFC) as an account maintained in foreign currency with an Authorised Dealer i.e. a bank dealing in foreign exchange. It is a facility provided to the foreign exchange earners, including exporters, to credit 100 per cent of their foreign exchange earnings to the account, so that the account holders do not have to convert foreign exchange into Rupees and vice versa, thereby minimizing the transaction costs.

All categories of foreign exchange earners, such as individuals, companies, etc. who are resident in India, may open EEFC accounts. An EEFC account can be held only in the form of a current account. No interest is payable on EEFC accounts. 100 per cent foreign exchange earnings can be credited to the EEFC account subject to the condition that the sum total of the accruals in the account during a calendar month should be converted into Rupees on or before the last day of the succeeding calendar month after adjusting for utilization of the balances for approved purposes or forward commitments. Cheque facility is made available for operation of the EEFC account. The bank opening the EEFC A/c requires the customer to first open a parent INR Current Account for crediting the INR leg of the transaction/converting the balance held in the EEFC account into INR as well as for paying the charges.

There is no restriction on withdrawal in Rupees of funds held in an EEFC account. However, the amount withdrawn in Rupees shall not be eligible for conversion into foreign currency and for re-credit to the account. EEFC account holders are permitted to access the forex market for purchasing foreign exchange only after utilizing fully the available balances in the EEFC accounts. EEFC account balances can be also hedged however the balances in the account sold forward by the account holders has to remain earmarked for delivery. The hedge contract is allowed to be rolled over.

What’s Duty Drawback Scheme?

The Government of India supports exports of goods from the country. In order to make exports competitive, Government provides cushion to exporters by reducing their production cost through various schemes. Duty Drawback is one of the many schemes in this direction. When exporters import materials/goods which are used as input for production of Export Goods, they need to pay custom duty, excise duty and service tax on input services. These duties increase the cost of production and can make the price of export product high which may ultimately lead to making the product uncompetitive in the international market. Therefore, under the scheme Government provides reimbursement of duties paid. The Duty Drawback facility on export of duty paid on imported goods is available in terms of Section 74 of the Customs Act, 1962. Under this scheme part of the Customs duty paid at the time of import is remitted on export of the imported goods, subject to their identification and adherence to the prescribed procedure.

 

The Duty Drawback is of two types: (i) All Industry Rate and (ii) Brand Rate. The All Industry Rate (AIR) is essentially an average rate based on the average quantity and value of inputs and duties (both Excise & Customs) borne by importer and Service Tax suffered by a particular export product. The All Industry Rates are notified by the Government in the form of a Drawback Schedule every year and the present Schedule covers about 4000 entries.

 

The Brand Rate of Duty Drawback is allowed in cases where the export product does not have any AIR of Duty Drawback or the same neutralizes less than 4/5th of the duties paid on materials used in the manufacture of export goods. This work is handled by the jurisdictional Commissioners of Customs & Central Excise.

 

The AIR of Duty Drawback are notified for a large number of export products every year by the Government after an assessment of average incidence of Customs, Central Excise duties and Service Tax suffered by the export products. The AIR are fixed after extensive discussions with all stake holders viz. Trade Associations, Export Promotion Councils and individual exporters to solicit relevant data, which includes the data on procurement prices of inputs, indigenous as well as imported, applicable duty rates, consumption ratios and FOB values of export products. The AIR of Duty Drawback is generally fixed as a percentage of FOB price of export product. Caps/Upper limits have been imposed in respect of many export products in order to avoid the possibility of misuse by dishonest exporters through over invoicing of the export value.

 

In case of goods which were earlier imported on payment of duty and are later sought to be exported within a specified period, Customs duty paid at the time of import of the goods, can be later claimed as Duty Drawback at the time of export of such goods under Section 74 of the Customs Act, 1962 read with Re-export of Imported Goods (Drawback of Customs Duty) Rules, 1995. For this purpose, the identity of export goods is cross verified with the particulars furnished at the time of import of such goods. Where the goods are not put into use after import, 98% of Duty Drawback is admissible under Section 74 of the Customs Act, 1962. In cases the goods have been put into use after import, Duty Drawback is granted on a sliding scale basis depending upon the extent of use of the goods. No Duty Drawback is available if the goods are exported 18 months after import. Application for Duty Drawback is required to be made within 3 months from the date of export of goods, which can be extended up to 12 months subject to conditions and payment of requisite fee as provided in the Drawback Rules, 1995.

 

The Duty Drawback on export goods is to be claimed at the time of export and requisite particulars filled in the prescribed format of Shipping Bill/Bill of Export under Drawback. It is not mandatory to have prior repatriation of export proceeds for grant of Duty Drawback. However, as per the rule if sale proceeds are not received within the period stipulated by the RBI, the Duty Drawback will be recovered as per procedure laid down in the Drawback Rules, 1995.

Operational Aspect of Running Account Export Credit Facilities

As we know, Pre-Shipment Credit to exporters is normally provided on lodgment of L/Cs or firm export orders. In some cases it has been observed that the availability of raw materials is seasonal. While in some other cases, it is noted that the time taken for manufacture and shipment of goods is more than the delivery schedule as per export contracts. In such types of cases, the exporters have to procure raw material, manufacture the export product and keep the same ready for shipment, in anticipation of receipt of letters of credit / firm export orders from the overseas buyers. Therefore obviously availment of PC by lodgment of L/Cs or firm export orders is not possible. To overcome this situation, RBI allows banks to extend Pre-shipment Credit ‘Running Account’ facility without insisting on prior lodgement of letters of credit / firm export orders.

 

Now, operationally, the Borrower, availing PC liquidates the same by availing Post Shipment Credit (PSC), and the PSC is liquidated by the proceeds of export bills received from abroad in respect of goods exported / services rendered. This chain on PC to PSC keeps rolling on. Operationally, the banker has to ensure that under Running PC, LC/firm orders should be produced within a reasonable period of time as may be decided by the bank. The bank also has to mark off individual export bills, as and when they are received for negotiation / collection, against the earliest outstanding Pre-Shipment Credit on 'First In First Out' (FIFO) basis. While marking off the Pre-Shipment Credit in the manner indicated above, banks should ensure that export credit available in respect of individual Pre-Shipment Credit does not go beyond the period of sanction or 360 days from the date of advance, whichever is earlier and for Post-Shipment the period prescribed for realisation of export proceeds is 365 days from the date of shipment. While the PC can also be marked-off with proceeds of export documents against which no packing credit has been drawn by the exporter, the Post-Shipment can also be repaid / prepaid out of balances in EEFC A/c or also from proceeds of any other unfinanced (collection) bills.

What is Post-shipment Credit?

Post-shipment Credit means any loan or advance granted or any other credit provided by a bank to an exporter of goods / services from India from the date of extending credit after shipment of goods / rendering of services to the date of realisation of export proceeds as per the period of realization prescribed by Foreign Exchange Dept. (FED) of RBI, and includes any loan or advance granted to an exporter, in consideration of, or on the security of any duty drawback allowed by the Government from time to time. As per the current instructions of FED, the period prescribed for realisation of export proceeds is 365 days from the date of shipment. With effect from May 05, 2012, banks have been given freedom to decide rate of interest to be charged by them on Post-shipment Credit.

Post-shipment advance can mainly take the form of: (A) Export bills purchased/discounted/negotiated (B) Advances against bills for collection (C) Advances against duty drawback receivable from Government.

Post-shipment credit is to be liquidated by the proceeds of export bills received from abroad in respect of goods exported / services rendered. Further, subject to mutual agreement between the exporter and the banker it can also be repaid / prepaid out of balances in Exchange Earners Foreign Currency Account (EEFC A/C) as also from proceeds of any other unfinanced (collection) bills. Such adjusted export bills should however continue to be followed up for realization of the export proceeds. In order to reduce the cost to exporters (i.e. interest cost on overdue export bills), exporters with overdue export bills may also extinguish their overdue post shipment rupee export credit from their rupee resources.

The Bold & Beautiful of Asset Lease Finance by Lease Rental Discounting

This is one of the bold innovative financing structures evolved in the field of lending. Urge of Lessors, Lessees, and Bankers to fall in love with it makes it really beautiful. Under an Asset Lease, there is a party who needs some asset(s) but does not want to shell out cash for purchasing the same. One of the reason may be that the balance sheet of the party is already heavily leveraged (i.e ratio of total outside liabilities to networth) and it does not want to further overstress the same. The other reason could be that the asset to be procured are expected to become obsolete after 2-3 years and the party may like to return these assets to the leasing agency and procure new assets (examples of such type of assets may be laptops, computers, servers etc. for office). In order to meet this requirement of the party, there are asset leasing agencies who supply the required assets on lease basis. Under the leasing arrangement, the assets are supplied for an agreed period (generally between 3 to 5 years) wherein the party agrees to pay monthly or quarterly rentals to the leasing agency. At the end of the lease period the party is provided option either to renew the contract for an extended period or return the assets to the leasing agency.

 

Now, the questions comes is that who funds the procurement cost for these equipments. Say for an example that the purchase cost of the equipments is USD 1100 and the party is willing to take these equipments for a one year lease and ready to pay USD 100 per month as rental. Therefore, if the leasing agency procures the equipment and puts on lease for a year it will get USD 1200 during the lease period of 12 months against the procurement cost of USD 1100 and difference of USD 100 will be the profit.  In order to earn this profit of USD 100, the lease agency will need to shell out USD 1100 from its own funds or other option is to take bank finance for a part of the procurement cost. Leasing agency would not like to entirely invest USD 1100 from its own coffers as it would need funds for expanding the business. Therefore, let’s say it decides to fund the procurement through bank loan.

Now the beautiful part of the transactions comes. The banker will discount the future expected monthly lease rentals (let’s assume nominal monthly discount rate of 20%) and arrives at value of USD 1080. So, the bank may provide USD 1050 and the leasing agency will shell out USD 50 (which will be treated as its contribution) for procurement of equipments worth USD 1100. The party to whom the equipments are rented is called Lessee, the leasing agency who procures the equipments for renting is called Lessor and the bank is called the Funder. The Lessor agrees to deposit the monthly rental into an escrow account with the banker so the banker is assured of directly getting the monthly instalment from the Lessee.  By the end of the lease period, the equipments become free from loan and can be put on lease again by the leasing agency. I would like readers to think about the risk factors involved in the transaction, and just to hint I would like to mention that there are many.

What is Pre-shipment/Packaging Credit?

The Government of India encourages commercial banks to finance the credit requirements of exporters. Pre-shipment and Post-shipment credit are two of the schemes under the same efforts of the Government.

Pre-shipment / Packing Credit (PC) means any loan or advance granted or any other credit provided by a bank to an exporter for financing the purchase, processing, manufacturing or packing of goods prior to shipment / working capital expenses towards rendering of services on the basis of letter of credit opened in his favour or in favour of some other person, by an overseas buyer or a confirmed and irrevocable order for the export of goods / services from India or any other evidence of an order for export from India having been placed on the exporter or some other person, unless lodgement of export orders or letter of credit with the bank has been waived. If pre-shipment advances are not adjusted by submission of export documents within 360 days from the date of advance, the advances will cease to qualify for subsidised interest rate offered by bank for export credit to the exporter. When PC is given by banks in Foreign Currency it is known as PCFC. With effect from May 05, 2012 banks have been given freedom to decide rate of interest to be charged by them on PC/PCFC.

The packing credit / pre-shipment credit granted to an exporter may be liquidated out of proceeds of bills drawn for the exported commodities on its purchase, discount etc., thereby converting pre-shipment credit into post-shipment credit. Further, subject to mutual agreement between the exporter and the banker it can also be repaid / prepaid out of balances in Exchange Earners Foreign Currency A/c (EEFC A/c) as also from rupee resources of the exporter to the extent exports have actually taken place. If not so liquidated/ repaid, banks are free to decide the rate of interest as prescribed by RBI.

It has been observed in many cases that the exporters have to procure raw material, manufacture the export product and keep the same ready for shipment, in anticipation of receipt of letters of credit / firm export orders from the overseas buyers. Having regard to difficulties being faced by the exporters in availing of adequate pre-shipment credit in such cases, banks have been authorised to extend Pre-shipment Credit ‘Running Account’ facility in respect of any commodity, without insisting on prior lodgement of letters of credit / firm export orders, depending on the bank’s judgement regarding the need to extend such a facility.

 

Banks may extend the ‘Running Account’ facility only to those exporters whose track record has been good as also to Export Oriented Units (EOUs)/ Units in Free Trade Zones / Export Processing Zones (EPZs) and Special Economic Zones (SEZs). In all cases where Pre-shipment Credit ‘Running Account’ facility has been extended, letters of credit / firm orders should be produced within a reasonable period of time to be decided by the banks. Banks should mark off individual export bills, as and when they are received for negotiation / collection, against the earliest outstanding pre-shipment credit on 'First In First Out' (FIFO) basis. Banks should ensure that export credit available in respect of individual pre-shipment credit does not go beyond the period of sanction or 360 days from the date of advance, whichever is earlier.