Word Final Project Report

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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


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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: 16thMay, 2014


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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 24thFeb, 2014 to 23rd 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)


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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


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13BSPHH011105

TABLE

OF

CONTENTS

A

UTHORIZATION

............................................................................................. III

ACKNOWLEDGEMENTS.................................................................................... IV

T

ABLE

O

F

C

ONTENTS

.......................................................................................

V

E

XECUTIVE

S

UMMARY

..................................................................................... IX

L

IST

O

F

F

IGURES

...............................................................................................X

L

IST

O

F

T

ABLES

................................................................................................

XI

1.INTRODUCTION................................................................................................ 1

1.1INTRODUCTION TO COMPANY....................................................... 2

1.2PURPOSE OF THE STUDY................................................................. 3

1.3SCOPE OF THE STUDY....................................................................... 3

1.4SOURCES OF THE DATA..................................................................... 3

1.5LIMITATION AND HINDRANCE....................................................... 4


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2.STRUCTURE OF ORGANIZATION.................................................................... 4

3.COMPANY ANALYSIS....................................................................................... 6

3.1PECS MISSION................................................................................ 6

3.2PECSVISION................................................................................... 6

3.3OBJECTIVES OF PEC ......................................................................... 6

3.4KEY INITIATIVES ................................. 7

3.5PECS OPERATION............................................................................ 7

3.6SWOT .............................................................................................. 9

3.7PESTEL ANALYSIS OF TRADE INDUSTRY.......................................... 11

3.8PORTERS FIVE FORCE ANALYSIS OF THE FIRM.............................. 13

4.PERFORMANCE................................................................................................. 14

4.1FIRM ANALYSIS USING FINANCIAL RATIOS..................................... 17

5.BUSINESS MODEL OF PECLIMITED.............................................................. 25

6.IMPORT ............................................................................................................. 266.1PROCEDURE OF IMPORT UNDER BACK TO BACK LC ................... 26

6.2PROCEDURE OF IMPORT UNDER GOVERNMENT ACCOUNT29

7.EXPORT............................................................................................................. 32

7.1EXPORT BY PARTICIPATING IN INTERNATIONAL TENDER.............. 32

7.2EXPORT FOR ASSOCIATE.................................................................. 33

7.2.1ON BEHALF OF PECLTD................................................. 33

7.2.2ON 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


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11.1CASH-IN-ADVANCE..................................................................... 38

11.1.1CHARACTERISTICS OF CASH -INADVANCE............. 38

11.1.2KEY POINTS.................................................................... 39

11.1.3CONDITIONS FOR USAGE ............................................. 39

11.2LETTERS OF CREDIT....................................................................... 40

11.2.1PARTIES TO ALETTER OF CREDIT................................ 40

11.2.2CHARACTERISTICS OF ALETTER OF CREDIT............... 42

11.2.3KEY POINTS.................................................................... 42

11.2.4ILLUSTRATIVE LCTRANSACTION.................................. 43

11.2.5TYPES OF LCS................................................................ 43

11.2.6METHODS OF SETTLEMENT.......................................... 45

11.2.7NOTE ON DOCUMENTARY LCS................................... 46

11.2.8DOCUMENTS REQUIRED IN AN LC.............................. 46

11.3DOCUMENTARY COLLECTIONS.................................................... 4811.3.1CHARACTERISTICS.......................................................... 49

11.3.2KEY POINTS.................................................................... 49

11.3.3FLOW OF TRANSACTION IN ADEAL........................... 50

11.4OPEN ACCOUNT............................................................................. 51

11.4.1CHARACTERISTICS OF AN OPEN ACCOUNT.................... 51

11.4.2KEY POINTS.................................................................... 52

12.FORFAITING................................................................................................... 52

12.1INTRODUCTION OF FORFAITING.................................................. 52

12.2DEFINITION OF FORFAITING......................................................... 53

12.3HOW FORFAITING WORKS IN INTERNATIONAL TRADE............. 53

12.4COST ELEMENT.............................................................................. 53


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12.5SIX PARTIES IN FORFAITING.......................................................... 54

12.6BENEFITS TO EXPORTER................................................................. 54

12.7BENEFITS TO BANKS....................................................................... 55

12.8DRAWBACKS OF FORFAITING....................................................... 55

13.FACTORING.................................................................................................... 55

13.1DEFINITION OF FACTORING......................................................... 55

13.2CHARACTERISTICS OF FACTORING............................................... 56

13.3DIFFERENT TYPES OF FACTORING................................................ 56

14.BUYERS CREDIT............................................................................................. 57

14.1BENEFITS OF BUYERS CREDIT TO IMPORTER............................... 58

14.2STEP INVOLVED IN BUYERS CREDIT............................................. 58

15.ROLLOVER PROCESS IN BUYERS CREDIT.................................................... 59

15.1PROCESS OF BUYERS CREDIT FOR CAPITAL GOODS................... 59

15.2COSTS INVOLVED........................................................................... 6015.3CONCEPT 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

16.4LIBOR CALCULATION METHOD................................................... 62

16.5SIGNIFICANCE OF LIBOR INTEREST............................................... 62

17.FUNDS MANAGEMENT................................................................................. 63

18.UCP600 ...................................................................................................... 66

19.INCOTERMS .............................................................................................. 67

20.FINDINGS AND CONCLUSION...................................................................... 70


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20.1.FIRMS FINANCIAL ANALYSIS....................................................... 70

20.2STUDY OF FINANCING INTERNATIONAL TRADE.......................... 76

21.RECOMMENDATIONS.................................................................................... 78

21.1FIRMS FINANCIAL ANALYSIS........................................................ 78

21.2STUDY OF FINANCING INTERNATIONAL TRADE.......................... 79

22.REFERENCES................................................................................................... 80


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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 ONPECS 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 werealsocarried 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 amongthe 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.


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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 10. Screenshot Trend Analysis 1 438






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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


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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


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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 timelyexecution 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,


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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, whichdeals 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.


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Secondary data:

Secondary data are collected from the secondary sources like annual report,

published reports, journals, internet data services (web sites) etc. These are thedata 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. STRUCTUREOF 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 CommercePart Time Director


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Shri. Santosh Kumar, Dy. Secretary, Department of CommercePart 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 Delhi110 001 and has 14 branch

offices spread all over India including 7 Port Offices.

Figure 1 - Organization Structure


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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 anddomestic 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.


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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


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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. PECalso 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 aconsistent 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.


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Domestic:

The Corporation undertakes domestic trading of agro commodities like

wheat, pulses, edible oils, etc. Domestic trading also includes coal/coke, steeland 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.
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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.

OPPORTUNITIES

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.


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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


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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


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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 bybankers and commercial parties in more

than 175 countries intrade finance.

3.8 Porters Five Force Analysis Of TheFirm

Porter five forces analysis is a framework for industry analysis and businessstrategy development. It draws upon industrial organization (IO) economics to

derive five forces that determine the competitive intensity and therefore

attractiveness of amarket.

Figure3 Porters Five Force Analysis
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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 102751119908964


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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


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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)


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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. L iquidity 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


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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 assetsinventories) / 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.


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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. Activi ty 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


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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 companyoperates 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 yearending 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 ratiofor the financial year ending March

2013 is 4.023635224
http://en.wikipedia.org/wiki/Equationhttp://en.wikipedia.org/wiki/Cost_of_goods_soldhttp://en.wikipedia.org/wiki/Inventoryhttp://en.wikipedia.org/wiki/Inventoryhttp://en.wikipedia.org/wiki/Cost_of_goods_soldhttp://en.wikipedia.org/wiki/Equation


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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 basiseither 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. Profi tabili ty 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:


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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 percentagethat 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 netprofit marginfor 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


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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


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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 ofPEC 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


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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,


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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 warehouseunder 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


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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:


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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


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


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The process of import of edible oil under the government account is as

follows:


given by PEC LTD.



The exporter than ships the goods to India.









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


given by PEC LTD.


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The exporter than ships the goods to India.









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.


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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 Origin12.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


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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 bankcharges, 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


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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.


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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.


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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 vostroaccount. 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,


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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


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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.


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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 goodshave been shipped or delivered as promised.

11.2.1 Parties To A Letter Of Credit

Appli cant (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 ofhis 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.


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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.

Confi rming 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.

Reimbur sing 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


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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


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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 goodsfrom the carrier.

11.2.5 Types of LCs:

a) Revocable & ir revocable 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


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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) Conf irmed & 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:


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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 l etter 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.


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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 ofcredit 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 slightomission 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


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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 Li st: 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 Certif icate: 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.

Certi fi cate of Or igin: 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 Certi fi cate: The extent of coverage and risks shouldbe 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.


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Air Waybil l: 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 l ist: Not synonymous to a packing list. This document breaks

down the shipment by weight. This is generally needed only if a

certificateis 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


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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 . Applicabil ity:

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 a

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