9 short term financing for wc

8/8/2019 9 Short Term Financing for WC

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Short TermShort Term

FinancingFinancing


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Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning ObjectivesThe need for short-term financing.

The advantages and disadvantages of short-termfinancing.Three types of short-term financing.Computation of the cost of trade credit,commercial paper, and bank loans.How to use accounts receivable and inventory ascollateral for short-term loans.


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Why Do Firms Need S hortWhy Do Firms Need S hort--termtermFinancing?Financing?Why Do Firms Need S hortWhy Do Firms Need S hort--termtermFinancing?Financing?

Cash flow from operations may not be sufficient to keep upwith growth-related financing needs.

Firms may prefer to borrow now for their inventory or othershort term asset needs rather than wait until they havesaved enough.Firms prefer short-term financing instead of long-termsources of financing due to:

easier availability usually has lower cost (remember yield curve)

matches need for short term assets, like inventory


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Sources of S hortSources of S hort--term Financingterm FinancingSources of S hortSources of S hort--term Financingterm FinancingS hort-term loans.

borrowing from banks and other financial institutions for one year or less.

Trade credit.borrowing from suppliers

Commercial paper.only available to large credit- worthy businesses.


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Wh ich source of funds to c hoose ?Wh ich source of funds to c hoose ?Wh ich source of funds to c hoose ?Wh ich source of funds to c hoose ?1. Cost:

interest rates vary, but share issues carry high administration costs

2. S ize of loan:large amounts are less likely to be found from internal resources

3. Gearing:the ratio between owners equity & borrowed money will affect creditworthiness

4. Risk:the likely profitability of the investment will affect whether owners or lenders arewilling to invest

5. Collateral:where firms have assets as guarantees against loans, institutions are morewilling to lend

6. S tatus:reputable firms will find fund raising easier & less expensive


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SHORTSHORT- -TERM LOANSTERM LOANSFROM FINANCIAL INSTITUTIONSFROM FINANCIAL INSTITUTIONSSHORTSHORT- -TERM LOANSTERM LOANSFROM FINANCIAL INSTITUTIONSFROM FINANCIAL INSTITUTIONS

I nsurance companies provide short-term loans tomanufacturing companies with an excellent track record.

S uch loans are unsecured and given for a period of 1year, renewable for two consecutive years.

A company, to be eligible for such loans, should satisfy certain conditions relating to dividend payment, debt-equity ratio, current ratio, and interest cover ratio.

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T ypes of s hortT ypes of s hort--term loans:term loans:T ypes of s hortT ypes of s hort--term loans:term loans:P romissory note

A legal IOU that spells out the terms of theloan agreement, usually the loan amount, theterm of the loan and the interest rate.Often requires that loan be repaid in full withinterest at the end of the loan period.

U sually with a Bank or Financial I nstitution;occasionally with suppliers or equipment manufacturers


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T ypes of s hortT ypes of s hort--term loans:term loans:T ypes of s hortT ypes of s hort--term loans:term loans:Line of Credit

The borrowing limit that a bank sets for a firm

after reviewing the cash budget.The firm can borrow up to that amount of money without asking, since it is pre-approved U sually informal agreement and may changeover timeU sually covers peak demand times, growthspurts,etc.


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T rade CreditT rade CreditT rade CreditT rade Credit

Trade credit is the act of obtaining funds by delaying payment to suppliers, who typically grant 30 days to pay.The cost of trade credit may be some interest chargethat the supplier charges on the unpaid balance.More often, it is in the form of a lost discount that would be given to firms who pay earlier.Credit has a cost. That cost may be passed along to thecustomer as higher prices, (furniture sales,Office Max),or borne by the seller as lower profits, or some of both.


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E stimation of Cost of S hortE stimation of Cost of S hort--T erm CreditT erm CreditE stimation of Cost of S hortE stimation of Cost of S hort--T erm CreditT erm Credit

Calculation is easiest if the loan is for a one year perioEffectiveI nterest Rate is used to determine the cost of the credit to be able to compare differing terms.

Eff ectiveInterest Rate

Cost (interest + f ees)Amount you get to use

=

Example:Example:You borrow $10 ,000 from a bank, at a stated rate of 10% , and must pay $1,000 interest at the end of the year. Your effective rate is the same as the stated rate: $1,000/ $10 ,000 = .10 = 10%


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Variations in Loan

Terms

Variations in Loan

Terms

Variations in Loan

Terms

Variations in Loan

Terms

A discount loan requires that interest be paid upfront when the loan is given.This changes the effective cost in the previousexample since you only get to use:($10 ,000 - $1,000 ) = $ 9 ,000 .Effective rate = $1,000/ $ 9 ,000 = .1111 = 11.11%.


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V ariations in Loan T ermsV ariations in Loan T ermsV ariations in Loan T ermsV ariations in Loan T erms

S ometimes lenders require that a minimumamount, called a compensating balance be kept inyour bank account.I t is taken from the amount you want to borrow.I f your compensating balance requirement is$5 00 , then the amount you can use is reduced by

that amount.Effective Rate for a $10 ,000 simple interest 10% loan with a $5 00 compensating balance =

$1,000/ ($10 ,000 -$5 00 ) = .10 5 3 = 10 .5 3% .


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B oth Discount Interest andB oth Discount Interest and

Com pensating B alanceCom pensating B alance

B oth Discount Interest andB oth Discount Interest and

Com pensating B alanceCom pensating B alanceS ometimes, lenders will require both discount interest (paid in advance) and a compensatingbalance.I f the interest is $1,000 and the compensatingbalance is $5 00 , then the effective rate becomes:$1,000 / $10 ,000 - $1,000 - $5 00 $1,000 / $ 8 ,5 00 = 11.7 6 %


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Cost of S hort T erm CreditCost of S hort T erm CreditCost of S hort T erm CreditCost of S hort T erm CreditCost of Trade Credit

Typically receive a discount if you pay early.S

tated as: 2 / 1

0 , net 6

0

P urchaser receives a 2 % discount if payment is made within 10 days of theinvoice date, otherwise payment is duewithin 6 0 days of the invoice date.

The cost is in the form of the lost discount if you dont take it.


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Calculating APR Calculating APR (Annual Percentage of rate)(Annual Percentage of rate)Calculating APR Calculating APR (Annual Percentage of rate)(Annual Percentage of rate)

$ I nterest = Rate x P rinciple x Timei.e. I nt = 6 % x $1,000 x 9 0/3 6 0 = $15

AP R = $ I nterest (cost ) x 1$ Net Borrowed Time

AP R = $15 x 1 / 90 = 1.5 % x 4 = 6.0%

$1,000 3 6 0 S ay you have a loan fee of $5.00 , then

AP R = $15 + $5 x 1 / 9 0 = 2.0% x 4 = 8 .0%

1,000 3 6 0


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Cost of T rade Credit 2/10 net 60Cost of T rade Credit 2/10 net 60Cost of T rade Credit 2/10 net 60Cost of T rade Credit 2/10 net 60

Assume your purchase is $100 list price.I f you take the discount, you pay only $ 98 . I f you dont take the discount, you pay $100 .Therefore, you (buyer) are paying $2 for the privilege ofborrowing $ 98 for the additional 5 0 days. (Note: the first 10 days are free in this example). AP R = $2 / $ 98 x 365 / 5 0 = 14 .9 % ( I f you pay in 6 0 days)What if 2 %/ 10 , net 30

AP R = $2 / $ 98 x 365 / 2 0 = 37 .25 %! ( I f you pay in30 days)


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Commercial PapersCommercial PapersCommercial PapersCommercial PapersS hort-term borrowings by corporate, financial institutions, primary dealers from the money market Can be issued in the physical form ( U sance P romissory Note) or demat formI ntroduced in 1

99 0

When issued in physical form are negotiable by endorsement and delivery and hence, highly flexibleI ssued subject to minimum of Rs. 5 lacs and in the multiple of Rs. 5 lacs after that

Maturity is7 days to 1 year U nsecured and backed by credit rating of the issuing company I ssued at discount to the face value


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Commercial PaperCommercial PaperCommercial PaperCommercial PaperU nsecured promissory notes issued to the public by largecorporationsMajor Advantage toI ssuer

I nterest rate is typically below the prime rate.

Disadvantage toI ssuer Banks provide a certain degree of loyalty, commitment, and flexibility to their customers (willing to help customers who havetemporary problems). Dealers in commercial paper are muchmore impersonal.

Direct P aper (FinanceP aper) I ssued by finance companies (e.g.,GE Credit) directly to institutional investors.Dealer P aper S old by companies through a dealer network.


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Commercial Paper Commercial Paper Commercial Paper Commercial Paper

Rating Requirements :Mandatory for all participants . Rating to be obtained from either CRISI L,I CRA,CARE,F I TCH or any other rating agencies as specified by RBI The minimum credit rating should beP -2 of CRISI L or such equivalent by other agencies. The issuers shall ensure at the time of issuance of C P that the rating

is current and has not fallen due for review.

Maturity : C P can be issued for maturities between a minimum of 15 days and a maximum of up to one year form the date of issue. Thematurity date of C P should not go beyond the date up to which the

credit rating of the issuer is valid.

Denominations : C P can be issued in denominations of Rs 5 lacs or multiples thereof.


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Rating RequirementRating RequirementRating RequirementRating Requirement

All eligible participants should obtain the credit rating for issuance of Commercial P aper Credit RatingI nformationS ervices of I ndiaLtd.

(CRISI L )I nvestment I nformation and Credit Rating Agency of I ndiaLtd. ( I CRA)Credit Analysis and ResearchLtd. (CARE)

Duff &P helps Credit RatingI ndiaP vt.Ltd. (DCRI ndia)The minimum credit rating shall beP -2 of CRISI L

or such equivalent rating by other agencies


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M aturit yM aturit yM aturit yM aturit y

C P can be issued for maturities between aminimum of 15 days and a maximum upto one

year from the date of issue.

I f the maturity date is a holiday, the company would be liable to make payment on theimmediate preceding working day.


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Limit and Amount of issue of CP :Limit and Amount of issue of CP :Limit and Amount of issue of CP :Limit and Amount of issue of CP :

C P

can be issued as aS

tand Alone product. The aggregate amount of C P

from anissuer shall be within the limit as approved by its Board of Directors or the quantuindicated by the Credit Rating Agency for the specified rating , which ever is lowe

An F I can issue C P within the overall umbrella limit fixed by RBI i.e. I ssue of C P together with other instruments viz. term money borrowing, term deposits, certificof deposits and inter corporate deposits should not exceed 100 percent of its net owned fund as per the latest audited balance sheet.

The total amount of C P proposed to be issued should be raised within a period of two weeks from the date on which the issuer opens the issue for subscription. C P

may be issued on a single date or in parts in different dates provided that in thelatter case, each C P shall have the same maturity date.

Every C P issue should be reported to Chief General Manager,I ECD, RBI throughthe I ssuing and P aying Agent within three days from the date of completion of theissue as per the prescribed format.


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Role and res ponsibilities :Role and res ponsibilities :Role and res ponsibilities :Role and res ponsibilities :

I ssuer : I ssuer would ensure the strict compliance of theguidelines stipulated by RBI or any other statutory bodiesIP A :

IP A would ensure that the issuer has a minimum credit rating as

stipulated by the RBI and amount mobilized through issuance of C P is within the quantum indicated by CRA for the specified rating

IP A has to verify all documents submitted by the issuer viz. copy ofboard resolution, signatures of authorized executants and issue acertificate that documents are in order.

I t should also certify that it has a valid agreements with the issuer.

Hold the certified copies of the original documents in its custody.


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Cost of Commercial Pa per Ex am pleCost of Commercial Pa per Ex am ple

$1 million issue of 90 day commercial paper quoted at 4% discount rate.

S tep 1:S tep 1:Calculate D = .04 x $1 mill. x 9 0 = $10 ,000 36 0

S tep 2:S tep 2:Calculate price (amount you get)= $1,000 ,000 - $10 ,000

= $ 99 0 ,000

S tep 3:S tep 3: Calculate effective rate (AP R)= $10 ,000 / $ 99 0 ,000 = 1.0 10% x 4 = 4 .04%


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REGULATIONS OF CPREGULATIONS OF CP MARKETMARKETGuidelines Issued by RBI for t h e Issue of Commercial PaperGuidelines Issued by RBI for t h e Issue of Commercial PaperREGULATIONS OF CPREGULATIONS OF CP MARKETMARKETGuidelines Issued by RBI for t h e Issue of Commercial PaperGuidelines Issued by RBI for t h e Issue of Commercial Paper

As On Tangibl

e NetWorth

Workin

gCapital

Aggr. Amt. O f

CP Issue

Maturity Denominatio

n

Minimu

m CPissuedper Investor s

Mode o f

Issuance

Ratin

g

January1990

Rs.10crore

Rs.25crore

20 per cent o f WorkingCapital ( f undbased limit)

3 to 6months

Multiple o f Rs.25 lakh

Rs.1crore

Physical Form P1+

April 24,1990

Rs.5crore

Rs.15crore

20 per cent o f WorkingCapital ( f undbased limit)

3 to 6months

Rs.10 lakhs Rs.50lakhs

Physical Form P1

May 30,1991

Rs.5crore

Rs. 10crore

30 per cent o f working Capital(f und basedlimit)

3 to 6months

Multiple o f Rs.5 lakhs

Rs.25lakhs

Physical Form P1

May 13,1992

Rs.5crore

Rs.5crore

75 per cent(f und basedlimit)

3 to 6months

Multiple o f Rs.5 lakhs

Rs.25lakhs

Physical Form P2


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CP Issue ExpensesCP Issue ExpensesCP Issue ExpensesCP Issue Expenses

1. Stamp duty 0.2% - If placed t hroug h banks1.0% - If placed t hroug h merc hant bankers

2. Rating fees* 0.10% (subject to a minimum of Rs.100,000)(for a rating from CAR E )

3. Issuing and paying agent fee 0.1%

Source: RBI Bulletins


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Public De positsPublic De positsPublic De positsPublic De positsThese are unsecured deposits from the public.

P ublic deposits cannot exceed 25 percent of share capital and free reserves.

The maximum maturity period allowed for public

deposits is3 years. However, for NBFCs it is 5 years.

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InterInter- -corporate depositscorporate depositsInterInter- -corporate depositscorporate deposits A deposit made by one company with another, normally

for a period up to six months is referred to as an inter-

corporate deposit.

I nter-corporate deposits are typically unsecured.

I nter-corporate deposits are usually of three types: call

deposits, three-month deposits, and six-month deposits.

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Accounts Receivable as CollateralAccounts Receivable as CollateralAccounts Receivable as CollateralAccounts Receivable as Collateral A pledge is a promise that the borrowing firm will pay the lender any payments received from the accountsreceivable collateral in the event of default.S ince accounts receivable fluctuate over time, thelender may require certain safeguards to ensure that the value of the collateral does not go below thebalance of the loan.

S o, normally a bank will only loan you 70 -7 5 % of thereceivable amount Accounts receivable can also be sold outright. This is

known as factoring.


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Cost of B orrowing against ReceivablesCost of B orrowing against ReceivablesCost of B orrowing against ReceivablesCost of B orrowing against Receivables Average monthly sales = $100 ,000 6 0 day terms, so average Acct Rec balance = $2 00 ,000 Bank loans70% of Accts Rec = $140 ,000 I nterest is3% over prime (say 8 % ) = 11% x $140 ,000 =$15,400

1% fee on all receivables = 1% x $100 ,000 x 12 =

$12,000 AP R = $15,400 + $12,000 x 1 / 1 = 19 .5 7%!

$140 ,000


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FACTORINGFACTORING AND FORFAITINGAND FORFAITINGFACTORINGFACTORING AND FORFAITINGAND FORFAITING

Factoring is of recent origin in Indian Context.

Kalyana Sundaram Committee recommended introduction of factoringin 1989.

Banking Regulation Act, 1949, was amended in 1991 for Banks settingup factoring services.

SBI/Canara Bank have set up their Factoring Subsidiaries:-SBI Factors Ltd., (April, 1991)

CanBank Factors Ltd., (August, 1991).

RBI has permitted Banks to undertake factoring services throughsubsidiaries.


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WH AT IS FACTORING ?WH AT IS FACTORING ?WH AT IS FACTORING ?WH AT IS FACTORING ?

Factoring is the Sale of Book Debts by a firm(Client) to a financial institution (Factor) on theunderstanding that the Factor will pay for theBook Debts as and when they are collected or ona guaranteed payment date. Normally, theFactor makes a part payment (usually up to 80%)immediately after the debts are purchasedthereby providing immediate liquidity to theClient.


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So, a Factor is,

a) A Financial Intermediaryb) That buys invoices of a manufacturer or a trader, at a discount,

and

c) Takes responsibility for collection of payments.

The parties involved in the factoring transaction are:-

a) Supplier or Seller (Client)b) Buyer or Debtor (Customer)c) Financial Intermediary (Factor)


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FACTORING PROCESSFACTORING PROCESS

1

Places order3

Delivers goods andinvoice with notice

to pay the factor

4 8 6

Sends Pays Followsinvoice balance upcopy amount

2 7Fixes 5 Pays

customer Prepayslimit up to

80%

CLIENT(SELLER)

CUSTOMER (BUYER)

FACTOR


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1. Follow-up and collection of Receivables fromClients.

2. Purchase of Receivables with or without recourse.3. H elp in getting information and credit line on

customers (credit protection)4. Sorting out disputes, if any, due to his relationship

with Buyer & Seller.

SERVICES OFFERED BY A FACTORSERVICES OFFERED BY A FACTOR


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PROCESS INVOLVED IN FACTORINGPROCESS INVOLVED IN FACTORINGPROCESS INVOLVED IN FACTORINGPROCESS INVOLVED IN FACTORING

Client concludes a credit sale with a customer.

Client sells the customers account to the Factor and notifies thecustomer.

Factor makes part payment (advance) against account purchased,after adjusting for commission and interest on the advance.

Factor maintains the customers account and follows up forpayment.

Customer remits the amount due to the Factor.

Factor makes the final payment to the Client when the account iscollected or on the guaranteed payment date.


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M ECH ANICS OF FACTORINGM ECH ANICS OF FACTORINGM ECH ANICS OF FACTORINGM ECH ANICS OF FACTORING

The Client (Seller) sells goods to the buyer and prepares invoice with anotation that debt due on account of this invoice is assigned to and must bepaid to the Factor (Financial Intermediary).

The Client (Seller) submits invoice copy only with Delivery Challan showingreceipt of goods by buyer, to the Factor.

The Factor, after scrutiny of these papers, allows payment (,usually upto 80%of invoice value). The balance is retained as Retention M oney (M arginM oney). This is also called Factor Reserve.

The drawing limit is adjusted on a continuous basis after taking into accountthe collection of Factored Debts.

Once the invoice is honoured by the buyer on due date, the Retention M oneycredited to the Clients Account.

Till the payment of bills, the Factor follows up the payment and sends regularstatements to the Client.


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CH ARGES FOR FACTORING SERVICESCH ARGES FOR FACTORING SERVICESCH ARGES FOR FACTORING SERVICESCH ARGES FOR FACTORING SERVICES

Factor charges Commission (as a flat percentage ofvalue of Debts purchased) (0.50% to 1.50%)

Commission is collected up-front.

For making immediate part payment, interestcharged. Interest is higher than rate of interestcharged on W orking Capital Finance by Banks.

If interest is charged up-front, it is called discount.


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TYPES OF FACTORINGTYPES OF FACTORINGTYPES OF FACTORINGTYPES OF FACTORING

Recourse Factoring

Non-recourse Factoring

M aturity Factoring

Cross-border Factoring


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RECOURSE FACTORINGRECOURSE FACTORINGRECOURSE FACTORINGRECOURSE FACTORING

Upto 75% to 85% of the Invoice Receivable is factored.

Interest is charged from the date of advance to the date ofcollection.

Factor purchases Receivables on the condition that loss arising onaccount of non-recovery will be borne by the Client.

Credit Risk is with the Client.

Factor does not participate in the credit sanction process.

In India, factoring is done with recourse.


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NONNON--RECOURSE FACTORINGRECOURSE FACTORINGNONNON--RECOURSE FACTORINGRECOURSE FACTORING

Factor purchases Receivables on the condition that theFactor has no recourse to the Client, if the debt turns outto be non-recoverable.

Credit risk is with the Factor.

H igher commission is charged.

Factor participates in credit sanction process and approvescredit limit given by the Client to the Customer.

In USA/UK, factoring is commonly done without recourse.


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M ATURITY FACTORINGM ATURITY FACTORINGM ATURITY FACTORINGM ATURITY FACTORING

Factor does not make any advance payment to the Client.

Pays on guaranteed payment date or on collection of

Receivables.

Guaranteed payment date is usually fixed taking intoaccount previous collection experience of the Client.

Nominal Commission is charged.

No risk to Factor.


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CROSSCROSS -- BORDER FACTORINGBORDER FACTORINGCROSSCROSS -- BORDER FACTORINGBORDER FACTORING

It is similar to domestic factoring except that there are four parties,viz.,a) Exporter,b) Export Factor,c) Import Factor, andd) Importer.

It is also called two-factor system of factoring.Exporter (Client) enters into factoring arrangement with ExportFactor in his country and assigns to him export receivables.Export Factor enters into arrangement with Import Factor and hasarrangement for credit evaluation & collection of payment for an

agreed fee.Notation is made on the invoice that importer has to make payment tothe Import Factor.Import Factor collects payment and remits to Export Factor whopasses on the proceeds to the Exporter after adjusting his advance, ifany.W

here foreign currency is involved, Factor covers exchange risk also.


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FACTORINGFACTORINGvsvs

BILLS DISCOUNTINGBILLS DISCOUNTING


BILLS DISCOUNTINGBILLS DISCOUNTINGBILL DISCOUNTING

1. Bill is separatelyexamined anddiscounted.

2. Financial Institutiondoes not haveresponsibility of SalesLedger Administrationand collection of Debts.

3. No notice of assignmentprovided to customersof the Client.

FACTORING1. Pre-payment made

against all unpaid and notdue invoices purchasedby Factor.

2. Factor has responsibilityof Sales LedgerAdministration andcollection of Debts.

3. Notice of assignment isprovided to customersof the Client.


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BILLS DISCOUNTINGBILLS DISCOUNTING (contd)(contd)


BILLS DISCOUNTINGBILLS DISCOUNTING (contd)(contd)BILLS DISCOUNTING

4. Bills discounting is usuallydone with recourse.

5. Financial Institution can getthe bills re-discountedbefore they mature forpayment.

FACTORING4. Factoring can be done

without or without recourseto client. In India, it is donewith recourse.

5. Factor cannot re-discount

the receivable purchasedunder advanced factoringarrangement.


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ACT APPLICABLE TO FACTORINGACT APPLICABLE TO FACTORINGACT APPLICABLE TO FACTORINGACT APPLICABLE TO FACTORING

Factoring transactions in India are governed by thefollowing Acts:-

a) Indian Contract Act

b) Sale of Goods Act

c) Transfer of Property Act

d) Banking Regulation Act.

e) Foreign Exchange Regulation Act.


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WH Y FACTORINGH AS NOT WH Y FACTORINGH AS NOT

BECOM E POPULAR IN INDIABECOM E POPULAR IN INDIA

WH Y FACTORINGH AS NOT WH Y FACTORINGH AS NOT

BECOM E POPULAR IN INDIABECOM E POPULAR IN INDIABanks reluctance to provide factoring services

Banks resistance to issue Letter of Disclaimer (Letter ofDisclaimer is mandatory as per RBI Guidelines).

Problems in recovery.

Factoring requires assignment of debt which attracts StampDuty.

Cost of transaction becomes high.


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FORFAITINGFORFAITINGFORFAITINGFORFAITINGForfait is derived from French word A Forfaitwhich means surrender of fights.

Forfaiting is a mechanism by which the right forexport receivables of an exporter (Client) ispurchased by a Financial Intermediary (Forfaiter)without recourse to him.

It is different from International Factoring in asmuch as it deals with receivables relating todeferred payment exports, while Factoring dealswith short term receivables.


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FORFAITINGFORFAITING ((contdcontd))FORFAITINGFORFAITING ((contdcontd))Exporter under Forfaiting surrenders his right for claiming paymentfor services rendered or goods supplied to Importer in favour ofForfaiter.

Bank (Forfaiter) assumes default risk possessed by the Importer.

Credit Sale gets converted as Cash Sale.

Forfaiting is arrangement without recourse to the Exporter (seller)

Operated on fixed rate basis (discount)

Finance available upto 100% of value (unlike in Factoring)

Introduced in the country in 1992.


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M ECH ANICS OF FORFAITINGM ECH ANICS OF FORFAITINGM ECH ANICS OF FORFAITINGM ECH ANICS OF FORFAITING

EXPORTER I M PORTER

FORFAITER AVALLING BANK

H ELD TILLM ATURITYSELL TO GROUPS OF INVESTORS

TRADE IN SECONDARYM ARKET


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ESSENTIAL REQUISITES OFESSENTIAL REQUISITES OF

FORFAITING TRANSACTIONSFORFAITING TRANSACTIONS

ESSENTIAL REQUISITES OFESSENTIAL REQUISITES OF

FORFAITING TRANSACTIONSFORFAITING TRANSACTIONSExporter to extend credit to Customers for periods above6 months.

Exporter to raise Bill of Exchange covering deferredreceivables from 6 months to 5 years.

Repayment of debts will have to be guaranteed by anotherBank, unless the Exporter is a Government Agency or aM

ulti National Company.

Co-acceptance acts as the yard stick for the Forfaiters tocredit quality and marketability of instruments accepted.


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CH ARACTERISTICS OFCH ARACTERISTICS OF

FORFAITINGFORFAITING


FORFAITINGFORFAITINGConverts Deferred Payment Exports into cash transactions,providing liquidity and cash flow to Exporter.

Absolves Exporter from Cross-border political or conversion riskassociated with Export Receivables.

Finance available upto 100% (as against 75-80% under conventionalcredit) without recourse.

Acts as additional source of funding and hence does not haveimpact on Exporters borrowing limits. It does not reflect as debtin Exporters Balance Sheet.

Provides Fixed Rate Finance and hence risk of interest ratefluctuation does not arise.


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FORFAITINGFORFAITING ((contdcontd.).)CH ARACTERISTICS OFCH ARACTERISTICS OF

FORFAITINGFORFAITING ((contdcontd.).)Exporter is freed from credit administration.

Provides long term credit unlike other forms of bank credit.

Saves on cost as ECGC Cover is eliminated.

Simple Documentation as finance is available against bills.

Forfait financer is responsible for each of the Exporterstrade transactions. H ence, no need to commit all of hisbusiness or significant part of business.

Forfait transactions are confidential.


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COSTS INVOLVED INCOSTS INVOLVED IN

FORFAITINGFORFAITING

COSTS INVOLVED INCOSTS INVOLVED IN

FORFAITINGFORFAITINGCommitment Fee:- Payable to Forfaiter by Exporter inconsideration of forfaiting services.

Commission:- Ranges from 0.5% to 1.5% per annum.

Discount Fee:- Discount rate based on LIBOR for theperiod concerned.

Documentation Fee:- where elaborate legal formalitiesare involved.

Service Charges:- payable to Exim Bank.


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FACTORING vs. FORFAITINGFACTORING vs. FORFAITINGFACTORING vs. FORFAITINGFACTORING vs. FORFAITING

POINTS OFDIFFERENCE

FACTORING FORFAITING

Extent of Finance Usually 75 80% of thevalue of the invoice

100% of Invoice value

CreditW orthiness

Factor does the creditrating in case of non-recourse factoringtransaction

The Forfaiting Bankrelies on thecreditability of theAvalling Bank.

Services provided Day-to-day administrationof sales and other alliedservices

No services areprovided

Recourse W ith or without recourse Always withoutrecourse

Sales By Turnover By Bills


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COM PARATIVE ANALYSISCOM PARATIVE ANALYSISCOM PARATIVE ANALYSISCOM PARATIVE ANALYSIS

BILLSDISCOUNTED

FACTORING FORFAITING

1. Scrutiny Individual SaleTransaction

Service of SaleTransaction

Individual SaleTransaction

2. Extent ofFinance

Upto 75 80% Upto 80% Upto 100%

3. Recourse W ith Recourse W ith orW ithoutRecourse

W ithoutRecourse

4. SalesAdministration

Not Done Done Not Done

5. Term Short Term Short Term M edium Term

6. ChargeCreation

H ypothecation Assignment Assignment


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WH Y FORFAITING H AS NOT WH Y FORFAITING H AS NOT

DEVELOPEDDEVELOPED

WH Y FORFAITING H AS NOT WH Y FORFAITING H AS NOT

DEVELOPEDDEVELOPEDRelatively new concept in India.Depreciating RupeeNo ECGC Cover

H igh cost of fundsH igh minimum cost of transactions (USD 250,000/-)RBI Guidelines are vague.Very few institutions offer the services in India. EximBank alone does.Long term advances are not favoured by Banks as hedgingbecomes difficult.Lack of awareness.


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Interest Rate Swa psInterest Rate Swa psInterest Rate Swa psInterest Rate Swa ps A swap is an agreement to exchange cash flows at specified future times according to certain specified rules.

U sually the calculation of cash flows involves thefuture values of one or more market variables.U sed for converting a liability / investment from:

fixed rate to floating rate.floating rate to fixed rate.


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DefinitionsDefinitionsDefinitionsDefinitionsI n a swap, two counterparties agree to a contractual arrangement wherein they agree to exchange cash flows at periodic intervals.

There are two types of interest rate swaps:S ingle currency interest rate swap P lain vanilla fixed-for-floating swaps are often just called interest rateswaps.I n this a company agrees to pay a fixed rate on a notional principal in

return of a floating rate from another company on same notional principal for same period.Cross-Currency interest rate swap

This is often called a currency swap; fixed for fixed rate debt service intwo (or more) currencies.


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Forward Rate AgreementForward Rate AgreementForward Rate AgreementForward Rate Agreement

A forward rate agreement (FRA) is an agreement that a certainrate will apply to a certain principal during a certain future time period.

An FRA is equivalent to an agreement where interest at a predetermined rate,R K is exchanged for interest at the market rate, R m .

An FRA can be valued by assuming that the forward interest rate is certain to be realized.


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I t is a financial contract between two parties to exchange interest payments based on a notional principal for a specified future period

Time line of the FRA

Trade date Maturity dateFRAsettlement dateFixing date

T=0 3 m 6m

Forward period Loan period

Forward Rate AgreementForward Rate AgreementForward Rate AgreementForward Rate Agreement


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Notional Princi pal Amounts Notional Princi pal Amounts Notional Princi pal Amounts Notional Princi pal Amounts

The two counterparties to an FRA agree to anotional principal amount that serves as a reference figure indetermining cash flows.

notional refers to the condition that the principal does not changehands, but is only used to calculate the value of interest payments.The buyer of the FRA agrees to pay a fixed-rate coupon payment and receive a floating-rate payment against thenotional principal at some specified future date.The seller of the FRA agrees to pay a floating-rate payment and receive the fixed-rate payment against the samenotional principal .


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FRA is a forward contractFRA is a forward contract based based on interest rateson interest ratesFRA is a forward contractFRA is a forward contract based based on interest rateson interest rates

Thebuyer of an FRA agrees to pay a fixed-rate coupon payment (at theexercise / contract rate ) and receive a floating-rate payment against a notional principal amount at a specified future date.

Thebuyer of an FRA will receive (pay) cashwhen theactual interest rateat settlement isgreater (less)than theexercise / contract rate(specified fixed-rate).

Theseller of an FRA agrees tomake a floating-rate payment and receive a fixed-rate payment against a notional principal amount at

a specified future date.Theseller of an FRA will receive (pay) cashwhen theactual interest rateat settlement isless (greater)than theexercise rate.


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T erminolog yT erminolog yT erminolog yT erminolog y3 x 6- An agreement to exchange interest payments for a3-month period, starting3 months from now.Borrower

Buy FRA pay contracted rate RK and receive reference rate RmLender

S ell FRA receive contracted rate RK and pay reference rate Rm

S ettlement takes place at the start date of the loan

Reference rate (Market Rate R m )

Buyer gains R m Increases over contract rate R K S eller gains R m D ecreases over contracted rate R K


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deferment period contract period

s potdate

contractrate

agreed

dealingdate fix

ingdate

referencerate

determined

settlementdate

settlementsum paid

maturit ydate


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THANK YOU THANK YOU THANK YOU THANK YOU

9 short term financing for wc

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