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CORPORATE FINANCE
Corporate Finance broadly classified under:

1. Fund Based Limits


2. Non-Fund Based Limits

Fund Based Limits can be in the form of working capital, term loan, Bill discounting, export
finance

Non-Fund Based limits are in the form of Bank Guarantee, Letter of Credit
Short term funds are required for working capital for the following:

 Purchase of raw materials and consumables and keeping at safety stock levels
 Payment for other factors of production such as labour, power, fuel so as to convert the
raw materials into goods in process and finally into finished goods.
 Stock of finished goods.
 Receivables till collection from the Debtors
Process Cycle or Operating cycle

Production or manufacture is a cycle where cash will be transformed to raw materials, then to
work in process, ends in Finished Goods which will become receivables(on credit sales) and
finally on cash, on payment by the debtors. This cycle starting from cash and ending in cash is
called Process Cycle or operating cycle.

Working capital finance by way of short term loans is also required for other reasons also:

a) Holding of Safety stock in order to prevent stock out in the event of fluctuations in Lead
Time (the time taken from placing an order for Raw materials till the time it is actually
received at the factory) or fluctuations in the pattern of consumption of raw materials. In
other words, if increased production is required to cater to a sudden increase in demand,
the extra amount of raw material required would be met from the Safety stock.
b) Seasonal nature of availability of an input. Almost all agro-based industry such as sugar,
cotton, jute, oilseeds, etc., need to be procured just after the harvest season, when the
holding of inventory peaks.
c) Seasonal nature of demand: There are items or products where demand will be much
higher during certain seasons; Eg;- Umbrella, fan, air-conditioners, coolers. Hence
additional inventory of finished goods may be required at this time, so as not to lose
market share.
WORKING CAPITAL FINANCE

Prior to 1970s working capital loans were extended on the basis of the security offered.
Loans to industries used to be granted against the security of factory land and buildings,
plant and machinery and stocks stored in warehouses. Thus loans were granted against
the security of pledge of goods or mortgage of real estate.

RBI set up a working Group headed by Tandon the then Chairman of PNB, in July 1974
to suggest methods for improving the delivery of industrial credit based on the
performance and projections of the borrower, rather than the security offered.

The committee suggested 3 methods of lending. Banks can work out the Maximum
Permissible Bank Finance (MPBF) based on these methods.
According to the recommendations of Tandon Committee, the Corporates should be
discouraged from accumulating too much of stocks (of current assets) and should move
towards very lean inventories and receivables level. The Committee even suggested the
maximum levels of raw materials, stock-in process and finished goods which a corporate
operating in an industry should be allowed to accumulate. These levels were termed as
inventory and receivable norms.
As per the extant guidelines from RBI, to expedite the credit sanctions to smaller
borrowers, whose total credit limits do not exceed Rs.5 crore, banks adopt what is called
Turnover Method. Under this method, after satisfying themselves about the achievability
of the projected sales for the ensuing year, banks fix 25% of the sales as the total fund
based requirements of the business and after stipulating a contribution of 5% of gross
turnover from the entrepreneur, sanction 20% of projected sales as the limit.

Turnover method of assessment is based on the assumption that the trade cycle of the
borrower is 3 months or in other words business can roll over 4 times in a year.
Security:
The assets created out of the bank’s loan are invariably taken as security. This is known
as the primary security. In cases of loan default, it is often found that it may not be
sufficient to cover the bank’s dues especially in the case of stocks and book debts. On
account of such possibilities, banks insist on a collateral security, that may be in the form
of :
i) Personal guarantee of the directors, partners
ii) Personal guarantee of third parties
iii) Mortgage of factory, land and buildings
iv) Mortgage of other property belonging to the owners or guarantors.
Creation of charge: Charge is created on the security by way of the following usual ways:

Pledge: the possession of the property/asset pledged passes to the creditor. But in the present
practice, the debtor holds the property as an agent for the creditor.

Hypothecation: The possession of asset remains with the debtor, and the creditor holds a
floating charge.

Mortgage: the borrower creates a charge on immovable property making a conditional


conveyance of the property that can be enforced in the event of default.
CONDUCT AND MONITORING OF INDUSTRIAL LOANS

Industrial loans require very close monitoring so as to ensure safety of the bank’s interests. The
following two points to be kept in mind.

i) Asymetric information: The borrowers have more information about the affairs of
their own industrial unit than the bank officials. Usually sensitive and negative
information could be withheld with the borrower, without sharing with their banker.
The bank has therefore to ascertain the correct position by remaining constantly
vigilant and meticulously follow the procedures.
ii) Moral hazard : The borrower has far less financial stake than the bank in the project.
This is because loans are usually given with a Debt Equity ratio of 3:1 or even more.
Thus the borrower has less to lose than the bank in case the enterprise does not
succeed. In other words, there is a possibility that the borrower may not take as much
care of the assets taken by the bank as security, but the possession of which remains
with the borrower, as he would have, had the entire money been his own.
Drawing Power (DP) : Based on the position of current Assets declared by the borrower in the
stock statement, the bank calculates the DP, or the level up to which the borrower can be
permitted to draw in his Cash Credit Account. The DP does not exceed the limit that has been
sanctioned to the borrower. Normally non-moving stocks and receivables beyond 90 days are
taken out from cover while calculating the DP under cash credit facilities. Current RBI
guidelines mandate that that if any corporate does not submit the required monthly stock
statement for three months continuously then the drawing power and drawing limit is required to
be brought to zero.
Renewal of Borrowal Accounts: All ODs/ Cash Credit limits are valid for one year only. Tehe
facilities must be renewed at intervals of not more than a year based on audited annual financial
statements not more than 6 months old. The renewal exercise is akin to the exercise for grant of
fresh limits, as a fresh sanction is granted as a result of the exercise. Current RBI guidelines also
stipulate that unless the various limits in an account are reviewed within six months of its annual
due date, the account required to be treated as a NPA.
EXPORT FINANCE

RBI first introduced the scheme Export Financing in 1967.

The following facilities are extended under Export Finance

Rupee Export Credit

- Pre-shipment Rupee Export Credit


- Post-shipment Rupee Export credit

Foreign currency Export Credit

- Pre-shipment Credit in Foreign Currency


- Post-shipment Credit in Foreign Currency
Pre-shipment or Packing credit means any loan or advance granted or any credit provided by a
bank to an exporter for financing the purchase, processing, manufacturing or packing of goods
prior to shipment.

Generally this type of advance is made against the lodgment of export orders or letter of credit
by the intending exporter
Period of Advance

The period for which a packing credit advance given by a bank will depend upon the merits of
the individual case, such as the time required for procuring, manufacturing or processing and
shipping the relative goods/rendering of services. On the basis of the appraisal for working
capital requirements, banks will decide the period for which a packing credit advance may be
given, having regard to the various relevant factors so that the period is sufficient to enable the
exporter to ship the goods/render the service.
If pre-shipment advance are not adjusted by submission of export documents within 360 days
from the date of advance, the advances will cease to qualify for concessive rate of interest to the
exporter ab initio.

RBI would provide refinance for such credits only for a period not exceeding 180 days.

Liquidation of Packing Credit

The packing credit/pre-shipment credit granted to an exporter is generally liquidated out of


proceeds of bills drawn for the export, thereby converting pre-shipment credit into post shipment
credit.

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