Question

Question: Question-1:Based on the details provided in the case study, assess and recommend the best course of action for Indian Textile Exporter based on its international trade finance requirements and options available. You must justify your assessment based on the facts provided in the case, by providing a critical appraisal of various alternatives. Question-2: Also, recommend the best method of foreign trade financing.

Mr Nitin Gupta, MD and CEO of Latest Fashions Pvt. Ltd., was sitting in his office on a mid-June morning thinking about the achievements his company had made since its inception. Nitin had just come back from the Annual General Meeting of Latest Fashions Pvt. Ltd. where he learned that the company had achieved a 30 per cent increase in sales compared to the previous financial year. Both the shareholders and employees were happy with the company’s performance, how the organisation had grown over the years and the company’s current goal of a 40 per cent increase in sales for the present year. But Nitin was worried about the working capital funds required to support the projected sales and was expecting large export orders from Europe and America that had to be supplied before Christmas. To deliver the orders on time, Nitin needed to procure raw material, hire labour and arrange for warehousing and shipping. “Where will these funds come from?” Nitin asked Mr Narayan Verma, his trusted financial advisor and the company’s Chartered Accountant.

Meeting with the bank Narayan arranged a meeting with the Chief Manager of Honest Bank, Ms Priyanka, who had been in the trade finance division of the bank for more than a decade and had successfully completed certificate courses in Trade Finance from one of the premium institutes of India.

Nitin: Good morning ma’am. How are you doing?

Priyanka: I Am good. How about you? How was the performance of your company last year?

Nitin: We did a turnover of INR50 crore last year which was a 30 per cent jump over the previous year. This year, we are expecting the sales to be up by a further 40 per cent. In fact, we have just received a few large orders from the USA and the EU.

Priyanka: That is good to hear. Tell me, how can we assist you?

Narayan: Over the years, the company has grown steadily and Nitin has been able to manage the growing fund requirement from his own funds and profits. Now that the company has reached a considerable size, we are looking to borrow funds from the bank to finance the international trade and enhance liquidity position of the company.

Priyanka: We would be glad to get associated with your reputed organisation by financing your requirement.

Nitin: What are the different ways in which you can extend loan to us?

Priyanka: We can extend a line of credit to you to finance your export business. This could include availing pre-shipment finance against a confirmed order. You may utilise these funds for procurement of raw material, labour costs and packaging. Once the goods are shipped, we can extend post-shipment finance by purchasing the drafts and discounting the bill of exchange. Are there also exports that are backed by Letter of Credit (LCs)?

Narayan: Our payment terms are for Letter of Credit (LCs), we receive LCs from buyers in the USA which are issued by top 10 banks of the world. Generally, the LC terms are for 180-day issuance from date of shipment. This leads to a temporary shortage of funds as we have already incurred the expenses for producing the goods and arranging to ship them; however, the payment from the importer becomes due on a later date.

Priyanka: In such a case, on receipt and acceptance of an LC from a reputed bank, we can extend funds to you in anticipation of funds on the due date.

Nitin: We are planning to import some machinery from Germany. Since the seller has a monopoly in the industry, they are insisting that we send them an advance before they ship the machinery to us.

Priyanka: We can issue a Letter of Credit on your behalf in favour of the overseas supplier. Once the goods are shipped, the seller will present the documents including the Invoice, Insurance Policy, Packing List, Certificate of Origin, Bill of Exchange and Transport Documents for checking. Once we ascertain that the documents are as per the terms of the Letter of Credit, we will make payment to the overseas buyer. You can further avail buyer’s credit for making payment to the supplier. To understand the complete process of a Letter of Credit.

Narayan: What is the significance of these documents?

Priyanka: The Commercial Invoice provides the details of goods shipped, along with the description of goods and their prices as agreed between the buyer and seller. An Insurance Policy is evidence of a contract of insurance and shows the full details of risks covered. A Packing List gives the details of the material packed. A Certificate of Origin is a proof that the goods originated in a particular country. A Bill of Exchange is a demand for payment issued by the exporter (drawer) to the importer (drawee).

Narayan: Thanks, ma’am, for your guidance. Let me speak to the supplier and urge him to accept a Letter of Credit in place of an advance payment. Is there any other way in which you can support us?

Priyanka: Yes, we can extend Bank Guarantees on your behalf as and when required. I would request you to share with me a copy of the latest audited balance sheet and a few details so that we can go ahead with the credit appraisal. This would involve assessing the balance sheet of your company.

Nitin: Thanks, Priyanka for taking out time for meeting us. Let me discuss your proposal with our team and get back to you. Priyanka leaves

Nitin: Narayan, would you recommend availing finance from the bank?

Narayan: I have scheduled a meeting with a factoring agency. Let us explore all the options and decide after that.

Meeting with the factoring agency Nitin and Narayan decide to meet Mr Kapil, the head of Reliable Factors Ltd. Kapil has been working with Reliable Factors for more than 15 years.

Kapil: Welcome Nitin and Narayan. I am obliged to meet you. I have heard many good things about your organisation at trade body meetings.

Nitin: We are pleased to know this. We set up this company 10 years ago with a modest promoter funding of INR1 million, and last year we reached a turnover of INR500 million.

Kapil: That is great to hear. Tell me, how I can be of assistance to you?

Narayan: We are projecting a 40 per cent growth in turnover for which we are looking at a factoring agency which can fund our exports and streamline our cash flows.

Kapil: We have been in the business of factoring for the past 15 years and have a sizeable portfolio in the textile sector. You can sell the export receivables to us in exchange of cash.

Nitin: We would like to understand the process involved in the factoring of our exports.

Kapil: We will sign a written agreement with you. Whenever you receive an order from the buyer, please let us know and we will do an examination of the creditworthiness of the buyer through our correspondent import factor based in the country of the buyer. Once this is done, you can ship the goods to the buyer. You can assign the invoices in our favour and we will provide a pre-agreed amount of cash in return. We will follow-up with the buyer for payment and the buyer will make the full payment to us.

Narayan: What if the payment doesn’t come from the buyer on the due date?

Kapil: There are two types of factoring: factoring with recourse, wherein, we will recover funds from you if the overseas buyer defaults and factoring without recourse, wherein, we will assume the payment risk of the overseas buyer and hence it is costlier than the first option.

Nitin: What would be the charges for your services?

Kapil: We usually charge interest in addition to the factoring commission which ranges between 1 and 3 per cent of the total transaction value depending on the credit standing of the buyer and buyer’s country.

Narayan: Is there any additional service that you can offer to us?

Kapil: In addition to providing financing, we can also perform credit investigations, guarantee commercial and political risks, assume collection responsibilities and offer marketing assistance. We can also look at doing forfaiting in case of medium- to long-term receivables.

Ntitin: How is forfaiting different from factoring?

Kapil: While factoring is used to finance short-term receivables ranging from 90 to 180 days, forfaiting is more relevant to capital goods and is used to finance medium- to long-term receivables, i.e. from 180 days up to 7 years. The financial instruments in forfaiting are usually time draft, bills of exchange and promissory notes. Forfaiting is always without recourse.

Narayan: How does forfaiting work?

Kapil: Forfaiting involves four parties – the exporter, the forfeiter, the importer and a bank from the importing country. Once the exporter manufactures the goods and sells them to the importer, the importer accepts Bills of Exchange drawn in its favour or issues promissory notes to the exporter. These financial instruments are guaranteed by a bank in the importer’s country usually on an irrevocable basis. On receipt of these financial instruments, the forfeiter extends funds to the exporter.

Nitin: Is there any difference in the pricing of factoring and forfaiting?

Kapil: Since forfaiting is always without recourse, it is more expensive than factoring. In the case of forfaiting, a commitment fees is taken by us in addition to the discount fees for our commitment to execute a specific forfaiting transaction at a firm discount rate within a specified time. It varies between 0.5 to 1.5 per cent per annum of the unutilized amount to be forfeited and is charged for the period between the date the commitment is given and the date the discounting takes place or until the validity of the contract, whichever is earlier.

Nitin: It was nice meeting you. We will share with you a list of the buyers, countrywise, that we deal with. Please let us know your tentative pricing for both factoring and forfaiting.

Kapil leaves

Nitin: What do you think about the proposal for factoring and forfaiting?

Narayan: Let us also visit the Web site of Exim Bank, India, and Export Credit Guarantee Corporation of India Ltd. (ECGC).

Export import Bank of India Exim Bank is the premier export finance institution of India. It was set up in 1982 under the Export Import Bank of India Act 1981, and the government’s objective behind it was to enhance exports from India and integrate the country’s foreign trade and investment with the overall economic growth. In 2014, the bank had a loan portfolio of INR745,983 million. The bank plays an important part in India’s trade by financing, promoting and facilitating India’s foreign trade and is the principal financial institution in the country for coordinating the working of institutions engaged in financing exports and imports. The Exim Bank has taken the following initiatives to promote India’s foreign trade:

Project exports: Exim Bank takes funded (Pre-Shipment Credit, Post-Shipment Credit, etc.) and non-funded exposure (Guarantee) for supporting turnkey projects, civil construction contracts, technical and consultancy service contracts, as well as supplies.

Overseas investment finance program: The bank encourages Indian companies to invest abroad by providing facilities for Indian investments and overseas acquisitions. These facilities include loans to Indian Companies for investing in overseas ventures, extending letters of credit and guarantees to facilitate local borrowings by the overseas ventures.

Lines of credit: Exim Bank extends Lines of Credit (LOC) to foreign governments or their nominated agencies and overseas financial institutions enabling them to finance imports of goods and services from India on deferred credit terms and thus promoting exports from India to target countries.

Buyer’s credit: Overseas buyers can avail this facility for import of goods and services from India on deferred payment terms. This facility enables overseas buyers to avail medium- to long-term financing at a low cost compared to high cost of funding in the country of the importer.

Marketing advisory services: Exim Bank supports Indian companies in their marketing initiatives on a success fees basis. The bank assists in identification of overseas opportunities for finding new markets, setting up plants and acquisition of overseas companies.

Corporate banking: The bank offers Term Loans in Indian Rupees/Foreign Currency to Indian Exporters, Export-Oriented Units (EOUs), Micro Small and Medium Enterprises (MSMEs) for financing projects, R&D, Expansion, working capital and modernisation.

Grassroots initiatives and development (GRID) programme: Under this programme, EXIM Bank extends financial support to create export capability in grassroots enterprises and promote grassroots initiatives and technologies having export potential.

Additionally, they also discussed getting the foreign credit insurance offered by the Export Credit Guarantee Corporation of India Ltd. backed by the government of the country to cover all kinds of risks associated with export trading, e.g. loss of money on account of foreign buyer becoming bankrupt or sudden import or exchange restrictions resulting in stopping of payments.

Narayan summarised the following list of products discussed during the different meetings for the ease of decision-making:

1. Bank: Pre-shipment finance; Post-Shipment Finance; Discounting against Letter of Credit; Letter of Credit; Buyer’s Credit; and Bank Guarantee.

2. Factoring Agency: Factoring with recourse; Factoring without recourse; Credit investigations; Guarantee commercial and political risks; Collection responsibilities; Marketing assistance; and Forfaiting.

3. Export Import Bank of India: Project Exports; Overseas Investment Finance Program; Lines of Credit (LOC); Buyer’s Credit; Marketing Advisory Services; Corporate Banking; and Grassroots Initiatives & Development (GRID) programme.

4. Export Credit Guarantee Corporation of India: Foreign credit insurance.

Answer 1

The Summary of list of products discussed during the different meetings for the ease of decision-making:

1. Bank: Pre-shipment finance; Post-Shipment Finance; Discounting against Letter of Credit; Letter of Credit; Buyer’s Credit; and Bank Guarantee.

2. Factoring Agency: Factoring with recourse; Factoring without recourse; Credit investigations; Guarantee commercial and political risks; Collection responsibilities; Marketing assistance; and Forfaiting.

3. Export Import Bank of India: Project Exports; Overseas Investment Finance Program; Lines of Credit (LOC); Buyer’s Credit; Marketing Advisory Services; Corporate Banking; and Grassroots Initiatives & Development (GRID) programme.

4. Export Credit Guarantee Corporation of India: Foreign credit insurance.

Based on the summary of discussions by Nitin and Narayan as above, the most preferred mode of financing would be Letters of Credit from Honest Bank and credit facility and insurance guarantee from Export Credit guarantee Corporation of India (ECGC). These are cheapest source of funding based on the facts is from EXIM, ECGC and Bank. The factoring agency can also be considered for those customers whose credit worthiness is in doubt, as for these customers the factoring can be done without recourse albeit at a higher cost. This way the risk can be transferred to the factoring agency. To conclude, Latest Fashion can opt for all the sources of finance considering they intend to grow by 40% over the previous year. This will enable them to have a free flow of funds by paying a fee for the facilties to all the institutions and the actual draw down of the credit can be done based on the need at each point in time.