spot_img

LETTER OF CREDIT CALCULATIONS | ABM NOTES

LETTER OF CREDIT CALCULATIONS

In this article, we will provide you some easy notes on the Calculations related to Letter of Credit from CAIIB ABM Study material 2022.

 

CAIIB ABM - Advanced Bank Management Syllabus Priority
Check Here
————————————————————-
Bank Financial Management - BFM Syllabus Priority
Check Here
————————————————————-
110+ CAIIB Case Study Videos
Check here
————————————————————-
ABM BFM Retail Previous Year Questions
Get Tests Here
————————————————————-
Full Course Videos in Hindi English
Check Here

CAIIB | ABM DEC 2022 EXAMS

As you would already know that the Advanced Bank Management paper is due on November 27th 2022. You can register for the same by October 20th without any late fees from the September 30th 2022. For more details click here: CAIIB latest Exam Details

 

Now, coming to main topic, our focus in today’s article is to clear your understanding of all the calculations related to Letter of Credit. So, let us begin with them.

 

But, first let us refresh the meaning of LC:

LETTER OF CREDIT:

A letter of credit, in short LC, is a written document which is issued by the importer’s bank (opening bank) on behalf of importer. Its purpose is to assure the exporter that the issuing bank will make a payment to the exporter for the international trade/deal conducted between the involved parties.

Process of Issue:

The importer is basically the applicant of the LC, while the exporter is the beneficiary & as per the T&Cs’ agreed timeline of LC, the issuing bank promises to pay the mentioned amount against specified documents.

Basis:

As a general principle, an LC is issued based on the documents presented to the issuing bank, and the issuing bank is not responsible for ensuring shipment of the goods. And unless the documents presented are contrary to the terms and conditions of the LC, the bank cannot deny the payment.

 

 

Limits of Letter of Credit

LC limits are fixed by the banks based on annual consumption of raw material which will be purchased against the LC. The Raw material in terms of consumption is calculated in the following way:

  • Banks are to ascertain what will be the requirement of ‘Consumption of Material (CM)’ per annum, which will be purchased under LC by the bank customer.
  • Then you need to calculate the Procurement Time or lead time (PT) for importing the raw materials. Procurement Time or Lead time is the time period in which goods are to be received including transit period after the LC is opened.
  • If the raw material is purchased under credit, you can also add usance period or Credit Period (CP) to procurement time.
  • This way, we will have the Total Time (TT) on adding credit period to procurement period. TT = PT + CP

 

In case Consumption of Material = Annual Consumption to be purchased against LC

We can compute LC limit which will be required by the customer by dividing the annual consumption of raw material to be purchased against LC by 12 and then multiplied by total time. 

i.e. Monthly Raw Material Purchases × Total Time. 

Note: For assessment of LC, Purchase value of goods is calculated on the basis of CIF i.e. is the total of cost, insurance and freight of goods. 

 

Thus, the formula for calculation of LC Limit = CM × TT ÷ 12

 

EOQ: Economic Order Quantity is a calculation done to find out the ideal order / purchase size, which allows to meet demand without overspending. Inventory managers also calculate EOQ to minimize the holding costs and excess raw materials. 

However, if minimum quantity (i.e. EOQ) to be procured > the limit calculated, then such request should be considered. This equation is to be adapted for LC under DA terms. 

 

ILLUSTRATION I: 

Calculation of DP- LC Limit:

 

Given: 

  1. Total annual purchase = Rs. 120,00,000
  2. of which purchase under LC (50%) = Rs. 60,00,000
  3. Of import of Raw Materialunder LC (50%) = Rs. 30,00,000

Assessment of Inland LC:

Lead time = 2 months

 

Monthly purchase for indigenous Raw Material 

= Rs. 60,00,000 – Rs. 30,00,000 / 12

= Rs. 2,50,000

Therefore, Inland Letter of Credit requirement 

= Monthly purchase * lead time 

= Rs. 250000 × 2 = Rs. 5,00,000 ———–(A)

 

Assessment of import LC:

Monthly purchase of import Raw Material 

= Rs. 30,00,000 / 12 

= Rs. 250000

Lead time = 4 months

Import LC requirement 

= Rs. 250000 × 4 

= Rs. 1000000 ———-(B)

 

Total LC requirement (A+B) 

= Rs. 500,000 + Rs. 10,00,000 

= Rs. 15,00,000 

i.e LC limit of Rs.15 lacs having the sub-limit of Rs.10 lacs for import LC and Rs.5 lakh for domestic LC.

 

ILLUSTRATION 2: 

Calculation of LC-DA limit

 

In the same example above, assume that there is usance of 2 months available in both for domestic and import cases. 

 

So, for assessment of LC under Usance, the usance period is to be added to the lead time.

Inland LC requirement = 

= monthly purchase x (lead time + usance period)

= Rs. 2,50,000 x (2 + 2) 

= Rs. 10,00,000 ———–(i)

 

Import LC requirement =

= Monthly purchase x (lead time + usance period)

= Rs. 2,50,000 x (4 + 2) 

= Rs. 15,00,000 ———–(ii)

 

Total LC requirement (i) + (ii) = 25 lacs having the sub-limits of Rs.10 lacs for domestic LC and Rs.15 lacs for import LC.

 

ILLUSTRATION 3: 

Calculation of (import) DA – LC limit with the help of EOQ

  • Total annual purchase of import Raw Material= Rs. 30,00,000
  • Monthly requirement of import Raw Material= Rs. 2,50,000
  • Minimum order level (EOQ) = Rs. 10,00,000
  • No. of LCs required to be opened (A / B) = Rs. 30,00,000/10,00,000 = 3
  • Frequency of LCs: (12/ No. of LC required to be opened) =12/3 = 4 months. (Therefore, the import order will be placed under LC once in every 4 months. 
  • But the Credit (usance) is available for 6 months and lead time of 2 months, making the Total lead time = (2 + 6) = 8 months

Because the 2nd order of Raw Material under LC shall be placed by the customer before the retirement of the 1st LC = Rs.10 lacs, therefore, LC outstanding at any point of time shall be < Rs.20 lacs.

 

In the instant case Import LC requirement without EOQ:

LC limit without EOQ = 

= monthly purchase x (lead time + Usance period)

= Rs. 2,50,000 x (2 + 6) = Rs. 20,00,000.00 

 

Assessment of DPG/APG: 

Since DPG is a substitution for term loans, it is assessed in the same manner as term loans. In the same way that fund-based limits are assessed, Advance Payment Guarantee (APG) is assessed. As the borrower receives advance payment for the material he will supply at a later date, the advance payment should be deducted from working capital gap.

 

Effect on Working Capital limit:

Whenever LC limits are sanctioned for the import of raw material or goods imported for the trading purposes, then such limits shall normally help in decreasing the working capital limit. 

Therefore, the following points are to be noticed while sanctioning/opening LCs:

In the case of DA LCs, the customer gets adequate time to process or sell the goods imported, therefore, the cash flow of the transactions is to be studied for DA LCs.

The LC limit for the working capital purpose shall be considered based on the annual consumption of raw material to be purchased as mentioned earlier. The limit sought after has to be uniform with the borrowers’ known trade practice.

The LC limit approved for working capital purposes cannot be utilized for the importing goods of capital nature. Therefore, banks have to check up from the customers on how they would arrange funds for retirement of LC which has been opened for the import of capital goods.

 

So, this was all about the Calculations that are important from the Letter of Credit Chapter of ABM Latest Syllabus 2022 from Certified Associate of the Indian Institute of Bankers.

 

IIBF | CAIIB DEC 2022 | ADVANCED BANK MANAGEMENT | LATEST STUDY MATERIAL 2022

Learning Sessions is one of the leading platforms to provide online coaching classes of CAIIB, Bank Promotion & Other Certification exams of IIBF. The classes are not only in-expensive but are best of the classes that are available elsewhere.

The classes get updated as per the latest Syllabus prescribed & are delivered by the expert faculty of Learning Sessions. Other than that, the ABM & Other Subjects’ (CAIIB) have the following features: 

  • Live + Recorded Lectures
    • Conceptual Videos
    • Questions Videos
  • Downloadable lectures (recorded ones)
  • 24 by 7 access to materials via our apps apps & website
  • Unlimited views of the video classes
  • Mock Tests Series including the Memory Recalled Questions & Mega Mock Tests
  • Lowest prices & Flexible packs
  • English language / Hinglish language both are available 
  • Latest ABM Syllabus DEC 2022 

Access the courses through:

 

REACH US

You can reach us for any query related to Study materials/video classes as well as offers on JAIIB, CAIIB, or other IIBF Certification Exams or Bank Promotion Exams on our WhatsApp No.: 8360944207

 

For daily free bank updates, join us:

 

We wish you best for your Exams!

Team: Learning Sessions

 

Also Like:

LEAVE A REPLY

Please enter your comment!
Please enter your name here

🤩 🥳 LS NEW OFFER 🥳 🤩spot_img
🤩 🥳 JAIIB CAIIB CLASSES 🥳 🤩spot_img
🤩 🥳 JAIIB NEW BATCH START 🥳 🤩spot_img

POPULAR POST

RELATED ARTICLES

JAIIB & CAIIB UPDATES | TRENDS IN BANKING AND FINANCIAL SERVICES IN INDIA | NOV 2022 EXAMS

TRENDS IN BANKING AND FINANCIAL SERVICES IN INDIA This post contains TRENDS IN BANKING AND FINANCIAL SERVICES IN INDIA in 2022 for IIBF Exams 2022...

LAWS OF LIMITATION ACT | BANKING RELATED LAW | JAIIB LRAB EXAMS 2022

LAWS OF LIMITATION ACT FOR JAIIB LRAB EXAMS 2022 In the post, we will get to know limitation period stipulated for various types of suit...

BANK PROMOTION (FREE) MOCK TEST QUESTIONS – PART 2 | BANKING OPERATIONS | IBPS FREE MOCK TESTS | INTERNAL PROMOTION EXAMS | 2022-23

BANK PROMOTION IMPORTANT (FREE) MOCK TEST MCQ PART - 2 In this post, you will find the IBPS Bank Promotion MCQs important MOCK TEST for...

BANK PROMOTION (FREE) MOCK TEST QUESTIONS PART – 1  | GENERAL ENGLISH | IBPS MOCK TESTS FOR INTERNAL PROMOTION EXAMS 

BANK PROMOTION IMPORTANT (FREE) MOCK TEST MCQ PART - 1   In this post, you will find the BANK PROMOTION IMPORTANT MCQ for the Institute of...