Case Study for Istisna

Scenario
M/s. ABC Garments Ltd. Was incorporated in 1980 and is a part of BCG
Group. The client is engaged in the manufacturing of Men formal and casual
wear. They sell its finished product to local and international buyers on credit
basis. Their export sale constitutes of more than 50% of their sale
The company has a strong banking relationship with MBL and the owners are
interested in Islamic banking. As the customer usually sell its goods on credit
basis so there is always a short term requirement of funds for working capital
needs. The owners of the company have approached the bank and informed
about their working capital requirements (to manufacture the goods for the
order). The customer has informed the bank that it has very sound
relationships with its customers and till to date there is no default in payment
and provides list of credible customers.
Related RMs decided to offer Istisna Financing to the customer

Statistics
Upon inquiry of the RM customer informed that it has a confirmed order in place for
the supply of 4000 units of Men sports Outfit to Faysal Agencies at Rs. 1.11 Mn for
which he has not yet started the production. Following additional information was also
obtained by the RM to determine the nature of the Istisna facility to the customer:
Market Price fluctuation: 5%

Cost Cushion: 5%

Credit Sale Period: 30 days

Delivery Date: After 120 Days of Disbursement

Zip Hoodie Sweat Shirt Mens
Number of Units:
1000
Cost price per unit:
Rs.274
Sale price per unit :
Rs.338
Gross Margin:
19%

Round Neck Sweat Shirt Boys

Number of Units:
1000
Cost price per unit:
Rs.240
Sale price per unit :
Rs.293
Gross Margin:
18%

Mens Short
Number of Units:
Cost price per unit:
Sale price per unit :
Gross Margin:

Mens Pique Shirt

Number of Units:
Cost price per unit:
Sale price per unit :
Gross Margin:

1000
Rs.254
Rs.318
20%

1000
Rs.130
Rs.156
17%

Istisna Pricing
1. Since the customer has a average gross margin of 19% for the four outfit
products, so the R.M decided to give order to the customer to manufacture
1000 units each at the following prices:
Zip Hoodie Sweat Shirt Mens
Cost Price for Istisna/Unit:
Rs.260
Market Selling Price/Unit:
Rs.338
Target Selling Price/Unit:
Rs.321

Round Neck Sweat Shirt Boys

Cost Price for Istisna/Unit:
Rs.228
Market Selling Price/Unit:
Rs.293
Target Selling Price/Unit:
Rs.278

Mens Short
Cost Price for Istisna/Unit:
Market Selling Price/Unit:
Target Selling Price/Unit:

Mens Pique Shirt

Cost Price for Istisna/Unit:
Market Selling Price/Unit:
Target Selling Price/Unit:

Rs.242
Rs.318
Rs.302

Rs.123
Rs.156
Rs.148

2. Customer intimate that it will deliver the manufactured goods to Bank after
120 days and before shipment.

Istisna Pricing

3. These Purchase prices of Rs.260/unit, Rs.228/unit, Rs.242/unit, Rs.123/unit

also gives a 5% cost cushion to RM to sell the goods in the market and to recover
its principal and profit in case the customer fails to sell the goods to the ultimate
purchaser as an agent of MBL (With confirmed order in place this risk is mitigated to a
huge extent)
4. After 30 days, customer delivers the goods to MBL and ownership is transferred
to MBL.

Istisna Pricing
MBL SELLING PRICE:
1)

MBL, after purchase of goods would ask the customer to sell the goods, as
MBLs agent to the ultimate purchase as per the purchase order at Rs.
1,049,988 (5% less than the normal order price of Rs, 1,105,250) to
mitigate the risk of price fluctuation in the market.

2)

As per the terms of the order MBL the agent would be required to bring
the sale proceeds to MBL within 30 days of the execution of sale.

3)

MBL will give a fixed agency fee to its agent @ 1% of the MBLs selling
price i.e Rs.11,053

Istisna Pricing
4) Incentive fee:
{Incentive fee = MBLs sale price - Agency fee - MBL Purchase price
MBLs profit margin {(MBL Purchase price x profit/365

x No. of days) }

Financing Period of 150 days= Istisna Delivery Period + Credit Sale Period)
Incentive Fee = MBLs Sale Price MBL Purchase Price Agency Fee
(1,049,988)
(853,221)
(11,053)

MBLs Profit Margin

(52,596)
Incentive Fee =

133,118

Istisna Process Flow

Credit Approval Stage
After necessary Credit and Shariah approvals, MBL & ABC
(Manufacturer) will enter into Master Istisna Agreement to manufacture
goods from time to time on agreed terms and conditions. The customer and
MBL will also enter into an Agency Agreement to sell/export the goods to
credible buyers Customer will also sign an independent corporate
guarantee for the creditworthiness of its customer by listing out their
names.
Upon the requirement of the facility the customer furnishes a Written Offer
(Appendix A) mentioning complete description of goods (Men sports outfit),
quantity (4000 Units), delivery date(after 120 days) and Istisna price (Rs.
853,221) etc along with copy of valid confirmed order.

Istisna Process Flow

Transaction Stage

Upon acceptance of the offer MBL disburses the fund into the account of
the customer.

Customer delivers the goods on 120th day of the acceptance of Written

offer.

MBLs representative inspects the goods to ensure existence of goods, its

proper identification & separation from the customers owned stocks (i.e.
goods not sold).

Istisna Process Flow

A Goods Receiving Note (Appendix B) will be executed at this moment by

the Bank representative & Customer to evidence the delivery of the Finished
Goods-Mens Sports Outfit (4000 units) to MBL. The risks and rewards
associated with the Goods will be transferred to MBL at this stage.

Agency Stage

As per the Agency Agreement MBL appoints the customer as his agent to sell
the goods at Rs. 1,049,988 (accounting for price fluctuation of 5%) and bring
the sale proceeds in 30 days as per the confirmed order.

Istisna Process Flow

Agency Stage
On the basis of financing model following agency fee and incentive fee was
agreed via schedule 2 of Agency Agreement:
Agency fee: Rs. 11,053 (1% of Minimum selling price)
Days from the
date of
Notice

Incentive Fee
(Rs.)

145

134,871

150

133,118

155

131,365

Istisna Process Flow

As an Agent, ABC will sell the goods to Faysal Agencies on credit basis of
30 days which will be evidenced via Confirmation of Sale of Finished
Goods (Schedule 3 of the Agency Agreement).
As per the payment terms, the buyer will pay the selling price to the
Agent. After receiving the payment, the Agent will pass on the proceeds
i.e. Rs.1,105,250 (net of applicable Agency & Incentive fee) to MBL on due
date.
If the customer makes the payment on due date the following will be the
net cash flow out of this transaction:
Outflow
PKR

Inflow
PKR

Agency fee
PKR

Incentive fee
PKR

Net inflow
PKR

Margin
PKR

853,221

1,049,988

11,053

133,188

7,777,397

15%

Istisna Process Flow

Following table debits different scenarios of early and late payment by the
customer (Customers incentive fee will be reduced/increased to account for his
performance)
S. No.

Bank
outflow

(853,221)

Inflow

Agency Incentive Net flow

fee

Profit

145

1,049,988

11,053

134,871

7,761,786

50,843

150

1,049,988

11,053

133,118

7,777,397

52,596

155

1,049,988

11,053

131,365

7,792,808

54,349

Appendixes for Istisna Agreement

APPENDIX A
WRITTEN OFFER

[Date]

To: [Insert name and address of the Bank]

Dear Sirs,
(1)

Written offer for manufacture of Goods [insert description]

We (the Manufacturer) are pleased to confirm our willingness to manufacture the Goods
subject to the following terms and conditions:
(a)

Description of the Goods: ------------------------------------------------------------------------------------------------------------------------------------------------------------

(b)

Detail of Goods and Istisna Cost Price (cost of manufacture):

S.no

Specification of Goods

Quantity

1
2
3

100% Cotton Flannel Dyed

100% Cotton Flannel Dyed
100% Cotton Flannel Dyed

5000
6900
7200

(c)

Per Unit Istisna

Price
158
285
352

Total Istisna
Price
5,000,158
1,966,500
2,534,400

Delivery Date
14 Feb 2011
14 Feb 2011
14 Feb 2011

Point of Delivery:

(2)

We also attach the original and valid [Letter of Credit][Purchase Order] (if available).

(3)

All terms and conditions (including the definitions) of the Master Istisna Agreement shall
apply to this Written Offer.

IN WITNESS WHEREOF, the Manufacturer has executed and delivered this Written Offer as of
the date mentioned hereinabove.
Yours faithfully,
For and on Behalf of the Manufacturer
______________________
WITNESSES:
1. __________________________

2. __________________________

Acceptance of the above Written Offer

We, Meezan Bank Limited accept the Written Offer of the Manufacturer dated ___ on the terms and
conditions contained in the Master Istisna Agreement.
______________________
For and on Behalf of Meezan Bank Limited
Dated: ________________

APPENDIX B
GOODS RECEIVING NOTE
(for ISTISNA Transactions)
[Date]
To:
[Insert name and address of the Manufacturer]
Dear Sirs,
Master Istisna Agreement dated [______] (Agreement) Goods Receiving Note
(1)

We confirm having received the Goods contracted to be delivered by you as per the
following details:
a) Date of Receipt:
b) Time:
c) Address:
d) Description of Goods received: The quantity, quality, and other specifications of the
Goods have not been ascertained.
e) Specification of Goods received:

Description
Pillow Case
Single Fitted Sheet
Double Fitted Sheet
f)

Qty
(Units)
5000
6900
7200

Specification
100% Cotton Flannel Dyed
100% Cotton Flannel Dyed
100% Cotton Flannel Dyed

Goods identification Method:

g) Date of Physical Inspection:

Value in PKR
(Per unit)
158
285
352

NOTE: The specifications of the Goods must match with the

specifications mentioned in the Written Offer i.e. Appendix A of
the Master Istisna Agreement (This text box is not a part of the
agreement.)

h) Additional remarks: This receipt of Goods is subject to the Goods being inspected and
found in order and Meezan Bank Limited reserves its rights to claim any remedies under
the law and in terms of the aforementioned Agreement from the Manufacturer if the
Goods are found not to be in order and as per the specifications agreed upon. Meezan
Bank Limiteds acceptance of the Goods hereunder does not amount to a waiver of any
of its rights under the law and/or under the Agreement.
Yours faithfully,
______________________________________
For and on Behalf of Meezan Bank Limited

Appendixes for Agency Agreement

SCHEDULE 1 (Agency Agreement)

Notice
(for ISTISNA Transactions)

[Date]
To,
[Agent]
[Address]
Attention:
From:

[
[

]
]

Re: Authorization to Sell the Goods as Undisclosed Agent

We refer to the Agency Agreement between [

] and us dated [

](Agency Agreement)

In pursuance of Clause 3 of the Agency Agreement, we hereby authorize you to sell the following Goods
(Sale Goods) on our behalf as our undisclosed agent and following the sale of the Sale Goods collect
and pay us the Sale Price immedietaly upon receipt of the Sale price. We hereby advise and authorize you
to take possession of the Sale Goods from [Point of Delivery] on [
] so as to be able to
execute the sale contemplated by this Notice and the Agency Agreement. Your Agency Fee and
Incentive Fee shall be as per attached Schedule 2

Description
Pillow Case
Single Fitted Sheet
Double Fitted Sheet
Total
Buyer (If identified)

Qty (Units)
5000
6900
7200

Specification
100% Cotton Flannel Dyed
100% Cotton Flannel Dyed
100% Cotton Flannel Dyed

Minimum Target
Selling Price (PKR
/ Unit)
158
285
352

NOTE: The specification and quantity of the Goods must match

with the specifications mentioned in the Goods Receiving Note.
(This text box is not a part of the agreement.)

Terms: Advance ____ days before sale (advance payment to be received after Notice)
Advance ___ days before sale (advance payment already received before Notice)
Spot (Cash)
Credit ____ days from Sale
Sale Price Payment Date (If identified):

Payment Instructions:
[to be credited to our account [
] with [
]
Without limiting the applicability of any other provision of the Agency Agreement or any of the other
related transaction documents) the provisions of the Agency Agreement shall apply (mutatis mutandis)
to this Notice as if the same were herein set out in full. In addition to the terms of the Agency
Agreement, the above authorization to sell as our undisclosed agent is subject to the following
conditions:
Examples of conditions include:
a.
b.
c.

Sale price below Rs. 40 per unit not allowed

(This text box is not a part of the agreement.)

IN WITNESSES WHEREOF, the Principal has executed and delivered this Notice as of the [*] day of
[*]
For and on behalf of
______________________________________
For and on Behalf of Meezan Bank Limited
WITNESSES:
1. _____________________

2. _____________________

Schedule 2
Agency Fee
1. Agency Fee Rs.11,053
2. Incentive Fee as per following Schedule:
Days from the date of Notice

Incentive Fee (Rs.)

15

129,612

30

122,599

45

117,339

60

112,080

Risk Mitigation
RISK MITIGANTS
Price Fluctuation Risk: This risk was covered by asking the customer to sell
the apparel at minimum value of Rs.95/kg as against market value of Rs.
100/kg. .
Ultimate Buyer Risk: This risk is covered by asking the customer to list
down its 4 creditworthy customer and provide a corporate guarantee for these
customers.
Delay Payment risk: This risk is covered by linking incentive fee with the
timely payment of the customer which reduces on daily basis for late
payments.