LC Assessment: Vikas Anand Y. G. Gurnani

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LC ASSESSMENT

VIKAS ANAND
Y. G. GURNANI
Definition:
A Letter of Credit (LC) also known as a Documentary
Credit is a conditional payment mechanism used in
International Trade to provide a financial guarantee from
a credit worthy bank to an exporter of goods.
It is used extensively as many of the times, the seller have
very little or no information about the buyer’s financial
standing.

LC issuing bank assumes the credit risk of the buyer paying


the seller for goods.
Letter of Credit limit is calculated by the
banks based on the annual consumption of
Raw Materials (RMs) to be purchased
under the LC and the credit period
extended by the seller of the goods.
Assessment of LC Limit:
# Parameters

1 Total Purchases of Raw Material (RM) (Est / Proj) A

2. Procurement of RM under LC (%) P%

3. Annual purchase of RM (under LC) A x P%

4. Monthly purchase of RM (under LC) say Q (AxP%)/12

5. Avg. Usance Period (a) months

6. Avg. Lead Time (b) months

7. Total Time say T (a+b) months

8. LC Limit required Q xT

9. LC Limit recommended for sanction (QxT)


Assessment of LC Limit:
# Parameters

1 Total Purchases of Raw Material (RM) (Est / Proj) Rs. 100/-


Assessment of LC Limit:
# Parameters

1 Total Purchases of Raw Material (RM) (Est / Proj) Rs. 100/-

2. Procurement of RM under LC (%) 48%


Assessment of LC Limit:
# Parameters

1 Total Purchases of Raw Material (RM) (Est / Proj) Rs. 100/-

2. Procurement of RM under LC (%) 48%

3. Annual purchase of RM (under LC) Rs. 48/-


Assessment of LC Limit:
# Parameters

1 Total Purchases of Raw Material (RM) (Est / Proj) Rs. 100/-

2. Procurement of RM under LC (%) 48%

3. Annual purchase of RM (under LC) Rs. 48/-

4. Monthly purchase of RM (under LC) say Q 48/12= Rs. 4/-


Assessment of LC Limit:
# Parameters

1 Total Purchases of Raw Material (RM) (Est / Proj) Rs. 100/-

2. Procurement of RM under LC (%) 48%

3. Annual purchase of RM (under LC) Rs. 48/-

4. Monthly purchase of RM (under LC) say Q 48/12= Rs. 4/-

5. Avg. Usance Period 2.5 months


Assessment of LC Limit:
# Parameters

1 Total Purchases of Raw Material (RM) (Est / Proj) Rs. 100/-

2. Procurement of RM under LC (%) 48%

3. Annual purchase of RM (under LC) Rs. 48/-

4. Monthly purchase of RM (under LC) say Q 48/12= Rs. 4/-

5. Avg. Usance Period 2.5 months

6. Avg. Lead Time 0.5 months


Assessment of LC Limit:
# Parameters

1 Total Purchases of Raw Material (RM) (Est / Proj) Rs. 100/-

2. Procurement of RM under LC (%) 48%

3. Annual purchase of RM (under LC) Rs. 48/-

4. Monthly purchase of RM (under LC) say Q 48/12= Rs. 4/-

5. Avg. Usance Period 2.5 months

6. Avg. Lead Time 0.5 months

7. Total Time say T 3.00 months


Assessment of LC Limit:
# Parameters

1 Total Purchases of Raw Material (RM) (Est / Proj) Rs. 100/-

2. Procurement of RM under LC (%) 48%

3. Annual purchase of RM (under LC) Rs. 48/-

4. Monthly purchase of RM (under LC) say Q 48/12= Rs. 4/-

5. Avg. Usance Period 2.5 months

6. Avg. Lead Time 0.5 months

7. Total Time say T 3.00 months

8. LC Limit required (QxT) Rs. 12/-


Assessment of LC Limit:
# Parameters

1 Total Purchases of Raw Material (RM) (Est / Proj) Rs. 100/-

2. Procurement of RM under LC (%) 48%

3. Annual purchase of RM (under LC) Rs. 48/-

4. Monthly purchase of RM (under LC) say Q 48/12= Rs. 4/-

5. Avg. Usance Period 2.5 months

6. Avg. Lead Time 0.5 months

7. Total Time say T 3.00 months

8. LC Limit required (QxT) Rs. 12/-

9. LC Limit recommended for sanction Rs. 12/-


Do you know….????
 Usance Period : It is the credit period extended to the
buyer by the supplier of the goods. So, this is basically
the purchase under credit transaction.

 Lead Time: Also known as Procurement Time. It is the


time taken in receiving the goods including transit
period after the LC is opened.
Key points:
 Satisfactory track record of the customer.

 For genuine trade transactions ONLY.

 Visibility of margin.

 RM holding and Production Cycle length as per


Industry benchmarks & past trends.
 Level of Sundry Creditors to be inline with the usance
period.
 Maximum usance to be inline with gross operating cycle as
per RBI guidelines.
Key points:
 Cash Flow must be analyzed properly.

 Regular devolvement is a warning signal.

 Incase of devolvements, further LC to be opened with step


up margin and preferably with prior permission from
competent authority.
 Working Capital LC should not be used for CAPEX.

**************
“Thank You”

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