advance against book debts updated

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COLLEGE OF AGRICULTURAL BANKING

RESERVE BANK OF INDIA

GANESHKHIND ROAD , PUNE 411016

ADVANCES AGAINST BOOK DEBTS

1. Need

Book Debts of account receivables arise out of sale of goods or service on credit . Because of

credit sales, the sellers available working funds become inadequate to support the scale of

operation necessitating bank finance. The system o financing credit sales or receivables by

bill finance i.e purchase or discount of bills is quite common. Another mode of financing

credit sales is by way of cash credits against book debts. Under this system the bank allows

the borrower to draw to the extent of the limit sanctioned to him provided the drawings are

backed by adequate receivables.

2. Disadvantages

The main disadvantages in this type of financing are that

(i) control over the account by the banker becomes difficult

(ii) the bank cannot enforce its claim on the borrower's debtors viz. the purchasers in

the event of a default by him. Thus this type of advance is more or less on par with

clean advance.

3. As composite security

Advances solely against book debts are not common as such transactions carry many risks.

The banks generally accept book debts as a collateral security or as a part of a composite

security.

4. Scrutiny of application

The application for advance has to be carefully examined taking into consideration the

following points about the borrower and his business.

(a) Credit Worthiness and capacity of the borrower and his debtors.



Sr.No. FIGB Channel/Advance against book debts updated/Aug.2007/Eng. 4 pgs.Version-1

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(b) The size of the receivable amount. While it is convenient to handle few accounts of large

sizes than many small sizes accounts, any concentration of the receivable amounts is also

not desirable.

(c) Age of book debts

Normally debts which are more than 3 months old should not be accepted.

5. Creation of Charge

Banks should create on Book debts either by means of hypothecation or assignment.

Hypothecation deed will attract stamp duty. The deed should embody all the terms and

conditions including authority to the bank to act as an attorney of the borrower and collect

book debts on behalf of the borrower. Banker as an assignee stands only in the shoes of the

assignor and cannot have better rights than those which the assignee possesses. If the debtor

has a counter claim against the assignee, the assignee will be entitled to only the balance. If

there is a breach of terms of contract between the assignee and his debtor, it may result in

repudiation of debt, the bank should therefore take due care of such facts before accepting

assignment of book debts. If the advance is given to a limited company, the bank’s charge is

to be registered with the Registrar of Companies within a period of 30 days of creating a

charge.

6. Guarantee

It is advisable to insist on personal guarantees of the proprietors, partners or directors of the

firm/company to ensure their cooperation in the matter of realisation of book debts.

7. Type of credit

Advance against book debts is made by way of cash credit or overdraft. The margin for

advances should not be less than 30-40% of the book debts accepted as security.

The limit sanctioned should be noted in the relevant ledger folio.




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8. Notification basis and non-notification basis

Advances on book debts may be on a non-notification basis or notification basis. In case ofnon-notification, the borrower is under obligation to pass onto the banks the amount received

from his debtors. In case of notification basis, the bank has to notify each debtor and direct

him to make payment to the bank. For this purpose, letters of authority for payment of book

debts direct to the bank should be obtained from the borrower in duplicate and the original

letter sent to the concerned debtors. The concerned debtors may also indicate their

willingness to abide by the bankers/borrowers request. As regards future debts the borrower

undertakes to submit the relative invoices together with proof of delivery of goods in

duplicate, with an endorsement in the original authorising payment to the bank. The original

may be forwarded by the bank to the concerned debtor with a request to make payments

directly to it.

9. Periodical Statement

The borrower should submit monthly statements showing the outstanding book debts party-

wise. The statements should be scrutinized with reference to the age of the book debts and the

drawing power reviewed and revised, if necessary. Where considered necessary duplicate

copies of sales invoices may also be obtained. The statement should also be verified with the

published Balance -Sheet whenever the period of the statement coincides with that of the

Balance-Sheet. Clarification if any should be called for. Care should be taken to ensure that

bad /doubtful debts, old debts (beyond 90 days), debts already realised, debts in respect of

which bill finance has been given are excluded. Receivables from affiliated or allied

companies or concerns should be considered as ineligible for advances. Goods sent to

branches of the borrowers concern or those sent on a consignment basis should not also be

included under book debts. The borrower should also submit a schedule of ‘Goods Returned’

every month.

10. Periodical Inspection

Periodical surprise inspection of the books of account of the borrower should be carried out

to ensure that there are no fraudulent acts or transactions or manipulations, in compiling book




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debts and that the debts are due to general credit sale of goods. Enquiries should also be made

periodically in respect of the financial position of debtors.

11. Miscellaneous

Wherever possible, steps should be taken to convert cash credit against book debts into bill

limits.

12. Documentation

i. Demand Promisory Note

ii. Letter of continuation of Security

iii. Personal Guarantee of proprietor / partner / director

iv. Letter of authority to pay debts directly to the bank

v. Undertaking to submit invoices in duplicate in respect of future debts.

vi. Monthly schedule of goods returned

vii. Monthly statement of book debts with age-wise classification.

13. Books, registers

viii. Advance Ledger

ix. Drawing power register

x. Inspection register

References:

1. Bill Finance & Bankers – U.S Sachdeva

2. Manual for Urban Co-operative Banks – RBI. Bombay

3. Practical Banking Advances – H. L. Bedi, V. K. Hardikar

4. Guidelines for inspection of Primary Urban Co-operative Banks under Banking

Regulation Act 1949 ( as applicable to cooperative Societies ) – ACD, RBI, Bombay5. Guidelines for Internal Bank Inspection – BTC. Bombay

6. Inspection Manual of DBOD, RBI, Bombay

Prepared by Smt. Sujatha Elizabeth Prasad, Member of Faculty (1997)

Updated by A K Chowdhury, Member of Faculty, CAB, Pune, August (2007)

advance against book debts updated

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