Fundamental of Banking

Meaning of Bank
An Institution having the following features:
It deals with money; it accepts deposits & advances loans
It deals with credit; has the ability to create credit
Its a commercial organization; its aim is to earn profit
It is a unique financial institution that creates demand deposits
which
serve as a medium of exchange &, as a result, the banks manage the
payment system of the country.
FUNCTIONS:
Accepting Deposits

Fixed Deposits Account

Current Deposits Account
Savings Account
Recurring Deposit Account

Advancing of Loans
Money at Call
Cash Credit
Overdraft
Discounting of Bills of
Exchange (BoE)
Term Loans

Agency Functions
Remittance of Funds

Collection & Payment of Credit

Instruments

Execution of Standing Orders

Purchasing & Sale of Securities
Collection of Dividends on

Shares

Income Tax Consultancy

Acting as Trustee & Executor

Acting as Representative &
Correspondent

General Utility Function

Locker Facility
Traveler's Cheque
Letter of Credit
Collection of Statistics
Underwriting Securities
Gift Cheques
Acting as Referee
Foreign Exchange Business

TYPES OF BANKS AND BANKING ACTIVITIES

Scheduled And Non-Scheduled Banks

In India the central banking authority is the Reserve Bank of India. It is also referred to as
the Apex Bank. It functions under an act called The Reserve Bank of India Act, 1934. All
the banks and other financial institutions operating in India come under the monitoring
and control of RBI. RBI controls the banking sector in India through an Act called The
Banking Regulations Act 1949. In the past, when there were very few banks, RBI used to
include all the scheduled banks in its schedule. Nowaday, when the number of banks has
gone up substantially, RBI has to change the schedule every now and then, hence
irrespective of whether a bank finds its name in the schedule to the RBI Act or not, its
schedule status can be found out from its banking licence. A Bank that is not a scheduled
bank is referred to as non scheduled bank even in it is having banking licence.
The difference lies in the type of banking activities that a bank can carry out in India. In
the case of a scheduled bank, it is licensed by the RBI to carry on extensive banking
operations including foreign exchange operations, whereas, a non-scheduled bank can
carry out only limited operations. There are a number of factors considered by RBI to
declare a bank as a scheduled bank, like the amount of share capital, type of banking
activities that the bank is permitted to carry out etc. An example of difference between a
scheduled and non-scheduled bank is dealing in Foreign Exchange.

Commercial And Co-operative Banks

Commercial banks are by far the most widespread banking institutions in India. They
provide major products and services in India. A commercial bank is run on commercial
lines, for profits of the organization.
A co-operative bank on the other hand is run for the benefit of a group of members of the
co-operative body. A co-operative bank distributes only a very small portion of its profit as
dividend, retaining a major portion of it in business.
All the nationalized banks in India and almost all the private sector banks are commercial
scheduled banks. There are a large number of private sector co-operative banks and most
of them are non-scheduled banks. In the public sector also, within a state, starting from
the State capital, there are State Co-operative Banks and District Central Co-operative
Banks at the District level. Under the District Central Co-operative Bank, there are Cooperative Societies.
At present, In India, the banks can be bifurcated into following categories.
Public Sector Banks or Nationalized Banks, which
scheduled Examples: State Bank of India, Bank of India etc.

are

commercial

and

Public Sector Banks, which are co-operative and non-scheduled-These are state
owned banks like the Maharashtra State Co-operative Bank, Junnar Co-operative Society
etc.

Private Sector Banks, which are commercial and scheduled-These could be foreign
banks, as well as Indian Banks. Examples: Foreign Banks- CITI Bank, Standard
Chartered Bank etc.
Indian Banks, Bank of Rajasthan Limited, VYSYA Bank Limited etc.

Various type of bank

Exchange Bank

Incorporated outside India

Carries on foreign exchange business in India
Under the direct guidance of the Reserve Bank of India

Primary functions

: Financing of foreign trade

Purchase of foreign exchange, bills of exchange

Supply of money for foreign trade

Other function:

Accept deposits and supply credit like other commercial bank

Example:
Honkong Bank , Standard Chartered Bank , City Bank , Bank of America

Agricultural Banks:
Established to meet the financial requirement of the farming class
Provide loans to the farmers at a low rate of interest
Type of loan provided short term & long term

Industrial Bank:

Specialized Financial Institution

Provide long term financial assistance to industrial concerns
Guide on technical and managerial Problems
Underwrite shares and debentures issued by industrial undertakings
Example:

IFCI, IDBI,

SFC, etc

Co-operative Banks:
Formed on the principles of co-operation
Extend credit facilities to farmers and small scale industrial
concerns

 Offer loans to cottage and small scale industries at a low rate of

interest

Function of Bank

MAIN FUNCTION

ACCEPTING DEPOSITS

Granting loans and advances

Saving account
Cash credit

Loans
Cash credit

Current account
Fixed deposit

Bill discounting

Recurring deposits
Flexi deposits

SUBSIDIARY FUNCTION
Agency functions:
Collection of cheques and bills
Payment of insurance premium
Purchase and sale of securities
Transfer of funds
Under writing of capital issues
Serving as a guarantor
Realization of accounts
Acting as a trustee executor etc.

Subsidiary Function
Utility functions
Safe custody of valuables
Issue of L/C
Issue of travelers cheque
Accepting of Bill of Exchange
Underwriting of capital issue

Providing credit information

Advice on financial matters
Dealing in foreign trade
Financing foreign trade
Credit creation

Accepting deposits:

One of the major activities of the Banks.

Banks are also called custodians of public money.
The money is accepted as deposit for safe keeping.
Banks use this money to earn interest from people who need money.
Banks share a part of this interest with the depositors.

Accepting deposits:

Types

Saving Account

Demand Deposits

Time Deposits

Payable on demand

Payable after fixed time

Current Account

Combination

Fixed Deposit

Recurring Deposits

Flexi Deposit account

Saving Account:

To park your temporary saving

To keep money required for expenses
Low rate of interest 3.5% to 4%
No restriction on deposits
Withdrawals are restricted to discourage habit of expenses
Any individual or HUF can open account but not commercial or artificial person.
Even a minor can open account
Account can be opened in joint names
Interest is calculated on the minimum balance on a specified date

Tips of opening a saving Account:

Select a Bank with minimum deposit requirement

Insist on a cheque book
Understand the restrictions on the deposits and withdrawal
Select a Bank which has minimum restrictions
Obtain a full schedule of service charges
Select Bank with minimum charges for services

Documents required to open account:

Duly filled- up Application form
May require introduction from an existing account holder
Passport sixe photographs In case joint account, photographs of all the account holders.

 Photocopy of PAN Card

If no PAN:
Copy of Identity Proof (Voter ID card, Driving license etc)
Address proof (Ration Card , Voter ID card, Electricity Bill etc)

Current account
Current Account is ideally suited for business or individuals who have large number of
transactions to be put through the account. There are no restrictions on the number of
transactions, or on cheques used by the customer. The balance standing in the customers
account is repayable on demand. A customer may be even granted an overdraft i.e. he may be
permitted to issue cheques up to an agreed limit, over and above the credit balance in the
account. Banks provide statements to its current account customers detailing credit and debit
entries in the account

Tips of opening a current account

Choose a relatively larger branch (additional services can be availed)

Select a Bank with least minimum deposit requirement
Insist on a cheque book and count the cheque leaves.
Store your cheque book carefully
Obtain a full schedule of service charges
Select Bank with minimum charges for services

Documents required to open Current account

Duly filled up Application form

May require introduction from an existing account holder
Passport size photograph-(owners of the organization-partners/proprietor etc.)
In case of Limited Company Copy Resolution is necessary
Photocopy of PAN card
Copy of constitutional deed (e.g. Partnership deed, Memorandum and Articles

of Association etc)
Copy of Trade License

Fixed deposits
Money deposited for specific tenure(15 days to five years or more)

Withdrawal is time based and not demand based

Higher rate of interest
Rate increases with increase in tenure
No movement of funds once deposited
Interest rate lowered if withdrawn before time

Tips for opening Fixed deposits

Decide the period in advance(time for which you will not need the money)
Shop around for the best rate of interest available.
Avoid Banks which do not have a sufficiently long history.
If need for withdrawal arises take advice of the banker-(if overdraft is more
feasible)
Be very careful while entrusting you money to finance companies which promise
lucrative rates of interest.

Documents for opening fixed deposits

Similar as required in case of current account and saving account.

Recurring deposits
Daily / Weekly / Monthly deposit of fixed amount.
Encourages the savings habit on a regular or recurring basis.
Rate of interest are almost equal to the rates of fixed deposits.
Generally range for a period of six months to ten years.
Minimum Rs. 5 and in multiple of Rs. 5/Interest is compounded quarterly.
Rate depends upon tenure.

Fixed Accounts

Combination of Fixed deposit and Saving account.

Also termed as two-in-one account.
Interest is higher than SB but lower than FD.
Not rigid like Fixed Deposits.
Cheque book facility is available.
Monthly statement available giving full particulars.
Interest on average balance maintained.

Bank Charges

Saving Account

Minimum balance charges

Cheque return charges
Inoperative charges
Outstation Cheque collection charges
High value clearing charges

Current Account
Minimum balance charges
Cheque return charges
Inoperative charges
Outstation Cheque collection charges
High value clearing charges
Cheque book charges
Ledger folio charges

Banking terms:

Cash reserve Ratio (CRR) is the amount of funds that the banks have
to keep with the RBI. If the central bank decides to increase the CRR, the
available amount with the banks comes down. The RBI uses the CRR to
drain out excessive money from the system.
CRR:

Scheduled banks are required to maintain with the RBI an average cash balance,
the amount of which shall not be less than 4% of the total of the Net Demand and
Time Liabilities (NDTL), on a fortnightly basis.
Repo Rate: The rate at which the RBI lends money to commercial banks is called
repo rate. It is an instrument of monetary policy. Whenever banks have any
shortage of funds they can borrow from the RBI. A reduction in the repo rate helps
banks get money at a cheaper rate and vice versa.
Reverse Repo rate: Reverse Repo rate is the rate at which the RBI borrows
money from commercial banks. Banks are always happy to lend money to the RBI
since their money are in safe hands with a good interest. An increase in reverse
repo rate can prompt banks to park more funds with the RBI to earn higher returns
on idle cash. It is also a tool which can be used by the RBI to drain excess money
out of the banking system.
Nonperforming Assets: Non-Performing Assets are popularly known as NPA.
Commercial Banks assets are of various types.
All those assets which generate periodical income are called as Performing Assets
(PA).
While all those assets which do not generate periodical income are called as NonPerforming Assets (NPA).

If the customers do not repay principal amount and interest for a certain period of
time then such loans become non-performing assets (NPA). Thus non-performing
assets are basically non-performing loans.
Types of NPA
NPA have been divided or classified into following four types:Standard Assets: A standard asset is a performing asset. Standard assets
generate continuous income and repayments as and when they fall due. Such
assets carry a normal risk and are not NPA in the real sense. So, no special
provisions are required for Standard Assets.
Sub-Standard Assets : All those assets (loans and advances) which are
considered as non-performing for a period of 12 months are called as SubStandard assets.
Doubtful Assets: All those assets which are considered as non-performing for
period of more than 12 months are called as Doubtful Assets.
Loss Assets: All those assets which cannot be recovered are called as Loss
Assets.
Causes of NPA
NPA arises due to a number of factors or causes like:Speculation: Investing in high risk assets to earn high income.
Default: Willful default by the borrowers.
Fraudulent practices: Fraudulent Practices like advancing loans to ineligible
persons, advances without security or references, etc.
Diversion of funds: Most of the funds are diverted for unnecessary expansion
and diversion of business.
Internal reasons: Many internal reasons like inefficient management,
inappropriate technology, labour problems, marketing failure, etc. resulting in poor
performance of the companies.
External reasons: External reasons like a recession in the economy,
infrastructural problems, price rise, delay in release of sanctioned limits by banks,
delays in settlements of payments by government, natural calamities, etc.

Bankers Bank: The central bank maintains accounts of all commercial banks. The
statutory reserves are to be kept with the central bank. These accounts are used
for inter-bank settlements and for foreign exchange transactions by commercial
banks with the Reserve bank.

The Reserve bank also acts as the lender of last resort to the commercial banks.
During critical situations banks may run out of reserves and may require selling
assets to meet their commitments. In such situations, Reserve Bank may come to
the rescue of these banks, by providing funds so that they can overcome the
immediate problem.
For example, on October 19, 1987 (Black Monday), the US stock market suffered
the worst one-day decline in its history with a wipe out of about 25% of the value
of stocks. This forced the banks, which were holding stocks as collateral securities,
to sell the stocks to avoid further loss. A large number of individuals and pension
funds had invested in stocks, and a huge financial collapse looked imminent. Early
next day, the Federal Reserve (Central Banking System of US) pledged to provide
emergency loans to banks to obviate dumping of stocks in the market. Thus, a
serious economic disaster was averted by the timely action of the countrys
central bank.

Working Capital Finance

Finance to meet the entire range of short-term fund requirements

Day-to-day operational cycle.

Inventories
Managing internal cash flows
Supporting supply chains
Funding production and marketing operations
Cash support to business expansion
Carrying current assets

Project Finance

Large Industrial & Infrastructure project

Purpose
Construction of ventures
Capital intensive business Expansion
Modernization and automation
Approved on the basis of assessment of
Strong in house appraisal of cost
Viability of the venture
Credit standing of promoter
Interest : Fixed of Floating
(bases upon risk involved)

Loan tenors : 5 to 10 years

(Structured on the basis of the projects revenue generation estimate)
Repayment scheduled : Depends on revenue generation estimate e.g.= Particular
project will not generate any revenue in the first 2 years. In such case a seven
years loan may be structured for repayment from the 3rd year onwards.

Corporate Term loans

Medium size term loan project

Purpose
Business Expansion
Repayment of high cost debt
Technology up-gradation
R & D expenditure
Leveraging specific cash streams
Implementing early retirement schemes
Supplementing Working Capital

Cash Credit

Most popular Working Capital finance in India.

Certain limit is sanctioned.
Withdrawals within allowed within the limit.
Borrower can use borrowing as per requirement.
Deposit surplus amount back into the amount.
Interest is charged on daily balance of amount.
Some of the bank charges nominal % or % as commitment charges.

Overdraft

Temporary borrowings to meet contingencies in business

Withdrawals exceeding balance in current account or limit sanctioned in cash
credit account.
Usually sanctioned by Branch Manager or assessment of customer urgencies.
Backed by collateral securities and Credit standing.

Difference
Cash Credit

Long term facility subject to

yearly renewal.
Need not repaid back periodically.
Security as a % of Book debt,
stock plant & M/c

Over Draft

Bill discounting

Borrower is granted loan against

bill.
Amount paid after dedicating
some % as margin.

Occasional Temporary facility.

Repayment in shot period as
agreed.
Security such as Shares, units,
LIC, Debentures etc.
In some cases clean O/Ds are
also granted depending on
perceived worth of Individual.

Bank presents this bill to drawee

at due date & collect the amount
of the bill.
Borrower is charged commission
plus Interest.
It can be one time transaction or
sometimes banker sanctions limit
for bill discounting.

Working Capital Requirement

Capital required for day-day requirements of a concern.

Required for maintenance of inventories, extending credit to customers and
maintaining cash balance.
Requirement is met by:
Partly out of credit extended by suppliers of goods and services.
Partly out of its own internal sources.
Partly out of short-term borrowings from banks.

Analysis of Working Capital

Gross working capital (GWC):
-

Firms total investment in current assets

Net Working capital (NWC)

=CA

(Current Assets)

NWC can be positive or negative

Positive

NWC

CA > CL

Negative

NWC

CA < CL

CL

(Current Liabilities)

Working capital cycle

Cash is converted back to cash after following the stages:

Raw material,
WIP,
Finished goods, and
Sundry debtors.s

BASIC DATA

Stocks:

Raw materials
Work-in-progress
Finished goods

Debtors
Creditors
Average working capital
Sales
Cost of sales
Purchase of raw material

Average amount
outstanding
1,50,000
96,000
81,600
2,00,200
1,32,000
3,95,800

Average value per day

(365days assumed)

3,080
2,400
1,200

Working Capital Cycle

Raw material holding:

Raw material stock

Daily purchases
Less Credit taken:

Creditors

Work-n-progress
Daily cost of sales

Finished goods turn-over: Finished goods

Daily cost of sales
Customer credit period:

= 125 Days

1,200
= 1,32,000

Daily purchases
Production Period:

1,50,000

1,200
=

96,000

= 110 Days
15 Days
= 40 Days

2, 400
= 81,600

= 34 Days

2,400

Debtors

= 2,00,200

Daily sales

3,080

= 65 Days
154 Days

The amount paid by the company , for its raw material, is received back by the company from sales
after 154 days.

Working capital Requirement can be calculated by applying following formula.

Total operating expenses expected during the year
No . of operating cycles in a year

There will be about 2.37 operating cycles (365 days / 154 days)
If the operating expenses are Rs. 5,00,000.
The working capital requirement will be Rs. 2,10,970(5,00000/2.37)

In other words :
If operating expenses per day are Rs. 1,000 and
The working capital cycle is 154 days.
It will take 154 days to the company to convert raw material into cash,
The working capital required is
Rs. 1,000*154 days = Rs. 1,54,000

Inventory Conversion Period

Total time needed for:
I.

Producing a product, and

Selling the product.

II.

Typically, it includes:
Raw material conversion period
Work-in-process conversion period
Finished goods conversion periods

Debtors Conversion Period

Time required to collect outstanding amount from customers.

Minimum Margin Money

Credit limits<Rs. 1 Crore :
-Bank to ensure maintenance margin of 5% of the annual turn over
Example:
Suppose annual turnover

: Rs. 1,00,000

Owners contribution at least : Rs. 5,000s

Minimum Current Ratio

Credit limit Rs. 1 crore:
-Banks to ensure maintenance minimum current ratio of 1.33:1
Example:
Lone requirement

: Rs. 1.5 crore

If:
Current Assets

: Rs. 1.33 crore

Than:
Current Liability must be Rs. 1 crore

Important ratios to be studied by banker in balance-sheet:

Current Ratio
Acid Test or quick Ratio
Gross Profit Ratio
Debtors Ratio
Net Return Ratio

Debtor/Creditor Ratio
Debt/Equity Ratio
Proprietary Ratio
Solvency Ratio
Inventory Turn-over Ratio

Current Ratio

Ratio between current assets and current liabilities

Obtained by dividing current assets by current liabilities
Important to a banker since it indicates the liquidity of the borrower.
Current assets
Current liabilities

Current assets:

Assets convertible into cash within a short period

Includes stocks, debtors, cash and investments

Current Liabilities :

Liabilities due for payment in a short period

Shorty- term bank borrowings, trade creditors, provision for a taxation, etc.

CURRENT RATIO
Ratio of 2:1 (Considered to be an ideal ratio)

Current assets are twice the current liabilities

Means there are sufficient assets to pay for the current liabilities

Ratio of 1:1 is satisfactory

Ratio below 1:1 is unsatisfactory
Decision can not always depend on ratio
Some times ratio may be 2:1 yet situation unfavourable
Quality of assets included as current assets is more important
The ratio by itself has no meaning if the assets are not good
E.G.:- Unsalable stock included in current assets

Acid Test or Quick Ratio

Also called Liquidity Ratio

Involves only the liquid resources in current Ratio
Quick assets(current assets minus inventory)

Quick liabilities (Current liabilities minus bank borrowings)

Quick assets includes:

Cash and bank balance, readily saleable securities and book debts

Current liabilities in this case shall not include

Short term bank borrowing , i.e. , overdraft and cash credit facilities

Acid Test or Quick Ratio

Decline in current ratio and quick ratio indicates overtrading

Good current ratio but low quick ratio
Indicate dis-proportionate high investment in stocks
(quick asset exclude inventory or closing stock from current assets)

Ratio of less than 1 will be undersirable a ratio of 2 ideal

Gross Profit to Sales Ratio/G.P. Ratio

Gross Profit*100
Sales

Yearly rise in this ratio considered a good sign

Generally expressed as a percentage
Compared with ratio of companies engaged in same line of business
Ratio reflects the efficiency or otherwise of management

Debtors Ratio
Account Receivable (Sundry Debtors and Bills Receivable)
Average Daily Monthly Credit Sales

Indicates what part of the sales is on credit basis

Indicates the period of credit extended to the customers
Too high ratio indicates slackness in collection
Resulting lack of cash to pay the creditors

Net Return Ratio

Nest Profit before interest and Tax

100

Nest Fixed Assets + Working Capital

Obtained by dividing net profit after depreciation but before taxation by net worth of the
company
Indicates profitability as compared to total own funds employed
Judges the overall performance of the concern
Comparison of ratio for multiple periods shows the utilization of facilities

Debt/ Equity Ratio

Current and long term Debts
Share Capital and Free Reserves
Obtained by dividing debt (borrowed fund ) by equity (own fund)
Indicating proportion of debt to equity
Normal level of debt equity ratio as to be seen by bank is 2:1

Proprietary Ratio
Proprietors Funds
Total Assets

Funds belonging to proprietors or shareholders as compared to the total assets.

Higher the ratio, it is for all concerned

Solvency Ratio
Net Tangible Assets
Total Outside Liabilities

Obtained by relating Net Tangible Assets to total outside liabilities.

Measures ability to repay all external debts out of own assets.
Ideally this ratio should be more than 1.
Larger the ratio , better is the solvency of the unit.

Cash Credit

Most popular working capital finance in India

Certain limit is sanctioned
Withdrawals within allowed within the limit
Borrower can use borrowings as per requirement
Deposit surplus amount back into the account
Interest is charged on daily balance of account
Some of the bank charges nominal % or % as commitment charges

Most popular working capital finance in India

Certain limit is sanctioned
Withdrawals within allowed within the limit
Borrower can use borrowings as per requirement
Deposit surplus amount back into the account
Interest is charged on daily balance of account
Some of the bank charges nominal % or % as commitment charges

Cash Credit

Margin
Bank do not extend finance equal to 100% of working capital
Some % say 25% are required to be contributed by borrower
Normal maximum permissible bank finance is 75% of your WC requirements

Sources of Working capital finance

Internal

External

Nest gains from operation

Sale of fixed assets
Capital introduction

Bank borrowings
Private loans

Term Loan by Indian banks

Granted by development banks:

Industrial Finance Corporation of India (IFCI),
The industrial Development Bank of India (IDBI),
The State Financial Corporations
Other Commercial banks
Bigger advances are granted by commercial banks in participation with the term- lending
institutions.

Tem Loan Appraisal

Depends to a large extent on estimates or forecasts on following broad basis:
Technical Feasibility
-Location and other infrastructure.
Economic feasibility
-demand for the additional output or the product.
Managerial Competence
-technical competence, administrative ability, integrity and
Resourcefulness of the management
Financial Feasibility
-Cost of the project , production, profitability , estimated cash flow and
Balance sheet

Difference

Term Lone

Working Capital

Purpose:
New projects or
Expansion, diversification or

Purpose:
Day-to-day requirements of the
concern.

Modernization of the existing units.

Generally granted for one year.

Repayment schedule 8 to 10 years.

Secured by immovable and movable

Against the hypothecation of stock

Properties .

Option to convert part of the loan into

No such clause.

Equity shares .

Appraisal on technical, economic and

Appraisal on short-term liquidity.

Financial feasibility.

Securities

Primary Securities

Collateral Securities

Securities offered primarily towards

Security in addition to the personal

his loan.

Obligation of the borrower.

Stock.
Debtors or other receivables ( in case
Of cash credit.)
Plant & Machinery
Other fixed assets ( in case of term
Loans.
Flat or buildings (in cash of housing loans.)
Cars ,Buses, Lorries ( in case of loans to
Purchase the same.)

Introduction- Documentary credit

Land & Building

Plant & Machinery
Life insurance policy( Endowment
Policy only)
Fixed Deposit with banks (But not
with post office)
NSC
KVP etc.

An arrangement between buyer and is Bank.

Bank acts at the request and on instruction of buyer.
Buyers Bank undertakes to make payment to the sellers Bank
Promotes trading in the course of import and export.
Documentary Credits are akin to bank guarantees.

Flow

- Documentary credit

Seller

Buyer
Sale
contract
Delivery of goods
Application for
LC

Advising
Bank

Issuing
Bank
LC (original)

Benefits (Letter of credit)

Universally accepted arrangement for payment against documents.
It allows the seller to rely on credit of the bank instead of the buyer.
The invoice is the sellers representation of what has been sold and shipped.
It assures to buyer that terms of contract has been complied with
Advantages of an LC for the Buyer
It allows the seller to rely on the credit of the bank instead of the buyer.
Advantages of an LC for the Buyer
The invoice is the sellers representation of what has been sold and shipped.

Types of documentary credit

Non funded facility where bank do not offer actual loan facility in terms of money.
Assures other party to the transaction on behalf of its customer about fulfillment of terms of
contact (guarantee)

 The documents giving such assurance are.

Letter
of
Credit

Bank
Guaran
tee

Type of LC

Revocable
Can be called back by the buyer
Advantageous to opening bank
Cheaper
Issued only in circumstances where
alternate buyer are available or in case
of affiliated parties or subsidiary
companies

Confirmed LC
Confirmation of LC by any bank in the
country
Enforcement or payment in local
country.

Irrevocable
Cant be called back or amended by the
buyer without consent of all the parties.
He is bound to discharge the same
On satisfaction of terms by the seller
The banker undertakes to buy the shipping
documents
If the documents are in order the bank will
pay irrespective of any controversy between
buyer and seller as regard fulfillment of
contract
Non- Confirmed LC
Without confirmation a LC may not be
operative in practical terms.

Application for LC
The Documentary credit operations starts with application by buyer on the basis of LC
requirement clause in PO
In Bankers prescribed form
The terms of credit are set as per purchase agreements
The LC should contain complete and precise conditions

Bank guarantee

Its a commercial instrument

Accessory contract
To secure compliance with the contract
It is a offshoot of main contract between two parties
The Promisor undertakes to indemnify the promise for debt, default miscarriage of another
person

Instances when BG is issued

Buyer to Seller to guarantee the future payment
Seller/ contractor as guarantee of contract fulfillment against advanced
Importer to safeguard against governmental policy changes and as a guarantee of due
payment
Performance guarantee

BANK AND HIRE PURCHASE FINANCE

Hire purchase

 Its contractual agreement between owner and hirer.

Owner let out his goods on hire to hirer.
An option is given to the to hirer for purchasing the goods in accordance with the terms of
contract.

Two aspects of Hire purchase Agreement

Bailment of goods

HP

Sale contract

Installment purchase

Leasing

Hire Purchase

Installment Purchase

Leasing

Ownership is transferred
after the user exercises
his option to purchase
the item

Ownership is transferred
immediately after the
first installment is paid

Leasing do not allow to

purchase the goods in all
cases e.g. in operating
lease

Product range for HP

TV, Audio Systems, Refrigerators, Automobiles etc.

Owners obligations

He must have title to goods at the time of delivery

Ensure that hirer has quite possession of goods
Deliver the possession of goods
Ensure goods are of merchantable quality
Reasonably fit for intended use

Hirers Obligation

He should take reasonable case of the goods

He cant sell the goods
Pledge them
Use for any other purpose than specified in the contract
Pay sum as agreed
Arrange for the insurance cover

Owner
Repossess the upon the breach of the
HP agreement

Rights

Hirer
Terminate the contract any time before
final payment
Purchase the goods before final
payment

Tax aspect
Income tax :
Depreciation is not allowed to the hirer on hire purchaser
Depreciation is allowed to the buyer on purchase by installment payment
Sales

Tax/VAT:
Hire purchase transactions are liable to sales tax/ VAT
Sales tax/VAT is levied only when the hirer assigns the option to purchase
Sales tax/ VAT must be determined with reference to the depreciated value of the items.
Rate caries from state to state.

Accounting Aspect
Hirers angle
The cash purchase price is capitalized and liability is recorded for cash price less down
payment.
Depreciation is charged on cash price
Interest component in is provided as expenses
Payment of installment is recorded

Accounting Aspect
In the books of finance company:
Cash price receivable is recorded as current asset
Finance income component recorded current liability under the head Unmatured Finance
Charges.
Down payment is recorded against Receivable A/c.
Appropriate part of the Unmatured Finance Income is recorded as current income of the
period.
At the end of each accounting period, the hire purchase price less the installment received is
shown as a receivable.
Cost + Profit
Cash Price
Debited to Asset A/C

Interest

H.P. Price

Debited to P/L A/c year to year

Example :
On 1st April, 2009 Anand & Co. (Hirer) acquired a pick- up van on hire purchase from French Motor
Co. Ltd.
The terms of the contract were as follows:
The cash price of the van was Rs. 5,00,000.
Rs. 2,00,000 was to be paid on as down payment.
The balance was to be paid in annual installments of Rs. 1,00,000 plus interest. Interest
chargeable on the