You are on page 1of 93

PROJECT REPORT

ON
INTERNATIONAL TRADE FINANCING:
A DETAILED STUDY ON PECS TRADING


By:
Gurpreet Singh
13BSPHH011105

Summer Intern, IBS Hyderabad



PEC LTD. A PREMIER INDIAN INTERNATIONAL
TRADING COMPANY


ii

PROJECT REPORT
ON
INTERNATIONAL TRADE FINANCING:
A DETAILED STUDY ON PECS TRADING

By:
Gurpreet Singh
13BSPHH011105
PEC LTD. A PREMIER INDIAN INTERNATIONAL
TRADING COMPANY

A report submitted in partial fulfillment of the requirements of
MBA Program of IBS Hyderabad

Submitted to:

Prof. Trilochan Tripathy
(Faculty Guide)

Mr. Thapan
(Finance Manager,
PEC Ltd., New Delhi)
Submission Date: 16
th
May, 2014

iii

AUTHORIZATION

The Project Report on International Trade Financing: A Detailed Study On
PECs Trading was undertaken at PEC Limited, headquartered at Hansalaya, 15-
Barakhamba Road, New Delhi, India, from 24
th
Feb, 2014 to 23
rd
May, 2014 as partial
fulfillment of the requirement of MBA Program at IBS Hyderabad.










Distribution list:
Prof. Trilochan Tripathy
(Faculty Guide)

Mr. Thapan
(Finance Manager,
PEC Ltd., New Delhi)

iv




ACKNOWLEDGEMENT

I would like to express my deep sense of hearty and special gratitude to
Mr. Suresh Kumar Banga, Chief Finance Manager, PEC Limited for giving me
an opportunity to work on the project, International Trade Financing and
PECs Trading activity.
I would like to further extend my heartiest gratitude towards Mr.
Thapan, Finance Manager, PEC Limited for providing me valuable inputs for
shaping up this project for what it is now. He always inspired me towards
learning and gaining knowledge and also helped me at all the stages of the
project by spending his invaluable time and efforts.
I would like to convey my deepest and heartiest gratitude to Prof.
Trilochan Tripathy, faculty guide, IBS Hyderabad for providing the regular
guidance and support throughout the duration of internship. His regular
directions during the internship were very much valuable for the successful
completion of the project.
It has indeed been a great learning experience both professionally and
personally by working in this project at PEC Limited.


Gurpreet Singh

v

13BSPHH011105






TABLE OF CONTENTS

AUTHORIZATION .............................................................................................. III
ACKNOWLEDGEMENTS ..................................................................................... IV
TABLE OF CONTENTS ....................................................................................... V
EXECUTIVE SUMMARY ...................................................................................... IX
LIST OF FIGURES ............................................................................................... X
LIST OF TABLES ................................................................................................. XI
1.INTRODUCTION ................................................................................................ 1
1.1 INTRODUCTION TO COMPANY ....................................................... 2
1.2 PURPOSE OF THE STUDY ................................................................. 3
1.3 SCOPE OF THE STUDY ....................................................................... 3
1.4 SOURCES OF THE DATA ..................................................................... 3
1.5 LIMITATION AND HINDRANCE ....................................................... 4

vi

2. STRUCTURE OF ORGANIZATION .................................................................... 4
3. COMPANY ANALYSIS ....................................................................................... 6
3.1 PECS MISSION ................................................................................ 6
3.2 PECS VISION ................................................................................... 6
3.3 OBJECTIVES OF PEC ......................................................................... 6
3.4 KEY INITIATIVES ................................. 7
3.5 PECS OPERATION ............................................................................ 7
3.6 SWOT .............................................................................................. 9
3.7 PESTEL ANALYSIS OF TRADE INDUSTRY .......................................... 11
3.8 PORTERS FIVE FORCE ANALYSIS OF THE FIRM .............................. 13
4. PERFORMANCE ................................................................................................. 14
4.1FIRM ANALYSIS USING FINANCIAL RATIOS ..................................... 17
5. BUSINESS MODEL OF PEC LIMITED .............................................................. 25
6. IMPORT ............................................................................................................. 26
6.1 PROCEDURE OF IMPORT UNDER BACK TO BACK LC ................... 26
6.2 PROCEDURE OF IMPORT UNDER GOVERNMENT ACCOUNT29
7. EXPORT ............................................................................................................. 32
7.1 EXPORT BY PARTICIPATING IN INTERNATIONAL TENDER .............. 32
7.2 EXPORT FOR ASSOCIATE .................................................................. 33
7.2.1 ON BEHALF OF PEC LTD ................................................. 33
7.2.2 ON BEHALF OF ASSOCIATE (FINANCING) ...................... 34
8. DOMESTIC FINANCING ................................................................................... 35
9. FORWARD BOOKING IN PEC ......................................................................... 36
10. SETTLEMENTS OF ACCOUNTS ...................................................................... 36
11. METHODS OF PAYMENT IN INTERNATIONAL TRADE ................................ 37

vii

11.1 CASH-IN-ADVANCE ..................................................................... 38
11.1.1 CHARACTERISTICS OF CASH -IN ADVANCE ............. 38
11.1.2 KEY POINTS .................................................................... 39
11.1.3 CONDITIONS FOR USAGE ............................................. 39
11.2 LETTERS OF CREDIT ....................................................................... 40
11.2.1 PARTIES TO A LETTER OF CREDIT ................................ 40
11.2.2 CHARACTERISTICS OF A LETTER OF CREDIT ............... 42
11.2.3 KEY POINTS .................................................................... 42
11.2.4 ILLUSTRATIVE LC TRANSACTION .................................. 43
11.2.5 TYPES OF LCS ................................................................ 43
11.2.6 METHODS OF SETTLEMENT .......................................... 45
11.2.7 NOTE ON DOCUMENTARY LCS ................................... 46
11.2.8 DOCUMENTS REQUIRED IN AN LC.............................. 46
11.3 DOCUMENTARY COLLECTIONS .................................................... 48
11.3.1 CHARACTERISTICS .......................................................... 49
11.3.2 KEY POINTS .................................................................... 49
11.3.3 FLOW OF TRANSACTION IN A DEAL ........................... 50
11.4 OPEN ACCOUNT ............................................................................. 51
11.4.1CHARACTERISTICS OF AN OPEN ACCOUNT .................... 51
11.4.2 KEY POINTS .................................................................... 52
12. FORFAITING ................................................................................................... 52
12.1 INTRODUCTION OF FORFAITING .................................................. 52
12.2 DEFINITION OF FORFAITING ......................................................... 53
12.3 HOW FORFAITING WORKS IN INTERNATIONAL TRADE ............. 53
12.4 COST ELEMENT .............................................................................. 53

viii

12.5 SIX PARTIES IN FORFAITING .......................................................... 54
12.6 BENEFITS TO EXPORTER ................................................................. 54
12.7 BENEFITS TO BANKS....................................................................... 55
12.8 DRAWBACKS OF FORFAITING ....................................................... 55
13. FACTORING .................................................................................................... 55
13.1 DEFINITION OF FACTORING ......................................................... 55
13.2 CHARACTERISTICS OF FACTORING ............................................... 56
13.3 DIFFERENT TYPES OF FACTORING ................................................ 56
14. BUYERS CREDIT ............................................................................................. 57
14.1 BENEFITS OF BUYERS CREDIT TO IMPORTER ............................... 58
14.2 STEP INVOLVED IN BUYERS CREDIT ............................................. 58
15. ROLLOVER PROCESS IN BUYERS CREDIT .................................................... 59
15.1 PROCESS OF BUYERS CREDIT FOR CAPITAL GOODS ................... 59
15.2 COSTS INVOLVED ........................................................................... 60
15.3 CONCEPT OF WHT (WITHHOLDING TAX) ................................ 61
16. LIBOR ........................................................................................................... 61
16.1. MEANING OF LIBOR ..................................................................... 61
16.2. THE CREATION OF LIBOR............................................................. 61
16.3. LIBOR PANEL BANKS ..................................................................... 62
16.4 LIBOR CALCULATION METHOD ................................................... 62
16.5 SIGNIFICANCE OF LIBOR INTEREST ............................................... 62
17. FUNDS MANAGEMENT ................................................................................. 63
18. UCP 600 ...................................................................................................... 66
19. INCOTERMS .............................................................................................. 67
20. FINDINGS AND CONCLUSION ...................................................................... 70

ix

20.1. FIRMS FINANCIAL ANALYSIS ....................................................... 70
20.2 STUDY OF FINANCING INTERNATIONAL TRADE .......................... 76
21. RECOMMENDATIONS .................................................................................... 78
21.1 FIRMS FINANCIAL ANALYSIS ........................................................ 78
21.2 STUDY OF FINANCING INTERNATIONAL TRADE .......................... 79
22. REFERENCES ................................................................................................... 80















x




EXECUTIVE SUMMARY
PEC LTD. is a government of India public sector enterprise under Ministry of Commerce and
Industry, Government of India. The company's primary business thrusts are in exports, imports, deemed
exports, third country trading, arranging financing and logistics. It was formed in 1971 and is
headquartered at Hansalaya, 15-Barakhamba Road, New Delhi, India.
The project INTERNATIONAL TRADE FINANCING: A DETAILED STUDY ON
PECS TRADING is a detailed study of the Import, Export & Domestic Trade as well as various
methods of financing International Trade with the main objective of making a successful career in this
sector by getting placed with one of the Indian International Trading Companies.
The purpose of the study is to fulfill the requirements towards the partial completion of the relevant
degree. Apart from that, to have an insight into the physical working environment of a trading organization
and to gain some working knowledge of which I will be a part in the near future.
The project has explored the need for trade finance and introduced some of the most common trade
finance tools and practices. With the fast growing international oriented transactions in business enterprise,
a proactive role of governments in trade finance may alleviate the lack of trade finance in emerging
economies and contribute to trade expansion and facilitation. While doing this project, different areas
which play vital role in growth of Global Trade Finance market such as Methods of Payments of
International Trade, Letter of Credit, concept of Forfaiting and Factoring, Buyers Credit, Buyers Credit
with Rollover process, concept of LIBOR, concept of Forward Booking, NOSTRO and VOSTRO accounts
and INCO terms were studied. For assessing various aspects of the firm, Financial Ratio Analysis,
PESTELs Analysis, SWOT Analysis and Porters Five Force Analysis were also carried out.
Trade financing in India is in nascent stage and in order to explore foreign exchange market &
smooth functioning of transactions, the government should undertake some initiative to with-stand among
the developed countries. Many importing companies in west are trying to preserve cash by delaying
payment and the number of SMEs in emerging Asian economies with high credit risk is growing. This is
partly the result of a regional trend toward unsecured, open-account type transactions. Many Western
buyers are asking their Asian suppliers to sell goods on open-accounts terms, instead of using guarantees
like letters of credit (LCs). These buyers simply do not want to bear the extra cost of payment guarantees
and will source their goods from somewhere else if they are not given open-accounts. As LCs or factoring
in China and many other countries in Asia are not yet commonly used, therefore Asian suppliers can often
do very little to protect themselves in cross-border transactions.

xi

So by promoting guaranteed L/C transactions and making Asian countries aware of it, will help the
economy to come out of slowdown. As in this way, these Asian companies will route their trade via PEC,
therefore PEC can also achieve a high trading margin.
Needless to say, no text paper or text book by itself can convey the full richness of either the
theoretical development or subtleness of practice in its chosen fields. This Project is a sincere attempt to
provide a basic understanding of the complexities of international trade of world finance in simple manner.
LIST OF FIGURES

Figure 1. Organization Structure 429
Figure 2. PESTEL Analysis 430
Figure 3. Porters Five Force Analysis 431-432
Figure 4. Business model of PEC Limited 433
Figure 5. Letter of Credit: Procedure 434
Figure 6. INCOTERMS 435
Figure 7. Screenshot Ratio Analysis 1 436
Figure 8. Screenshot Ratio Analysis 2 437
Figure 9. Screenshot Ratio Analysis 3 437
Figure 10. Screenshot Trend Analysis 1 438
Figure 11. Screenshot Trend Analysis 2 438
Figure 12. Screenshot Trend Analysis 3 438
Figure 13. Screenshot Trend Analysis 4 439
Figure 14. Screenshot Trend Analysis 5 439

xii

Figure 15. Screenshot Trend Analysis 6 439
Figure 16. Screenshot Trend Analysis 7 439
Figure 17. Screenshot Index Analysis 1 439
Figure 18. Screenshot Index Analysis 2 439
Figure 19. Comparison of Payment methods 439
Figure 20. Risk associated with these payment methods 439
LIST OF TABLES

Table 1. Last 6 years financial performance 503
Table 2. Performance of PEC against MOU 504
Table 3. Financial parameters for the years 2008-09 to 2011-13 505












1

1. INTROUCTION
Although international trade has been in existence for centuries, trade
finance has developed as a means of facilitating it further. The widespread use
of trade finance is one of the factors that have contributed to the enormous
growth of international trade in recent decades.
The term Trade Finance means financing a Trade. For a trade to take
place we have a seller to sell the goods and we have a buyer to buy the goods.
Various intermediaries such as banks, Financial Institutions can facilitate the
trade by financing it. When transactions take place beyond national borders,
naturally finance has to be provided on international basis. Thus, financing
international trade is nothing but providing trade finance worldwide.
In its simplest form, trade finance works by reconciling the divergent
needs of an exporter and importer. While an exporter would prefer to be paid
upfront by the importer for an export shipment, the risk to the importer is that
the exporter may simply pocket the payment and refuse shipment. Conversely, if
the exporter extends credit to the importer, the latter may refuse to make
payment or delay it inordinately. The most common solution to this problem is
through a letter of credit, which is opened in the exporter's name by the importer
through a bank in his or her home country. The letter of credit essentially
guarantees payment to the exporter by the bank issuing the letter of credit upon
receipt of documentary proof that the goods have been shipped. Although this is
a somewhat cumbersome process, the letter of credit system is one of the most
popular international trade finance mechanisms.
The financing of international trade includes activities such as lending,
issuing letters of credit, factoring, export credit and insurance. Companies
involved with trade finance include importers and exporters, banks and

2

financiers, insurers and export credit agencies, as well as other service
providers. Trade finance is of vital importance to the global economy, with the
World Trade Organization estimating that 80 to 90% of global trade is reliant on
this method of financing.
1.1 Introduction to Company

PEC ltd. is a government of India public sector enterprise under Ministry
of Commerce and Industry, Department of Commerce, Government of India.
The company's primary business thrusts are in exports, imports, deemed exports,
third country trading, arranging financing, logistics, project exports and
management. It was formed in 1971 and is headquartered at Hansalaya, 15-
Barakhamba Road, New Delhi, India. PEC Limited (formerly known as The
Projects & Equipment Corporation of India Limited), is a government of
India public sector enterprise under Ministry of Commerce and Industry,
Department of Commerce, Government of India.
PEC, a trading house has over Forty years of international trading
experience in setting up turnkey projects and execution of high value supply
contracts under international competitive bidding procedures including
multilateral funded and EXIM Bank of India Line of Credit tenders by
associating with reputed Indian manufacturers and contracting companies. PEC
acts as main interface between the foreign buyer and manufacturer and closely
monitors the execution of the contracts and ensures successful and timely
execution of the contracts.
PEC identifies the best and most reliable manufacturing associates for
each type of goods, services and turnkey projects and ensures adherence to
contractual obligations of quality and delivery. For this, PEC maintains close
liaison with Government and other agencies in public and private sectors,

3

connected with financing, manufacturing, transport and shipping of goods on
the one hand and consultancy services on the other.
1.2 Purpose of the Study
The purpose of the study is to fulfill the requirements towards the partial
completion of the relevant degree. Apart from that, to have an insight into the
physical working environment of an organization and to gain some working
knowledge of which I will be a part in the near future.
1.3 Scope of the Study
The scope of the study consists of two main parts. Part one is
International Trade Financing which deals with various forms of financing the
international trade and second part is PECs trading, which deals with various
operations like import, export and domestic trading. My study will be done on a
detailed basis regarding the use of Letter of credit in import.
1.4 Sources of The Data
The study is based on the data from two sources:
Primary source:
Data from the primary source is known as the primary data. These data are
collected from the interactions with the guide, officials and individuals within
the organization. These data can be relied upon. Apart from the interactions, the
collection of the data is done from files, ledger, records etc.




4

Secondary data:
Secondary data are collected from the secondary sources like annual report,
published reports, journals, internet data services (web sites) etc. These are the
data which are already available for collection of information.
1.5 Limitation and Hindrance
The study is based upon the reliability of the gathered information and the
data from the above two sources. The whole aspect of international trade
finance is a vast subject which transcends limitations of a small report of
this nature.
This study incorporates on shortcomings which are inherent in the available
limited information.
The area of study considered is quite a vast field of study & lack of
sufficient time is also a constraint.
Inaccessibility to internal & confidential information makes the analysis
limited to external information available.
The study solely depends on the reliability of the data available &
information collected from the secondary sources. Thus it incorporates
limitations that are inherent in the available published information.

2. STRUCTURE OF ORGANIZATION
PEC is headed by Chairman-cum-Managing Director and one whole time
Directors. The Board consists of the following members:
Shri. A.K. Mirchandani, CMD
Shri. Ravi Kumar, Director (Marketing)
Ms. Aditi Das Rout , Director, Ministry of Commerce Part Time Director

5

Shri. Santosh Kumar, Dy. Secretary, Department of Commerce Part Time
Director
The total manpower of the Corporation is 202, including 175
Officers and remaining 27 staff members. PECs Headquarter is at
Hansalaya, 15-Barakhamba Road, New Delhi 110 001 and has 14 branch
offices spread all over India including 7 Port Offices.

Figure 1 - Organization Structure




6

3. COMPANY ANALYSIS
3.1 PECs Mission
To Trade in the international and domestic market in a manner to create an
image of quality, reliability, ethical values and sustained long term
relationship with the customers and other business partners by:
Export of engineering projects and equipment especially from small and
medium enterprises.
Export, Import and Domestic trade of commodities, raw materials and
Bullion etc and develop new products and new markets.
To serve as an effective instrument of public policy and social responsibility.

3.2 PECs Vision
To be a highly market focused company, engaged in international and
domestic trade; organization which is lean and flexible; capable of
responding to the changing environment and always conscious of its
obligations of delivering value to stakeholders.
To be a company which is capable of providing total service to the
customers related to international trade.

3.3 Objectives of PEC
To be a profit oriented international trading organisation.
To provide adequate return to the stakeholders, commensurate with the
market expectations.
To seek new opportunities in the global and domestic market.

7

To focus on export of engineering projects and equipment especially from
small and medium enterprises.
To trade in commodities such as agricultural products, industrial raw
materials, chemicals and bullion.
To continuously strive for enhancement of the corporate image of a reliable,
long term and professionally competent organisation.
To continuously strive for improvement in productivity and
competitiveness.
3.4 Key Initiatives
PEC continues with its commitment to promote export of engineering and
manufactured goods. Over the years, business of PEC has changed with
industrial raw materials, agro commodities and bullion constituting major part
of its turnover and profit. Some of the key initiatives have been consolidation of
existing line of business and selective diversification into sustainable business
areas, improving operational efficiency and cost effectiveness.
PEC has invested in equity of Indian Bullion Market Association
(IBMA), a subsidiary of National Spot Exchange Limited. Association with
IBMA shall extend us facilities of trading, clearing and settlement to give
further impetus to our bullion trade. PEC is committed towards technological
improvement. Networking through computers within the organization has been
undertaken to implement commercial and accounting automation and achieve
efficiency in operations.

3.5 PECs Operations
Exports:
As far as the export is concerned, PEC concentrates on exports from small
and medium sector. Its major markets are in Bangladesh, Nepal, Bhutan, Sri

8

Lanka, Mauritius, Ethiopia, etc. It exports engineering items like conductors,
line-hardware, transformers, buses, defence stores, bulk handling equipment,
etc. PEC also exports small projects like tea factories, textile mills, cement
units, transmission line and associated sub-station, pre-fabricated steel structures
etc.
The Corporation undertakes export of agro commodities viz. wheat, rice,
corn & soybean and industrial raw materials.PEC is also the nominated agency
of government of India for export of wheat along with STC and MMTC.
Imports:
PEC is actively engaged in trading of industrial raw materials. It imports
coking coal, steam coal, coke, Lam Coke, Anthracite Coal for buyers in India
from major producers in Australia, China, Indonesia and South Africa. Steel is
imported in the form of scrap, billets, HR Coils and Wire Rods. Zinc and
Manganese concentrates are imported from Australia and Latin America. PEC
also imports Industrial Solvents like Toluene, Methanol, Butyl Acetate etc.
Trading in agricultural products
PEC has established itself as a reliable trader of rice, wheat,
soyabean/meal, edible oil, sugar, corn etc. and has emerged as one of the largest
traders in commodities from India. With expertise gained over years as a
consistent player in the international agro commodity market, PEC is able to
source agro commodities from world over to meet the requirements of Indian
buyer and also able to export agro commodities of Indian produce.



9

Domestic:
The Corporation undertakes domestic trading of agro commodities like
wheat, pulses, edible oils, etc. Domestic trading also includes coal/coke, steel
and other items like cotton yarn, home appliances, defense equipments, etc.
3.6 SWOT
A SWOT analysis is a structured planning method used to evaluate the
strengths, weaknesses, opportunities, and threats involved in a project or in a
business venture. A SWOT analysis can be carried out for a product, place,
industry or person. It involves specifying the objective of the business venture
or project and identifying the internal and external factors that are favorable and
unfavorable to achieve that objective.
STRENGTHS
1. Performance: Since its inception, PEC has been continuously in profit
and has paid dividend to the Govt. regularly.PEC received Prime
Ministers MOU Award for achieving excellence in performance and was
adjudged one of the top 10 Public Sector Undertakings in India by the
Department of Public Enterprises, for six years continously, starting from
1998-1999.

2. Investment with IBMA: PEC has high investment in equity of
IBMA(Indian Bullion Market Association) which is a subsidiary of
NSEL(National Stock Exchange Limited). And this has provided PEC
with extended facility of trading , clearing and settlement, which further
boosts its bullion trade.


10

3. Commitment towards technological improvement: PEC has developed
strong networking through computers within the organization which has
led to implementation of commercial and accounting automation and
achieve efficiency in operations.

4. Being a GOVT. PSU, it is rated high in credit worthiness.

WEAKNESSES
1. Bargaining power of customers is high due to stiff competition in the
market.
2. A lot of documentation is carried out, so transaction costs are high.
3. Cash flow management requires heavy investment in PEC.

OPPORTUNI TI ES
1. Because LCs or factoring in China and many other countries in Asia are
not yet commonly used or available, Asian suppliers can often do very
little to protect themselves in cross-border transactions.So by promoting
guaranteed L/C transactions and making Asian countries aware of it, will
help PEC to earn freater margins.
2. Being a GOVT. PSU, it is rated high in credit worthiness, so it can easily
get credit at a competitive rate and thus expand its business by importing
on Govt. account.
THREATS
1. Debtors turnover ratio of PEC Ltd. is decreasing continuously from 2008,
which means it is taking more time to recover cash from debtors as
compared to its performance in 2008. So there is a threat of bad debts.

11

2. By analysing Net Profit Margin it was found that PEC has low profit
margin. When there is low net margin, then it becomes difficult for the
company to survive in financial crisis.
3.7 PESTEL Analysis of Trade Industry
This analysis is done identify that are effects of various factors on an
industry.

Figure 2 - PESTEL Analysis


1. Political factors: These factors tell that what is the effect on trade
industry when Govt. intervenes. Various political factors include:
a. Tariffs: They are the taxes imposed on goods that cross national
border. They are usually set by the Govt. of importing country.
Percentage of tax imposed on various types of goods have an
impact on trade industry

12

b. Withholding tax: The overseas bank has to pay WHT on the
interest amount remitted overseas to the Indian tax authorities.
(The WHT is not applicable where Indian banks arrange for
buyers credit through their offshore offices).
c. Trade restrictions: Some of the trade restrictions imposed by
Govt. which affect trade industry are:
National defence: There is a restriction on import of
defense goods because foreign manufacturers cant be
relied upon.
Infant industries: Start up industries may not be able to
effectively compete against foreign producersbecause of
their small size. So these are protected until suitable
economies of scale can be achieved.

2. Economic factors: Every year RBI declares its monthly policies and
accordingly various measures and rates are implemented which has an
impact on the trade sector.
3. Social factors: life style in India is changing rapidly. People are
demanding high class western products, which is boosting imports in
trade industry.
4. Technological factors: If the companies switch to electronic trading
and payment systems ,they may cut significant costs out of the labor-
intensive trade finance process and will also make payment delays
more difficult to justify, thereby boosting trade.
5. Environmental factors: with the use of stringent environmental
regulations in international trade like use of green recognized packing
material in trade etc., companies involved in international trade will
have to face adverse affects on their international competitiveness and

13

this inturn will slow down the pace at which the trade industry is
growing.
6. Legal factors: Entire legal aspects of trade industry are governed by
UCP 600. The Uniform Customs and Practice for Documentary
Credits (UCP) is a set of rules on the issuance and use of letters of
credit. The UCP is utilized by bankers and commercial parties in more
than 175 countries in trade finance.
3.8 Porters Five Force Analysis Of The Firm
Porter five forces analysis is a framework for industry analysis and business
strategy development. It draws upon industrial organization (IO) economics to
derive five forces that determine the competitive intensity and therefore
attractiveness of a market.
Figure 3 Porters Five Force Analysis


14

1. Threat of new entrants: Threat of new entrants is increasing. Various
domestic trade financing companies, who have grown enough in past few
years, are ready to expand internationally.
2. Competitive rivalry within the industry: PEC is facing stiff competition
from:
a. MMTC LTD. (Money and Minerals Trading Corporation of India)
b. SITCO (Sai Trading Company)
c. IITC (Indian International Trade Centre)
3. Bargaining power of suppliers: Being a GOVT. PSU, it is rated high in
credit worthiness, so it can easily get credit at a competitive rate. So we
can say that bargaining power of suppliers is low.
4. Bargaining power of customers: Bargaining power of customers is high,
as PEC is not able to increase their margins because of the stiff
competition in the market.
5. Threat of substitutes: Threat of substitutes is increasing as now the private
sector banks which are ready to take risk and provide various financing
options directly to the importers is increasing, thereby posing a threat to
financing options provided by companies like PEC LTD.


4. PERFORMANCE
The last 6 years financial performance is as under:
Table 1 - Last 6 years financial performance
Year Turnover ( Crore) Profit Before Tax( )
2007-2008 5672
614654294
2008-2009 10275
1119908964

15

2009-2010 11026
1028712402
2010-2011 9970
1044228476
2011-2012 11641
1185325031
2012-2013 12183
1130728432
Since its inception, PEC has been continuously in profit and has paid
dividend to the Govt. regularly. PEC is an MOU signing Company.
The performance of PEC against MOU during the last 6 years has been rated as
under:
Table 2 - Performance of PEC against MOU
YEAR RATING
2007-2008 Excellent
2008-2009 Excellent
2009-2010 Excellent
2010-2011 Very Good
2011-2012 Excellent
2012-2013 Excellent


16

The financial parameters for the years 2008-09 to 2011-13 are given below:-
Table 3 - Financial parameters for the years 2008-09 to 2011-13
2008-09 2009-10 2010-11 2011-12 2012-13
Paid up Equity ( Crores) 20.00 20.00 20.00 20.00 60.00
Sales ( Crores) 10275 11026 9970 11641 12183
Profit Before Tax ( Crores) 111.99 102.87 104.42 118.53 113.07
Net Worth ( Crores) 180.69 232.03 285.51 347.63 362.03
Return on Capital
Employed
(%) 61.97 44.33 36.57 34.09 31.23
Sales/Employee ( Crores) 51.63 55.97 51.66 55.97 60.91
PAT ( Crores) 72.07 67.71 70.92 79.55 96.95

PEC received Prime Ministers MOU Award for achieving excellence in
performance and was adjudged one of the top 10 Public Sector Undertakings in
India by the Department of Public Enterprises, for the years 1998-99, 1999-
2000, 2000-2001, 2001-02, 2002-03 and 2003-04. PEC has also received MOU
excellence certificate for the years 2006, 2007, 2008, 2009 and 2011.
(Annul report, 2012-2013)

17

4.1 Firm Analysis Using Financial Ratios
For analyzing the performance of PEC LTD., few financial ratios were
used. The ratios were calculated in an excel sheet with the help of balance sheet
and income statement provided in the audit reports of PEC LTD. A brief
description of these financial ratios along with their application is as follows:
1. Liquidity Ratios: Liquidity Ratios refer to a class of financial metrics that
is used to determine a company's ability to pay off its short-terms debts
obligations. Generally, higher the value of the ratio, larger is the margin of
safety that the company possesses to cover short-term debts.
Common liquidity ratios include the current ratio, the quick ratio and the
operating cash flow ratio.A company's ability to turn short-term assets into cash
to cover debts is of the utmost importance when creditors are seeking payment.
Some liquidity ratios include:

A. Current ratio: A liquidity ratio that measures a company's ability to pay
short-term obligations.
The Current Ratio formula is:



Also known as "liquidity ratio", "cash asset ratio" and "cash ratio". This
ratio is mainly used to give an idea of the company's ability to pay back its
short-term liabilities (debt and payables) with its short-term assets (cash,
inventory, receivables). The higher the current ratio, the more capable the
company is of paying its obligations. A ratio under 1 suggests that the company
would be unable to pay off its obligations if they came due at that point. While
this shows the company is not in good financial health, it does not necessarily

18

mean that it will go bankrupt - as there are many ways to access financing - but
it is definitely not a good sign.
The current ratio can give a sense of the efficiency of a company's
operating cycle or its ability to turn its product into cash. Companies that have
trouble getting paid on their receivables or have long inventory turnover can run
into liquidity problems because they are unable to alleviate their obligations.
Because business operations differ in each industry, it is always more useful to
compare companies within the same industry.
The value of current ratio for the financial year ending March 2013 is
1.071392608.

B. Quick ratio: An indicator of a companys short-term liquidity. The quick
ratio measures a companys ability to meet its short-term obligations with its
most liquid assets. For this reason, the ratio excludes inventories from current
assets, and is calculated as follows:

Quick ratio = (current assets inventories) / current liabilities

The quick ratio measures the dollar amount of liquid assets available for
each dollar of current liabilities. Thus, a quick ratio of 1.5 means that a company
has $1.50 of liquid assets available to cover each $1 of current liabilities. The
higher the quick ratio, the better the company's liquidity position.
The quick ratio is more conservative than the current ratio because it
excludes inventories from current assets. The ratio derives its name presumably
from the fact that assets such as cash and marketable securities are quick sources
of cash. Inventories generally take time to be converted into cash, and if they
have to be sold quickly, the company may have to accept a lower price than
book value of these inventories. As a result, they are justifiably excluded from
assets that are ready sources of immediate cash.

19

The value of quick ratio for the financial year ending March 2013 is
0.93266372.
C. Cash ratio: The ratio of a company's total cash and cash equivalents to its
current liabilities. The cash ratio is most commonly used as a measure of
companys liquidity. It can therefore determine if, and how quickly, the
company can repay its short-term debt. A strong cash ratio is useful to creditors
when deciding how much debt, if any, they would be willing to extend to the
asking party.
Cash ratio = cash / current liabilities
The cash ratio is generally a more conservative look at a company's
ability to cover its liabilities than many other liquidity ratios. This is due to the
fact that inventory and accounts receivable are left out of the equation. Since
these two accounts are a large part of many companies, this ratio should not be
used in determining company value, but simply as one factor in determining
liquidity.
The value of cash ratio for the financial year ending March 2013 is
0.06958707.
2. Activity Ratios: The percentage of a mutual fund or other investment
vehicle's holdings that have been "turned over" or replaced with other holdings
in a given year. The type of mutual fund, its investment objective and/or the
portfolio manager's investing style will play an important role in determining its
turnover ratio.
All things being equal, investors should favor low turnover funds. High
turnover equates to higher brokerage transaction fees, which reduce fund
returns. Also, the more portfolio turnover in a fund, the more likely it will
generate short-term capital gains, which are taxable at an investor's ordinary
income rate.
A. Accounts receivables turnover: An accounting measure used to quantify a

20

firm's effectiveness in extending credit as well as collecting debts. The
receivables turnover ratio is an activity ratio, measuring how efficiently a firm
uses its assets.

Formula:


By maintaining accounts receivable, firms are indirectly extending
interest-free loans to their clients. A high ratio implies either that a company
operates on a cash basis or that its extension of credit and collection of accounts
receivable is efficient.
A low ratio implies the company should re-assess its credit policies in
order to ensure the timely collection of imparted credit that is not earning
interest for the firm.
The value of accounts receivables turnover ratio for the financial year
ending March 2013 is 0.837414535.
B. Inventory turnover ratio: The Inventory turnover is a measure of the
number of times inventory is sold or used in a time period such as a year. The
equation for inventory turnover equals the Cost of goods sold divided by the
average inventory. Inventory turnover is also known as inventory turns, stock
turn, stock turns, turns, and stock turnover.



The value of Inventory turnover ratio for the financial year ending March
2013 is 4.023635224

21

C. Total assets turnover: The amount of sales or revenues generated per dollar
of assets. The Asset Turnover ratio is an indicator of the efficiency with which a
company is deploying its assets.

Asset Turnover = Sales or Revenues/Total Assets
Generally speaking, the higher the ratio, the better it is, since it implies
the company is generating more revenues per dollar of assets. But since this
ratio varies widely from one industry to the next, comparisons are only
meaningful when they are made for different companies in the same sector.
Asset Turnover is typically calculated over an annual basis either fiscal
or calendar year with the Total Assets figure used in the denominator
calculated as the average of assets at the beginning and end of the year.
The value of total assets turnover ratio for the financial year ending
March 2013 is .276920988.
3. Profitability ratios: A class of financial metrics that are used to assess a
business's ability to generate earnings as compared to its expenses and other
relevant costs incurred during a specific period of time. For most of these ratios,
having a higher value relative to a competitor's ratio or the same ratio from a
previous period is indicative that the company is doing well.
Some examples of profitability ratios are profit margin, return on assets and
return on equity.
A. Gross profit margin :A financial metric used to assess a firm's financial
health by revealing the proportion of money left over from revenues after
accounting for the cost of goods sold. Gross profit margin serves as the source
for paying additional expenses and future savings.
Calculated as:


22

Where:
COGS = Cost of Goods Sold
Also known as "gross margin."
The gross margin is not an exact estimate of the company's pricing
strategy but it does give a good indication of financial health. Without an
adequate gross margin, a company will be unable to pay its operating and other
expenses and build for the future. In general, a company's gross profit margin
should be stable. It should not fluctuate much from one period to another, unless
the industry it is in has been undergoing drastic changes which will affect the
costs of goods sold or pricing policies.
The value of Gross profit margin for the financial year ending March
2013 is 0.009261682
B. Net profit margin : The ratio of net profits to revenues for a company or
business segment - typically expressed as a percentage that shows how much
of each rupee earned by the company is translated into profits. Net margins can
generally be calculated as:

Most publicly traded companies will report their net margins both
quarterly (during earnings releases) and in their annual reports. Companies that
are able to expand their net margins over time will generally be rewarded with
share price growth, as it leads directly to higher levels of profitability.
The value of net profit margin for the financial year ending March 2013 is
0.007941528
C. ROI (Return on Investment): A performance measure used to evaluate the
efficiency of an investment or to compare the efficiency of a number of different

23

investments. To calculate ROI, the benefit (return) of an investment is divided
by the cost of the investment; the result is expressed as a percentage or a ratio.
The return on investment formula:

In the above formula "gains from investment", refers to the proceeds
obtained from selling the investment of interest. Return on investment is a very
popular metric because of its versatility and simplicity. That is, if an investment
does not have a positive ROI, or if there are other opportunities with a higher
ROI, then the investment should be not be undertaken.
The definition of the term in the broadest sense just attempts to measure
the profitability of an investment and, as such, there is no one "right"
calculation.
The value of ROI for the financial year ending March 2013 is
0.312322501.
D. ROE (Return on Equity): The amount of net income returned as a
percentage of shareholders equity. Return on equity measures a corporation's
profitability by revealing how much profit a company generates with the money
shareholders have invested.
ROE is expressed as a percentage and calculated as:
Return on Equity = Net Income/Shareholder's Equity
Net income is for the full fiscal year (before dividends paid to common
stock holders but after dividends to preferred stock.) Shareholder's equity does
not include preferred shares.
The value of ROE for the financial year ending March 2013 is
1.884547387.
E. EPS (Earnings Per Share): One of two methods for categorizing shares
outstanding. The other method is fully diluted earnings per share (EPS). The

24

term "basic EPS" is more commonly used instead of "primary EPS." Basic EPS
is the simpler method to categorize outstanding shares, as it uses the number of
shares currently available for trading. To calculate basic EPS, divide net income
by the number of shares outstanding.
EPS can be calculated in many different ways depending on the
accounting methods and assumptions the company uses.
The value of EPS for the financial year ending March 2013 is 162.
4. Leverage ratios: Any ratio used to calculate the financial leverage of a
company to get an idea of the company's methods of financing or to measure its
ability to meet financial obligations. There are several different ratios, but the
main factors looked at include debt, equity, assets and interest expenses.
A. Debt equity ratio: A measure of a company's financial leverage calculated
by dividing its total liabilities by stockholders' equity. It indicates what
proportion of equity and debt the company is using to finance its assets.
The value of debt equity ratio for the financial year ending March 2013 is
0.171284462.
B. Debt asset ratio: Total debt to total assets is a leverage ratio that defines the
total amount of debt relative to assets. This enables comparisons of leverage to
be made across different companies. The higher the ratio, the higher is the
degree of leverage, and consequently, financial risk. This is a broad ratio that
includes long-term and short-term debt (borrowings maturing within one year),
as well as all assets tangible and intangible. (Pandey I M, 2005)
The value of debt asset ratio for the financial year ending March 2013 is
0.001916676.



25

5. BUSINESS MODEL OF PEC LIMITED

PEC LIMITED is basically a trading company. Its main objective is to
bridge the gap between deficit area and the surplus area. The trading activity of
PEC Limited can be broadly classified into three types. Those are as follows

Figure 4 - Business model of PEC Limited








A. IMPORT
B. EXPORT
C. DOMESTIC

TRADING ACTIVITY

26


6. IMPORT


6.1 Procedure of Import Under Back To Back LC
1. The local party who wants to import communicates its intention to PEC stating
the name of the exporter from whom it wants to import.
2. An agreement is entered into by PEC Ltd. with the buyer, also known as the
associate. The entire trading is carried on with reference to the terms and
conditions agreed upon by both the parties to the agreement. An agreement
usually contains the following elements:
Item & Price
Advance or Margin money
Security
Conditions for the establishment of the Letter of Credit
PECs trading margin
Other charges
BACK TO BACK LETTER OF
CREDIT
Back to back letter of credit is the FIRST METHOD.
GOVERNMENT ACCOUNT
Govt. account is the SECOND METHOD.

27

Quality, quantity and pre-shipment inspection
Insurance
High Seas Sale agreement
Inland transportation
Sales tax
Release and pledged goods
Payment of interest
Settlement of account
3. Performa invoice/the contract is received from the exporter for the supply of
goods, which is an agreement between PEC Ltd. and the supplier and
contains the following terms:
Details of the seller and buyer
Material to be traded with
Specifications of the material
Quantity
Price
Shipping address
Other terms and conditions
4. On the receipt of advance or the margin money as per terms of agreement,
PEC approaches to a bank with an application to open letter of credit in favor
of the exporter (also known as the beneficiary). It contains all details
regarding the transaction. The bank, in other words known as the issuing bank
accepts the request and opens the letter of credit. Amendments in the Letter of
credit are carried on, if required.
5. The associate has the right to accept or reject the discrepancies mentioned in
the import documents.
6. The supplier ships the goods, obtains the bill of lading from the shipping co.
and along with other sets of documents, submits it in the advising bank,

28

which is the exporters bank. The advising bank in turn sends it off to the
issuing bank by courier. The issuing bank then intimates to PEC and then
PEC intimates about them to the associate.
7. If the associate gives its acceptance, PEC further gives its acceptance to the
issuing bank for such receipt of documents.
8. The finance division of PEC Ltd. intimates about this to the marketing
division. Then the marketing division delivers the documents to the associate,
who upon the presentation of the same can take delivery of the goods.
9. Generally following documents are required for compliance:
Commercial invoice
Bill of lading
Shipping certificate
Certificate of origin
Certificate of weight and sizing
Certificate of analysis
Beneficiarys certificate
Marine insurance

10. PEC enters into high seas sale agreement and issues high seas sale invoice
to enable the associate to file the bill of entry and clear the goods.
11. Simultaneously, the goods are pledged to PEC Ltd. and kept in warehouse
under the supervision of independent surveyors appointed by PEC Ltd.
12. The associate lifts the quantity as per the requirement in lots in lieu of the
delivery order issued by PEC Ltd, against the payment.
13. In case of getting the bill discounted, some documents are to be attached.
They are:
Bill of exchange

29

High seas sale invoice and contract
De-pledging order
Performa invoice
Inland letter of credit
14. On the date of maturity of the letter of credit the payment is made by PEC
Ltd to the exporter.
15. If the associate delays payment beyond the date of the maturity, then PEC, s
per its agreement with the associate charges overdue interest for the delayed
period.
16. PEC Ltd along with the calculation of interest prepares its cost sheet. The
total amount is either settled or the surplus amount is adjusted with other the
other running letter of credits with the same associate.
6.2 Procedure of Import under Government Account
Under this type of import model PEC LTD import commodities on behalf
of the government of India in its name.
There are basically two types of import under this type of import model
PEC LTD. They are as follows:
1) P.D.S Scheme
2) 15% reimbursement scheme
1) Public distribution system scheme
Under this scheme this is an option of two different commodities:
a) Pulses
b) Edible oil
a) Pulses
The main objective behind this scheme is to reduce barriers. The main features
of this scheme are as follows:

30

Subsidy of Rs.10 per kg
There is no specific allocation of states; every state can participate.
1.2% service charge
Selling price =(cost + service charge) - subsidy
The process of import of pulses under the government account is as follows:
A float tender/ global tender for buying or importing the commodity is
given by PEC LTD.
The contract with L-1 or lowest 1 is finalized
Subsequently cargo is arranged.
The exporter then ships the goods to India.
The exporter sends the shipping documents through banking channel to the
letter of credit issuing bank.
PEC enters into high seas sale agreement and issues high seas sale invoice
to enable the associate to file the bill of entry and clear the goods.
Then the goods are pledged to PEC LTD and kept in warehouse under the
supervision of independent surveyors.
On the date of maturity of the letter of credit the payment is made by PEC
LTD to the exporter.
Sale is made according to H1 or highest one.
b) Edible oil
The main objective behind this scheme of edible oil is to reduce the barrier. The
main features of this scheme are as follows
Subsidy of Rs. 15 per kg
There is specification of states; the states which are eligible are Himachal
Pradesh and Tamil Nadu
0.75% service charge
Selling price =(cost+ service charge) subsidy

31

The process of import of edible oil under the government account is as
follows:
A float tender/ global tender for buying or importing the commodity is
given by PEC LTD.
The contract with L-1 or lowest 1 is finalized
Subsequently cargo is arranged.
The exporter than ships the goods to India.
The exporter sends the shipping documents through banking channel to the
letter of credit issuing bank.
PEC enters into high seas sale agreement and issues high seas sale invoice
to enable the associate to file the bill of entry and clear the goods.
Then the goods are pledged to PEC LTD and kept in warehouse under the
supervision of independent surveyors.
On the date of maturity of the letter of credit the payment is made by PEC
LTD to the exporter.
Sale is made according to H1 or highest one

2) 15% reimbursement scheme
This scheme was started in the year 2007 with an objective of increasing
supply in country during the food inflation. Under this scheme 15% of losses
would be reimbursed by the government of India. An agreement is entered into
by the PEC LTD and the subsequent buyer called the bid bond in order to avoid
default.
The process of 15% reimbursement scheme import under the government
account is as follows
A float tender/ global tender for buying or importing the commodity is
given by PEC LTD.

32

The contract with L-1 or lowest 1 is finalized
Subsequently cargo is arranged.
The exporter than ships the goods to India.
The exporter sends the shipping documents through banking channel to the
letter of credit issuing bank.
PEC enters into high seas sale agreement and issues high seas sale invoice
to enable the associate to file the bill of entry and clear the goods.
Then the goods are pledged to PEC LTD and kept in warehouse under the
supervision of independent surveyors.
On the date of maturity of the letter of credit the payment is made by PEC
LTD to the exporter.
Sale is made according to H1 or highest 1

7. EXPORT
The type of export financing carried out by PEC LTD can be broadly classified
into two types:
1. Export by Participation In International Tender
2. Export for Associate
a) Export on behalf of PEC Ltd.
b) Export on behalf of associate

7.1 Export by participating in international tender
1. PEC purchases tender documents.
2. PEC then sends tender document to manufacturer for their bid/offer.
3. It prepares the bid document on the basis of manufacturers offer and opens
the bid guarantee required as per the terms of the tender.

33

4. If PEC wins the tender, then it ships the contract with the buyer. On the
basis of the contract, it signs agreement with the manufacturer.
5. PEC then obtains the performance guarantee from the manufacturer and
opens it in favor of the buyer.
6. If the payment terms contain advance payment terms, then PEC opens the
advance payment guarantee.
7. On the receipt of advance payment, PEC releases the same to the
manufacturer against advance payment guarantee.
8. Buyer provides or arranges letter of credit in favor of PEC for the balance
amount.
9. Manufacturer starts manufacturing for the supply of the goods within time.
10. Manufacturer raises the sale invoice on PEC.
11. PEC prepares the export documents like:
o Export Invoice
o Shipping Bill
o Certificate of Origin
12. PEC negotiates the letter of credit compliance documents.
13. On receipt of payment, PEC makes payment to the manufacturer after
deducting its trading margin and other expenses.
7.2 Export for Associate

7.2.1 On Behalf Of PEC Ltd

The local party who wants to export communicates its intention to PEC LTD
stating the name of the importer to whom it wants to export.
The export contract is signed between overseas buyer, associate supplier and
PEC.
An agreement is entered into by PEC LTD with the local detailing of the
terms and conditions which inter- alia contains terms of payment, trading

34

margin of PEC LTD and documents to be submitted against the export
contract which is entered into.
Against the agreement with the local party, the terms of export packing
credit against the foreign contract are specified.
PEC provides export packing credit to the local party for procurement of
material against the foreign contract.
The local party prepares the export documents as per the foreign contract
and submits to PEC the documents which inter-alia includes Bill Of Lading,
certificate of quality, certificate of weight ,certificate of origin and the
shipping bill for submission to negotiating bank for negotiation of
documents.
After scrutinizing the documents PEC prepares bill of exchange and bank
forwarding and with all documents and send it to the negotiating bank for
negotiation.
On realization of export proceeds, cost sheet is prepared, adjusting the
financing given to the local party, trading margin given and all bank
charges, letter is taken from the local party for either payment or adjustment
of surplus balance, if any against some other contract of the same party.
7.2.2 On Behalf Of Associate (FINANCING)
In export financing, the entire trading is carried on by the exporter. The
involvement of PEC Ltd is only to the extent of providing finance to the
exporter. PEC Ltd. provides finance to the exporter either for procurement of
goods amounting to about 80-90% of the total goods and the remaining is borne
by the exporter himself.
After the goods procured, they are stored in the warehouse where, PEC
Ltd gets the title of the goods in form of warehouse receipt. And it is agreed

35

upon by both the parties that the PEC Ltd can dispose off the goods in case of
default.
Then the exporter does all the work of exporting the goods to the
importer. When it comes to payment, the bank makes payment of the entire
amount to PEC Ltd.
PEC Ltd then remits the amount to the exporter only after deducting the
amount it had financed to the exporter, plus its trading margin and all other
expenses.
8. DOMESTIC FINANCING
Procedure for financing domestic trade is as follow:
1. The associate approaches PEC for financing of domestic purchase of
material from the concerned supplier.
2. An approval for certain financing is passed by the management and sent to
the finance division.
3. Finance division after scrutinizing the documents (VAT, invoice, packing
slip, letter of receipt of goods at godown from surveyor and other transport
documents) arranges to release the payment in favor of the supplier,
provided margin money against such financing has been received in PECs
bank account.
4. A cheque in favor of the supplier is issued by PEC after receiving the
goods in the godown.
5. Seller invoices the goods to PEC and PEC further sells the goods to the
associate.
6. The associate takes partial delivery on the basis of VAT invoice raised by
PEC and thereby makes payment according to the quantity lifted in respect
to such sale.

36


9. FORWARD BOOKING IN PEC

Forward booking is a way of trading currency to minimize the risk of
volatile exchange rates. The booking company will write up a contract
specifying what the rate of exchange will be, and in doing so will assume the
exchange rate risk. The contract will also outline a timeline in which the trade
must be made. The fee associated with the forward book is usually based on a
percentage of the amount being traded in the contract. (Gupta S.L.,2006)
For example:
If our Indian importer has to import materials from a US exporter, they
enter into a forward contract in which the exchange rate is determined in
advance. Lets say that the prevailing rate of exchange is Rs. 55 for $1. So if the
exchange rate gets determined in advance, it saves either of the parties to
overcome the risk of exchange rate fluctuations in future.
If the value of rupee depreciates, then the importer gains by paying less as
compared to what he would have paid had he not entered into the forward
booking contract.
And if the value of dollar depreciates, the exporter would not lose out of
the trading.

10. SETTLEMENTS OF ACCOUNTS
Whenever, there is an international trade and inflow and outflow of foreign
exchange, there must be some mechanism for settlement of these transactions.
The need for settlement leads to opening of accounts by banks in other
countries.


37

1. NOSTRO ACCOUNT
Banks in India are permitted to open foreign currency accounts with bank
abroad. Indian bank having an account with foreign Bank is a Nostro Account.
It is OUR ACCOUNT WITH YOU. When an Indian bank issue a foreign
currency draft, payable abroad on a correspondent bank, the Nostro Account of
the Indian bank is debited and the amount paid to the beneficiary. In the same
way when the bill or Cheques is received for collection the proceeds will be
credit to the Nostro Account Only. Nostro accounts are usually in the currency
of the foreign country. This allows for easy cash management because currency
doesn't need to be converted. Nostro is derived from the Latin term "ours."

2. VOSTRO ACCOUNT
It is the account in India in Indian rupees maintained by overseas bank. If a
foreign bank opens an account with Indian bank in India, it is a Vostro
Account. It is YOUR ACCOUNT WITH US. Any draft, TC, issued by
overseas correspondent in Indian rupees is paid in India, to the debt of vostro
account. It is the account a correspondent bank holds on behalf of a foreign
bank. (Akshatha B.G., Akash S.B., 2014)
11. METHODS OF PAYMENT IN
INTERNATIONAL TRADE
To succeed in todays global marketplace, exporters must offer their
customers attractive sales terms supported by the appropriate payment method
to win sales against foreign competitors. As getting paid in full and on time is
the primary goal for each export sale, an appropriate payment method must be
chosen carefully to minimize the payment risk while also accommodating the
needs of the buyer. As shown below, there are four primary methods of
payment for international transactions. During or before contract negotiations,

38

it is advisable to consider which method in the diagram below is mutually
desirable for you and your customer.
11.1 Cash-in-advance
With this payment method, the exporter can avoid credit risk, since
payment is received prior to the transfer of ownership of the goods. Wire
transfers and credit cards are the most commonly used cash-in-advance options
available to exporters. However, requiring payment in advance is the least
attractive option for the buyer, as this method creates cash flow problems.
Foreign buyers are also concerned that the goods may not be sent if payment is
made in advance. Thus, exporters that insist on this method of payment as their
sole method of doing business may find themselves losing out to competitors
who may be willing to offer more attractive payment terms.
11.1.1 Characteristics of cash -in -advance payment method

I. Applicability :
It is recommended for use in high-risk trade relationships for export
markets and ideal for Internet- based businesses.
I I . Risk :
Exporter is exposed to virtually no risk as the burden of risk is placed
nearly completely on the importer.
I I I . Pros:
a) Payment before shipment
b) Eliminates risk of non-payment.
I V. Cons :
a) May lose customers to competitors over payment terms
b) No additional earnings through financing operation

39

11.1.2 Key points
Full or significant partial payment is required, usually via credit card or
bank/wire transfer, prior to the transfer of ownership of the goods.
Cash-in-advance, especially a wire transfer, is the most secure and
favorable method of international trading for exporters and consequently,
the least secure and attractive option for importers.
Insisting on these terms ultimately could cause exporters to lose
customers to competitors who are willing to offer more favorable
payment terms to foreign buyers in the global market.
Creditworthy foreign buyers, who prefer greater security and better cash
utilization, may find cash-in-advance terms unacceptable and may
simply walk away from the deal.
11.1.3 Conditions For Usage
The importer is a new customer and/or has a less-established operating
history.
The importers creditworthiness is doubtful, unsatisfactory, or
unverifiable.
The political and commercial risks of the importers home country are
very high.
The exporters product is unique, not available elsewhere, or in heavy
demand.
The exporter operates an Internet-based business where the use of
convenient payment methods is a must to remain competitive.



40

11.2 Letters of credit
Letters of credit (LCs) are among the most secure instruments available
to international traders. An LC is a commitment by a bank on behalf of the
buyer that payment will be made to the exporter, provided that the terms and
conditions have been met, as verified through the presentation of all required
documents. The buyer pays its bank to render this service. An LC is useful
when reliable credit information about a foreign buyer is difficult to obtain, but
you are satisfied with the credit worthiness of your buyers foreign bank. An
LC also protects the buyer since no payment obligation arises until the goods
have been shipped or delivered as promised.
11.2.1 Parties To A Letter Of Credit
Applicant (Opener): Applicant which is also referred to as account party
is normally a buyer or customer of the goods, who has to make payment
to beneficiary. LC is initiated and issued at his request and on the basis of
his instructions.
I ssuing Bank (Opening Bank): The issuing bank is the one which create
a letter of credit and takes the responsibility to make the payments on
receipt of the documents from the beneficiary or through their banker.
The payment has to be made to the beneficiary within seven working days
from the date of receipt of documents at their end, provided the
documents are in accordance with the terms and conditions of the letter of
credit. If the documents are discrepant one, then the rejection thereof has
to be communicated within seven working days from the date of receipt
of documents at their end.

41

Beneficiary: Beneficiary is a seller of the goods, who has to receive
payment from the applicant. A credit is issued in his favor to enable him
or his agent to obtain payment on surrender of stipulated document.
If LC is a transferable one and he transfers the credit to another party,
then he is referred to as the first or original beneficiary.
Advising Bank: An Advising Bank provides advice to the beneficiary and
takes the responsibility for sending the documents to the issuing bank and
is normally located in the country of the beneficiary.
Confirming Bank: Confirming bank adds its guarantee to the credit
opened by another bank, thereby undertaking the responsibility of
payment/negotiation acceptance under the credit, in additional to that of
the issuing bank. Confirming bank play an important role where the
exporter is not satisfied with the undertaking of only the issuing bank.
Negotiating Bank: The Negotiating Bank is the bank who negotiates the
documents submitted to them by the beneficiary under the credit either
advised through them or restricted to them for negotiation. On negotiation
of the documents they will claim the reimbursement under the credit and
makes the payment to the beneficiary provided the documents submitted
are in accordance with the terms and conditions of the letters of credit.
Reimbursing Bank: Reimbursing Bank is the bank authorized to honour
the reimbursement claim in settlement of negotiation/acceptance/payment
lodged with it by the negotiating bank. It is normally the bank with which
issuing bank has an account from which payment has to be made.
Second Beneficiary: Second Beneficiary is the person who represents the
first or original Beneficiary of credit in his absence. In this case, the

42

credits belonging to the original beneficiary is transferable. The rights of
the transferee are subject to terms of transfer.
11.2.2 Characteristics Of A Letter Of Credit
I . Applicability
Recommended for use in new or less-established trade relationships
when you are satisfied with the creditworthiness of the buyers bank.
I I . Risk
Risk is evenly spread between seller and buyer provided all terms and
conditions are adhered to.
III. Pros
a) Payment after shipment.
b) Having opened a letter of credit, the importer proves his ability to
pay and can count on more favorable payment terms in the future.
c) Reducing the production risk, first of all, for the situations when the
buyer cancels or changes his order.
d) Importer/Buyer will receive timely delivery of the goods because the
LC terms dictate acceptable shipment date
IV. Cons
a) Requires detailed, precise documentation.
b) Relatively expensive in terms of transaction cost.
11.2.3 Key points
An LC, also referred to as a documentary credit, is a contractual
agreement whereby a bank in the buyers country, known as the issuing
bank, acting on behalf of its customer (the buyer or importer), authorizes a

43

bank in the sellers country, known as the advising bank, to make payment
to the beneficiary (the seller or exporter) against the receipt of stipulated
documents.
The LC is a separate contract from the sales contract on which it is based
and, therefore, the bank is not concerned whether each party fulfils the
terms of the sales contract.
The banks obligation to pay is solely conditional upon the sellers
compliance with the terms and conditions of the LC. In LC transactions,
banks deal in documents only, not goods.
11.2.4 Illustrative LC Transaction
i. The importer arranges for the issuing bank to open an LC in favor of the
exporter
ii. The issuing bank transmits the LC to the advising bank, which forwards
it to the exporter.
iii. The exporter forwards the goods and documents to a freight forwarder.
iv. The freight forwarder dispatches the goods and submits documents to the
advising bank.
v. The advising bank checks documents for compliance with the LC and
pays the exporter.
vi. The importers account at the issuing bank is debited.
vii. The issuing bank releases documents to the importer to claim the goods
from the carrier.
11.2.5 Types of LCs:
a) Revocable & irrevocable letter of credit
LCs can be issued as revocable or irrevocable. Most of the LCs are
irrevocable, which means they may not be changed or cancelled unless

44

both the buyer and seller agree. If the LC does not mention whether it is
revocable or irrevocable, it automatically defaults to irrevocable.
Revocable LCs is occasionally used between parent companies and
their subsidiaries conducting business across borders.
b) Confirmed & unconfirmed letter of credit
When a buyer arranges a letter of credit, they usually do so with their
own bank, known as the issuing bank. The seller will usually want a bank in
their own country to check that the letter of credit is valid. For extra security,
the seller may require the letter the LC to be confirmed by the bank that
checks it. By confirming the LC, the second bank agrees to guarantee
payment even if the issuing bank fails to make it. So a confirmed LC
provides more security than an unconfirmed one.
In case of an unconfirmed LC, the advising bank forward an
unconfirmed LC to the exporter, without adding its own undertaking to make
payment or accept responsibility for payment at a future date, but confirming
its authenticity.
c) Back to back letter of credit:
In this, one Irrevocable Letter of Credit facilitates the seller to obtain
another Letter of Credit. To obtain the Back to Back Letter of Credit the
permission of the Buyer or the applicant of the first Letter of Credit is not
required. Back to Back Letter of Credit is generally used by the middleman or
agencies to hide the identity of the real suppliers or manufacturers. The seller
can utilize this Back to back Letter of Credit as a security for his bank, to
issue a back to back Letter of Credit in favour of his suppliers in order to get
a very competitive rate for his purchases and increase his profit margin in the
process. Thus this can very well be used by the seller to raise quick funds and
complete his orders in the scheduled time.
d) Transferable & non-transferable letter of credit:

45

A letter of credit that permits the beneficiary of the letter to make some
or all of the credit available to another party, thereby creating a secondary
beneficiary, is called as a transferable LC. The party that initially accepts the
transferable letter of credit from the bank is referred to as the first
beneficiary. The bank issuing the letter of credit must approve the transfer.
However, the letter of credit must state expressly that the credit is
transferable. Otherwise, no credit can be transferred regardless of any other
factors.
And the LC that cannot be transferred is called as a non-transferable LC.
e) Stand by letter of credit:
Standby letters of credit are created as a sign of good faith in business
transactions, and are proof of a buyer's credit quality and repayment abilities.
The bank issuing the SLOC will perform brief underwriting duties to ensure
the credit quality of the party seeking the letter of credit, then send notification
to the bank of the party requesting the letter of credit
f) Revolving letter of credit:
A letter of credit established one time that enables the receiver to access
specific amounts of credit for scheduled shipments over a specified period of
time is called a revolving LC.
11.2.6 Methods of Settlement
The documentary letters of credit can be opened in two ways:
Sight Letter of Credit:
A Sight Letter of Credit is a credit in which the seller obtains payment
upon presentation of documents in compliance with the terms and conditions.

46

Time Draft or Usance Letter of Credit:
A Time Draft or Usance Letter of Credit is a credit in which the seller will
be paid at a fixed or determinable future time. A time Draft or usance letter of
credit allows the drafts to be drawn on and accepted by the buyer, provided
that documents are presented in good order. The buyer is obligated to pay the
face amount at maturity. However, the issuing bank's obligation to the seller
remains in force until and unless the draft is paid.
11.2.7 Note on Documentary LCs
Documentary Letters of Credit hinge much on the appropriateness of
documents. Banks involved in the transaction do not need to know about the
physical state of the goods in question but concern themselves only with
documents. If proper documents are presented, banks will make payment
whether or not the actual goods shipped comply with the sales contract. Thus,
special care needs to be taken in preparation of the documents since a slight
omission or discrepancy between required and actual documents may cause
additional costs, delays and seizures or even total abortion of the entire deal.
11.2.8 Documents Required In an LC:
Below are the most common documents required in an Import or Export
Letter of Credit and the definition of each document.
Bill of Lading: A Bill of Lading is considered the most important
document involved in a shipment of merchandise. An exporter receives a
Bill of Lading when delivering the merchandise to the shipping company
for transport to an importer.
Draft: A draft is a bill of exchange and a legally enforceable instrument
which may be regarded as the formal evidence of debt under a letter of

47

credit. Drafts drawn at sight are payable by the drawee on presentation.
Term (usance) drafts, after acceptance by the drawee, are payable on their
indicated due date.
Commercial I nvoice: The commercial invoice is an itemized account
issued by the beneficiary and addressed to the applicant, and must be
supplied in the number of copies specified in the letter of credit.
Packing List: A packing list is usually requested by the buyer to assist in
identifying the contents of each package or container. It must show the
shipping marks and number of each package. It is not usually required to
be signed.
I nspection Certificate: As a preventative measure against fraud or as a
means of protecting the buyer against the possibility of receiving
substandard or unwanted goods, survey or inspection certificates issued
by a reputable third party may be deemed prudent. Such certificates
indicate that the goods have been examined and found to be as ordered.
Certificate of Origin: As the name suggests, a certificate of origin
certifies as to the country of origin of the goods described and should
comply with any stipulations in the letter of credit as to originating
country and by whom the certificate is to be issued. The certificate should
be consistent with and identified with the other shipping documents by
shipping marks and numbers, and must be signed.
I nsurance Policy or Certificate: The extent of coverage and risks should
be agreed upon between the buyer and seller in their initial negotiations
and be set out in the sales contract. Since the topic of marine insurance is
extremely specialized and with conditions varying from country to
country, the services of a competent marine insurance broker are useful
and well-advised.

48

Air Waybill: An air waybill is a receipt issued by an air carrier indicating
receipt of goods to be transported by air and showing goods consigned to
a named party. Being a non-negotiable receipt it is not a document of title.
Weight list: Not synonymous to a packing list. This document breaks
down the shipment by weight. This is generally needed only if a
certificate is required. (Thomas H.,2009)

Figure 5 - Letter of Credit: Procedure



11.3 Documentary Collections
A documentary collection is a transaction whereby the exporter entrusts
the collection of a payment to the remitting bank (exporters bank), which
sends documents to a collecting Bank (importers bank), along with

49

instructions for payment. Funds are received from the importer and remitted
to the exporter through the banks involved in the collection in exchange for
those documents. Documentary collections involve the use of a draft that
requires the importer to pay the face amount either on sight or on a specified
date in the future. The draft lists instructions that specify the documents
required for the transfer of title to the goods. Although banks do act as
facilitators for their client sunder collections, documentary collections offer
no verification process and limited recourse in the event of non payment.
These are generally less expensive than letters of credit.

11.3.1 Characteristics
I . Applicability:
It is recommended for use in established trade relationships and in stable
export markets.
I I . Risk:
Exporter is exposed to more risk as D/C terms are more convenient and
cheaper than an LC to the importer.
I I I . Pros:
a) Bank assistance in obtaining payment
b) The process is simple, fast, and less costly than LCs
I V. Cons:
a) Banks role is limited and they do not guarantee payment.
b) Banks do not verify the accuracy of the documents.
11.3.2 Key Points

50

D/Cs is less complicated and more economical than LCs.
Under a D/C transaction, the importer is not obligated to pay for goods
prior to shipment.
The exporter retains title to the goods until the importer either pays the face
amount on sight or accepts the draft to incur a legal obligation to pay at a
specified later date.
While the banks control the flow of documents, they do not verify the
documents nor take any risks, but can influence the mutually satisfactory
settlement of a D/C transaction.
11.3.3 Flow Of Transaction In A Deal
i. Exporter/drawer and Importer/drawee agree on a sales contract, including
payment to be made under a Documentary Collection.
ii. The Exporter ships the merchandise to the foreign buyer and receives in
exchange the shipping documents.
iii. Immediately thereafter, the Exporter presents the shipping documents
with detailed instructions for obtaining payment to his bank (Remitting
bank).
iv. The Remitting bank sends the documents along with the Exporter's
instructions to a designated bank in the importing country (Collecting
Bank).
v. Depending on the terms of the sales contract, the Collecting Bank would
release the documents to the importer only upon receipt of payment or
acceptance of draft from the buyer. (The importer will then present the
shipping documents to the carrier in exchange for the goods).
vi. Having received payment, the collecting bank forwards proceeds to the
Remitting Bank for the exporter's account.

51

vii. Once payment is received, the Remitting bank credits the Exporter's
account, less its charges.
11.4 Open account
An open account transaction means that the goods are shipped and
delivered before payment is due, usually in 30 to 90 days. Obviously this is
the most advantageous option to the importer in cash flow and cost terms,
but it is consequently the highest risk option for an exporter. Due to the
intense competition for export markets, foreign buyers often press exporters
for open account terms since the extension of credit by the seller to the buyer
is more common abroad. Therefore, exporters who are reluctant to extend
credit may face the possibility of the loss of the sale to their competitors.
However, with the use of one or more of the appropriate trade finance
techniques, such as export credit insurance, the exporter can offer open
competitive account terms in the global market while substantially
mitigating the risk of non-payment by the foreign buyer.
11.4.1 Characteristics Of An Open Account
I . Applicability :
Recommended for use
1) In secure trading relationships or markets or
2) In competitive markets to win customers with the use of one or more
appropriate trade finance techniques.
I I . Risk :
Exporter faces significant risk as the buyer could default on payment obligation
after shipment of the goods.
I I I . Pros :

52

Boost competitiveness in the global market to establish and maintain a
successful trade relationship.
I V. Cons :
1. Exposed significantly to the risk of non-payment
2. Additional costs associated with risk mitigation measures.

11.4.2 Key points
The goods, along with all the necessary documents, are shipped directly to
the importer who agrees to pay the exporters invoice at a future date,
usually in 30 to 90 days.
Exporter should be absolutely confident that the importer will accept
shipment and pay at agreed time and that the importing country is
commercially and politically secure.
Open account terms may help win customers in competitive markets, if
used with one or more of the appropriate trade finance techniques that
mitigate the risk of non payment. (Giovannucci D.,2014)


12. FORFAITING
12.1 Introduction Of Forfaiting
Forfaiting and Factoring are services in international market given to an
exporter or seller. Its main objective is to provide smooth cash flow to the
sellers. The basic difference between the forfaiting and factoring is that
forfaiting is a long term receivables (over 90 days up to 5 years) while factoring
is short termed receivables (within 90 days) and is more related to receivables
against commodity sales.

53

12.2 Definition Of Forfaiting
The terms forfaiting is originated from a old French word forfait, which
means to surrender ones right on something to someone else. In international
trade, forfaiting may be defined as the purchasing of an exporters receivables at
a discount price by paying cash. By buying these receivables, the forfaiter frees
the exporter from credit and the risk of not receiving the payment from the
Importer.
12.3 How Forfaiting Works In International Trade
The exporter and importer negotiate according to the proposed export sales
contract. Then the exporter approaches the forfaiter to ascertain the terms of
forfaiting. After collecting the details about the importer, and other necessary
documents, forfaiter estimates risk involved in it and then quotes the discount
rate.
The exporter then quotes a contract price to the overseas buyer by loading
the discount rate and commitment fee on the sales price of the goods to be
exported and sign a contract with the forfeiter. Export takes place against
documents guaranteed by the importers bank and discounts the bill with the
forfaiter and presents the same to the importer for payment on due date.
12.4 Cost Element
The forfaiting typically involves the following cost elements:
1. Commitment fee, payable by the exporter to the forfaiter for latters
commitment to execute a specific forfaiting transaction at a firm discount rate
within a specified time.
2. Discount fee, interest payable by the exporter for the entire period of credit
involved and deducted by the forfaiter from the amount paid to the exporter
against the availed promissory notes or bills of exchange.

54

12.5 Six Parties In Forfaiting
1. Exporter (India)
2. Importer (Abroad)
3. Exports Bank (India)
4. Imports Bank (Abroad)
5. EXIM Bank (India)
6. Forfaiter (Abroad)
12.6 Benefits To Exporter
i. 100 per cent financing
Without recourse and not occupying exporter's credit line that is to say
once the exporter obtains the financed fund, he will be exempted from the
responsibility to repay the debt.
ii. Improved cash flow
Receivables become current cash inflow and its is beneficial to the
exporters to improve financial status and liquidation ability so as to
heighten further the funds raising capability.
iii. Reduced administration cost
By using forfaiting, the exporter will be free from the management of the
receivables. The relative costs, as a result, are reduced greatly.
iv. Advance tax refund
Through forfaiting the exporter can make the verification of export and get
tax refund in advance just after financing.
v. Risk reduction
Forfaiting business enables the exporter to transfer various risk resulted
from deferred payments, such as interest rate risk, currency risk, credit risk,
and political risk to the forfaiting bank.
vi. Increased trade opportunity

55

With forfaiting, the exporter is able to grant credit to his buyers freely, and
thus, be more competitive in the market.
12.7 Benefits To Banks
Banks can offer a novel product range to clients, which enable the client
to gain 100% finance, as against 80.85% in case of other discounting
products. Bank gain fee based income, lower credit administration and credit
follow up.
12.8 Drawbacks Of Forfaiting
i. Non Availability of short periods
ii. Non availability for financially weak countries
iii. Dominance of western countries
iv. Difficulty in procuring international banks guarantee

13. FACTORING
13.1 Definition Of Factoring
This involves the sale at a discount of accounts receivable or other debt
assets on a daily, weekly or monthly basis in exchange for immediate cash. The
debt assets are sold by the exporter at a discount to a factoring house, which will
assume all commercial and political risks of the account receivable. In the
absence of private sector players, governments can facilitate the establishment
of a state-owned factor; or a joint venture set-up with several banks and trading
enterprises.
Definition of factoring is very simple and can be defined as the conversion
of credit sales into cash. Here, a financial institution which is usually a bank
buys the accounts receivable of a company usually a client and then pays up to
80% of the amount immediately on agreement. The remaining amount is paid to

56

the client when the customer pays the debt. Examples includes factoring against
goods purchased, factoring against medical insurance, factoring for construction
services etc.
13.2 Characteristics Of Factoring
1. The normal period of factoring is 90 to 150 days and rarely exceeds more
than 150 days.
2. It is costly.
3. Factoring is not possible in case of bad debts.
4. Credit rating is not mandatory.
5. It is a method of off balance sheet financing.
6. Cost of factoring is always equal to finance cost plus operating cost.
13.3 Different Types Of Factoring
1. Disclosed factoring
In disclosed factoring, clients customers are aware of the factoring agreement.
Disclosed factoring is of two types:
Recourse factoring
The client collects the money from the customer but in case customer
dont pay the amount on maturity then the client is responsible to pay the
amount to the factor. It is offered at a low rate of interest and is in very common
use.
Nonrecourse factoring
In nonrecourse factoring, factor undertakes to collect the debts from the
customer. Balance amount is paid to client at the end of the credit period or

57

when the customer pays the factor, whichever comes first. The advantage of
nonrecourse factoring is that continuous factoring will eliminate the need for
credit and collection departments in the organization.
2. Undisclosed
In undisclosed factoring, client's customers are not notified of the
factoring arrangement. In this case, client has to pay the amount to the factor
irrespective of whether customer has paid or not. (Gurusamy S.,2009)
14. BUYERS CREDIT
A financial arrangement whereby a financial institution in the exporting
country extends a loan directly or indirectly to a foreign buyer to finance the
purchase of goods and services from the exporting country. This arrangement
enables the buyer to make payments due to the supplier under the contract.
Buyer's credit is the credit availed by an Importer (Buyer) from overseas
Lenders i.e. Banks and Financial Institutions for payment of his Imports on due
date. The overseas Banks usually lend the Importer (Buyer) based on the Letter
of comfort (a Bank Guarantee) issued by the Importers (Buyer's) Bank.
Importers Bank / Buyers Credit Consultant / Importer can arrange buyers
credit from international branches of Indian Bank or other international bank.
For this service Importers Bank / Buyers credit consultant charges a fee called
arrangement fee. Buyers credit helps local importers to access cheaper foreign
funds close to LIBOR rates as against local sources of funding which are costly
compared to LIBOR rates. Buyers credit can be availed for 1 year in case the
Import is for trade-able goods and for 3 years if the Import is for Capital Goods.
Every six months the interest on Buyers credit may get reset.


58


14.1 Benefits Of Buyers Credit To Importer
a) The exporter gets paid on due date; whereas importer gets extended date for
making an import payment as per the cash flows.
b) The importer can deal with exporter on sight basis, negotiate a better
discount and use the buyers credit route to avail financing.
c) The funding currency can be in any FCY (USD, GBP, EURO, JPY etc.)
depending on the choice of the customer.
d) The importer can use this financing for any form of trade viz. open account,
collections, or LCs.
e) The currency of imports can be different from the funding currency, which
enables importers to take a favorable view of a particular currency.
14.2 Step Involved In Buyers Credit
1. The Indian customer will import the goods either under DC, Collections or
open account.
2. The Indian customer requests the Buyer's Credit Arranger before the due
date of the bill to avail buyers credit financing.
3. Arranger requests overseas bank branches to provide a buyers credit offer
letter in the name of the importer. Best rate is quoted to importer.
4. Overseas Bank then funds importers existing bank Nostro account for the
required amount.
5. Existing bank makes import bill payment by utilizing the amount credited (if
the borrowing currency is different from the currency of Imports then a cross
currency contract is utilized to effect the import payment)
6. On due date existing bank recovers the principal and amount from the
importer and remits the same to Overseas Bank. (Mustafa A.,2010)

59

15. ROLLOVER PROCESS IN BUYERS
CREDIT
Buyers Credit can be used both for Raw Material and Capital Goods. Below
gives complete detailed information along with process.
15.1 Process Of Buyers Credit For Capital Goods
o Term Loan Sanction.
o LC Issuance for import of Machinery.
o On due date of payment of LC convert it to Buyers Credit and
rollover for 3 year.
o At end of 3 year convert to term loan.
Stage 1
Banks Term Loan Sanction : Buyer obtains term loan sanction by stating
following clauses:
Facility: Buyers Credit in lieu of Foreign L/C (to be converted to Term loan
after 3 years).
Purpose for Purchase of Machinery only.
Tenure of 36 months with rollover every 6 / 12 months till Month / Year
The buyers credit is proposed to be retired through term loan and the same
will be repaid in say 24 equal monthly installments (example of 5 year term
loan), starting from Month / Year. In-case buyer credit is not available for
further rollover at any point of time, the buyer credit will be converted to
term loan and the repayment will start immediately from the next month of
conversion, repayable in monthly installments (starting from the next month
of conversion) equally divided into the balance tenure.
Stage 2
Based on the agreement with the supplier either a sight LC or USANCE LC get
opened from bank. Based on this supplier will ship machinery.

60

Stage 3
The Indian customer will import the goods either under DC, Collections or
open account.
The Indian customer requests the Buyers Credit Arranger before the due
date of the bill to avail buyers credit financing.
Arranger requests overseas bank branches to provide a buyers credit offer
letter in the name of the importer. Best rate is quoted to importer.
Overseas Bank then funds importers existing bank Nostro account for the
required amount.
Existing bank to make import bill payment by utilizing the amount credited
(if the borrowing currency is different from the currency of Imports then a
cross currency contract is utilized to effect the import payment).
On due date (6 / 12 Month) it will again get rollover (Principal + interest)
with the same foreign bank or another bank based on the pricing and
availability on that day. This will keep on happening till 3 years.
Stage 4
Based on the sanction the buyers credit gets converted into term loan at the end
of 3rd year.
15.2 Costs Involved
1. Interest cost: This is charged by overseas bank as a financing cost.
2. Letter of Comfort / Undertaking: Importers existing bank would charge
this cost for issuing letter of comfort / Undertaking.
3. Forward Booking Cost / Hedging Cost
4. Arrangement fee: Charged by person who is arranging buyer's credit for
importer.
5. WHT (Withholding Tax): The customer has to pay WHT on the interest
amount remitted overseas to the Indian tax authorities. (The WHT is not

61

applicable where Indian banks arrange for buyers credit through their
offshore offices). (Mandavia S.,2013)

15.3 Concept Of WHT (Withholding Tax)
It is the tax levied on the interest paid by the Indian corporates to overseas
lenders on the loans taken from them. Rates charged by overseas lenders are net
of taxes.
16. LIBOR
16.1 Meaning Of Libor
LIBOR stands for London Interbank Offered Rate. LIBOR is an indicative
average interest rate at which a selection of banks (the panel banks) are prepared
to lend one another unsecured funds on the London money market. Although
reference is often made to the LIBOR interest rate, there are actually 150
different LIBOR interest rates. LIBOR is calculated for 15 different
maturities and for 10 different currencies. The official LIBOR interest rates
(bbalibor) are announced once a day at around 11:45 a.m. London time
by Thomson Reuters on behalf of the British Bankers Association (BBA).

16.2 The Creation Of Libor
At the start of the nineteen eighties there was a growing need amongst the
financial institutions in London for a benchmark for lending rates. This
benchmark was particularly needed in order to calculate prices for financial
products such as interest swaps and options. Under the leadership of the BBA a
number of steps were taken from 1984 onwards which led in 1986 to the
publication of the first LIBOR interest rates (bbalibor).

62

16.3 Libor Panel Banks
As has already been indicated, LIBOR is an average interest rate at which a
selection of banks will lend one another funds. These banks are called panel
banks. The selection is made every year by the British Bankers Association
(BBA) with assistance from the Foreign Exchange and Money Markets
Committee (FX&MMC). A panel is made up for each currency consisting of at
least 8 and a maximum of 16 banks which are deemed to be representative for
the London money market. Banks are assessed on market volume, reputation
and assumed knowledge of the currency concerned. Because the criteria applied
are strict, the rates can generally be considered to be the lowest interbank
lending rates on the London money market.
16.4 Libor Calculation Method
The LIBOR interest rates are not based on actual transactions. On every
working day at around 11 a.m. (London time) the panel banks inform Thomson
Reuters for each maturity at what interest rate they would expect to be able to
raise a substantial loan in the interbank money market at that moment. The
reason that the measurement is not based on actual transactions is because not
every bank borrows substantial amounts for each maturity every day. Once
Thomson Reuters has collected the rates from all panel banks, the highest and
lowest 25% of value are eliminated. An average is calculated of the 50%
remaining mid values in order to produce the official LIBOR (bbalibor) rate.
16.5 Significance Of Libor Interest
LIBOR is viewed as the most important benchmark in the world for short-term
interest rates. On the professional financial markets LIBOR is used as the base
rate for a large number of financial products such as futures, options and swaps.
Banks also use the LIBOR interest rates as the base rate when setting the

63

interest rates for loans, savings and mortgages. The fact that LIBOR is often
treated as the base rate for other products is the reason why LIBOR interest rates
are monitored with great interest by a large number of professionals and private
individuals worldwide. (www.investopedia.com, 2014)
17. FUNDS MANAGEMENT
Funds Management refers to the management of the cashflow of a
financial institution. The funds manager ensures that the maturity schedules of
the deposits coincide with the demand for loans. To do this, the manager looks
at both the liabilities and the assets which influence the institutions ability to
issue credit. A fund manager must also pay close attention to cost and risk in
order to really capitalize on the cash flow opportunities. A financial institution
like PEC LTD. runs on the ability to offer credit to customers. Ensuring the
proper liquidity of the funds is a crucial aspect of the managers position. Funds
management also refers to the management of fund assets.
(www.investopedia.com, 2014)
PEC LTD. has more than seventy bank accounts with following banks:
1. DBS BANK, NEW DELHI
2. DEUTSCHE BANK AG, PCFC, A/C
3. ICICI,AHMEDABAD
4. ICICI,KOTA
5. ICICI,TUTICORIN
6. ICICI,KOL(ESTBLMNT)
7. IDBI,BANGLORE
8. IDBI,HYDERABAD
9. IDBI,JAIPUR
10. IDBI,LUCKNOW

64

11. IDBI,PANCHKULA
12. SECURED OVERDRAFT-INDIAN BANK
13. SBBJ
14. SBP CASH CREDIT A/C,NEW DELHI
15. STATE BANK OF SAURASHTRA
16. THE BANK OF TOKYO-MITSUBISHI UFJ LTD
17. UBI (PCFC A/C NO.3766) MAIZE
18. UBI (PCFC A/C NO.3865) FABRICS
19. VIJAYA BANK
20. CORPORATION BANK NEW DELHI
21. DENA BANK NEW DELHI
22. HDFC ACE SETTLEMENT A/C
23. HDFC NMCE SETTLEMENT A/C
24. IDBI,INDORE
25. SBI-MCX CLIENT A/CNEW DELHI
26. SBI-NSEL SETTLEMENT A/C MUMBAI
27. YES BANK NEW DELHI
28. DEVELOPMENT CREDIT BANK ND
29. ICICI-BUSINESS A/C
30. ICICI-CLIENT A/C
31. ICICI- EXCHANGE DUES A/C
32. ICICI SETTLEMENT A/C
33. IDBI MUMBAI
34. SBI-NCDEX SPOT SETTLEMENT A/C MUMBAI
35. SBBJ ND
36. DEUTSCHE BANK AG,ND
37. NATIONAL COMM BANK, ALBEIDA
38. SBI - MCX SETTLEMENT A/C ND

65

39. SBI,KAKINADA(TRADE)
40. UBI,ND
SHORT TERM DEPOSITS
1. IDBI BANGLORE
2. SBI, DHAKA
3. SBI KAKINADA
4. BANK OF BARODA,ND
5. HDFC ND
6. SBT
7. ICICI,KOLKATA
8. IDBI,CHENNAI
9. IDBI,VISHAKHAPATNAM
10. INDUSIND,ND
11. PNB,ND
12. SOCIETE GENERALE ND
13. SBI CAG KOLKATA
14. SBI GANDHIDHAM
15. SBI OB MUMBAI
16. SYNDICATE ND
17. CENTRAL BANK OF INDIA ND
18. VIJAYA BANK ND
19. CORPORATION BANK
20. HSBC ND
21. ICICI ND
22. IDBI ND
23. INDIAN BANK ND
24. INDIAN OVERSEAS BANK ND
25. SBI CAG BR ND

66

26. STATE BANK OF INDORE ND
27. SBP ND
28. UBI
29. UTI BANK ND
Balance in each account is checked everyday. Fistly all the LCs which
are maturing next day are reviewed and then a detailed summary is made in
which the total amount due by next date is specified. Now the manager has to
arrange funds for that amount one day in advance.
After checking balance in all accounts, the surplus amount is transferred
to an A/C maintained with SBI, New Delhi. Now the payment for the amount
that is due next day is transferred to beneficiary from this A/C which is
maintained with SBI, New Delhi with the help of RTGS mode of payment.

18. UCP 600
UCP 600 is the latest version of the rules that govern letters of credit
transactions worldwide. UCP 600 is prepared by International Chamber of
Commerces (ICC) Commission on Banking Technique and Practice. Its full
name is 2007 Revision of Uniform Customs and Practice for Documentary
Credits, UCP 600, and (ICC Publication No. 600). The ICC Commission on
Banking Technique and Practice approved UCP 600 on 25 October 2006. The
rules have been effective since 1 July 2007.
Currently majority of letters of credit issued everyday is subject to latest
version of the UCP. This widely acceptance is the key sign that shows the
importance of the UCP, which are the most successful private rules for trade
ever developed.
Letters of credit remain an important tool for financing and settling
international trade transactions. They enjoy wide acceptance in the trading

67

community because they are considered to carry low financial risk. Letters of
credit are subject to specific rules that were first codified by the International
Chamber of Commerce (ICC) in 1929 and since updated on a regular basis.
Provisions
Care should be taken in specifying expiration dates.
The applicant must specify if the letter of credit is transferable.
The applicant must specify that the conformance of the letter.
The currency of the letter of credit should be designated using ISO
currency code.
The applicant should designate the nominating bank
Applicant must specify clearly whether the letter of credit will be available
for partial shipment.
The letter of credit should provide transport details.
Under rule of strict compliance, banks are authorized to reject documents
if there are any discrepancies.
Banks are not required to investigate trade customs or usage.
Description of the Goods should be clear and brief as possible.
The listing of documents should list the contents of each document.
Transportation documents must be clear.
Insurance documents must be clear.
Time periods for presentation of documents must be specified.
(www.iibf.org.in ,2007)

19. INCOTERMS
Incoterms are a set of three-letter standard trade terms most commonly
used in international contracts for the sale of goods. It is essential that to be are
aware of these terms of trade prior to shipment.

68

They include:
EXW EX WORKS ( named place of delivery)
The Sellers only responsibility is to make the goods available at the Sellers
premises. The Buyer bears full costs and risks of moving the goods from there
to destination.
FCA FREE CARRIER ( named place of delivery)
The Seller delivers the goods, cleared for export, to the carrier selected by the
Buyer. The Seller loads the goods if the carrier pickup is at the Sellers
premises. From that point, the Buyer bears the costs and risks of moving the
goods to destination.
CPT CARRIAGE PAID TO ( named place of destination))
The Seller pays for moving the goods to destination. From the time the goods
are transferred to the first carrier, the Buyer bears the risks of loss or damage.
CIP CARRIAGE AND INSURANCE PAID TO ( named place of
destination)
The Seller pays for moving the goods to destination. From the time the goods
are transferred to the first carrier, the Buyer bears the risks of loss or damage.
The Seller, however, purchases the cargo insurance.
DAT DELIVERED AT TERMINAL ( named terminal at port or place
of destination)
The Seller delivers when the goods, once unloaded from the arriving means of
transport, are placed at the Buyers disposal at a named terminal at the named
port or place of destination. Terminal includes any place, whether covered or
not, such as warehouse, container yard or road, rail or air cargo terminal. The

69

Seller bears all risks involved in bringing the goods to and unloading them at the
terminal at the named port or place of destination.
DAP DELIVERED AT PLACE ( named place of destination).
The Seller delivers when the goods are placed at the Buyers disposal on the
arriving means of transport ready for unloading at the names place of
destination. The Seller bears all risks involved in bringing the goods to the
named place.
DDP DELIVERED DUTY PAID ( named place)
The Seller delivers the goods -cleared for import to the Buyer at destination.
The Seller bears all costs and risks of moving the goods to destination, including
the payment of Custom duties and taxes.
MARITIME-ONLY TERMS
FAS FREE ALONGSIDE SHIP ( named port of shipment)
The Seller delivers the goods to the origin port. From that point, the Buyer bears
all costs and risks of loss or damage.
FOB FREE ON BOARD ( named port of shipment)
The Seller delivers the goods on board the ship and clears the goods for export.
From that point, the Buyer bears all costs and risks of loss or damage.
CFR COST AND FREIGHT ( named port of destination)
The Seller clears the goods for export and pays the costs of moving the goods to
destination. The Buyer bears all risks of loss or damage.
CIF COST INSURANCE AND FREIGHT ( named port of destination)

70

The Seller clears the goods for export and pays the costs of moving the goods to
the port of destination. The Buyer bears all risks of loss or damage. The Seller,
however, purchases the cargo insurance. (www.foreign-trade.com, 2014)
Figure 6 - INCOTERMS


20. FINDINGS AND CONCLUSION
20.1 Firms Financial Analysis:
Following are the screenshots of the results obtained after performing various
types of analysis to assess firms financial performance:



71

1. Ratio analysis
Figure 7 - Screenshot Ratio Analysis 1

Figure 8 - Screenshot Ratio Analysis 2


72

Figure 9 - Screenshot Ratio Analysis 3

2. Trend analysis
Figure 10 - Screenshot Trend Analysis 1

Figure 11 - Screenshot Trend Analysis 2


73

Figure 12 - Screenshot Trend Analysis 3

Figure 13 - Screenshot Trend Analysis 4

Figure 14 - Screenshot Trend Analysis 5


74

Figure 15 - Screenshot Trend Analysis 6

Figure 16 - Screenshot Trend Analysis 7









75

3. I NDEX ANALYSI S
Figure 17 - Screenshot Index Analysis 1

Figure 18 - Screenshot Index Analysis 2


76

Analysis showed that PEC is getting consistent return on capital
employed since past 6 years, shown by consistency in ROCE. By analyzing the
inventory turnover ratio, it was found that the PEC is turning inventory of
finished goods into sales at a rate of 4.0123, which is quite good figure. As the
current ratio represents the margin of safety and 1:1 is a satisfactory ratio,
therefore, by looking at the current ratio of PEC Ltd. which is 1.071, we can
say that PEC has satisfactory current ratio.
20.2 Study of Financing International Trade
After analyzing in detail all the payment methods in international trade, a brief
comparison among all of them can be made as follows.
Figure 19 Comparison of Payment method


77


This comparison clearly differentiates the four methods on the basis of
payment time, delivery time of goods, the extent of risks involved both to
exporter as well as importer.
A pictorial representation of the risk associated with these four payment
methods is as follows:
Figure 20 Risk associated with these payment methods

The recent economic slowdown is making the need for sound trade
finance policies and strong financial systems more acute. Many companies are
trying to preserve cash by delaying payment and the number of SMEs in
emerging Asian economies with high credit risk is growing. This is partly the
result of a regional trend toward unsecured, open-account type transactions.
Many Western buyers are asking their Asian suppliers to sell goods on open-
accounts terms, instead of using guarantees like letters of credit (LCs). These
buyers simply do not want to bear the extra cost of payment guarantees and

78

will source their goods from somewhere else if they are not given open-
accounts.
21. RECOMMENDATIONS
21.1 Firms Financial Analysis
Quick ratio of PEC Ltd. is improving since 2008, but we can say the
quick ratio is still below the minimum acceptable value of 1:1 and it can
become difficult for the company to survive in financial crisis. It has a quick
ratio of .93. Thus, a quick ratio of .93 means that a company has $.93 of
liquid assets available to cover each $1 of current liabilities. By analyzing
Net Profit Margin it was found that PEC has low profit margin. When there
is low net margin, then it becomes difficult for the company to survive in
financial crisis.
Debtors turnover ratio of PEC Ltd. is decreasing continuously from 2008,
which means it is taking more time to recover cash from debtors as compared
to its performance in 2008. The main reason behind this is the expansion of
business. Its business has expanded to such an extent that its funds are now
blocked with debtors for larger periods.
So I would recommend PEC to raise the interest rates which they charge
from their associates in case they delay the payment beyond the maturity
date of an import L/C. This would make the associates to pay PEC on time
and in this way PEC can recover funds in a faster way and thus improve
debtors turnover.



79

21.2 Study of Financing International Trade
As LCs or factoring in China and many other countries in Asia are not
yet commonly used or available, therefore Asian suppliers can often do very
little to protect themselves in cross-border transactions.
So if PEC promotes guaranteed L/C transactions and makes Asian
countries aware of it, then the SMEs in these countries will route their trade
through PEC and in this way PEC can earn greater margins. And this will also
help the economy to come out of slowdown.
Also if the companies switch to electronic trading and payment systems,
they may cut significant costs out of the labor-intensive trade finance process
and will also make payment delays more difficult to justify, thereby helping the
economy to come out of slowdown.
When PEC is importing under Govt. account and later sells it to an
Indian party, then it acts as an independent buyer or importer. And after
observing the risks involved with the four methods of payment in international
trade, it is clear that LETTER OF CREDIT method of payment can be regarded
as the optimum one. This is because risk is evenly spread between seller and
buyer provided all terms and conditions are adhered to. Moreover no risk of
non payment is there. And also the buyer i.e. is not obligated to pay until the
goods have been shipped by supplier.
So it will be better for PEC LTD. to follow LETTER OF CREDIT
method of payment in all transactions and also make Asian countries aware of
it.



80


REFERENCES
1. Annual report. (2012-2013)
2. PANDEY I.M. (2005). Financial Management. 9
th
Edition. Noida: Vikas
Publishing House Pvt. Ltd.
3. GUPTA S.L. (2006). Financial Derivatives: Theory, Concepts And Problems. New
Delhi: Prentice Hall Of India Pvt Ltd.
4. Akshatha B.G., Akash S.B. (2014). Nostro and Vostro accounts effective tool for
cross border settlement. [Online]. Volume:4, Issue:2. Available from:
http://www.indianjournals.com [Accessed 28 April 2014]
5. Giovannucci D. (2014). Basic Trade Finance Tools: Payment Methods in
International Trade. [Online]. Available from: http://web.worldbank.org. [Accessed
15 April 2014]
6. Thomas H. (2009). Letters of Credit and Documentary Collections : An Export and
Import Guide. USA: Xlibris Corporation
7. Gurusamy S. (2009). Financial Services. 2
nd
Edition. New Delhi: Tata McGraw-Hill
Education Pvt. Ltd.
8. Mustafa A. (2010). Foreign Trade Finance and Documentation .New Delhi: Laxmi
Publications Pvt. Ltd.
9. Mandavia S. (2013). Transfer of Limits from One Bank to Another : Buyers Credit
Rollover Process. [Online]. Available from: http://buyerscredit.wordpress.com/
[Accessed 6 May 2014]

81

10. Investopedia. (2014). LIBOR. [Online].Available from:
http://www.investopedia.com/video/play/london-interbank-offered-rate-libor/
[Accessed 23 April 2014]
11. Investopedia. (2014). Funds Management. [Online]. Available from:
http://www.investopedia.com/terms/f/funds-management.asp [Accessed 10 April
2014]
12. Indian Institute of Banking & Finance. (2007). UCP 600. [Online]. Available from:
http://www.iibf.org.in/scripts/pns1_ru_ucp.asp [Accessed 28 March 2014]
13. www.foreign-trade.com. (2014). INCOTERMS. [Online]. Available from:
http://www.foreign-trade.com/reference/incoterms.cfm [Accessed 4 April 2014]