The Companies Act 1980 introduced the legal term ‘quasi-loan’ in sections concerning the restrictions on companies making loans to directors. A quasi-loan arises when the company incurs a liability or agrees to incur such a liability in circumstances when the director is under an obligation to reimburse the company for the amount involved. An example would be where the company holds a credit card and that card is used in a transaction for the sole benefit of a director personally. The company has assumed a liability through use of the card and the director, as beneficiary of the transaction, must reimburse the company.
Quasi-Equity financing is debt that appears, in some aspects, as an equity investment. Characteristics of quasi-equity financing would include either being an unsecured loan, or being a flexible loan repayment schedule. Mezzanine debt and junior debt are examples of quasi-equity financing as they are both usually unsecured and flexible when it comes to the repayment schedule of the loan.
Quasi-equity investments are usually based on the company’s future cash flow growth. The lender must use projected cash flow statistics of the company they are investing in, and they base the structure of the quasi-equity investment upon what the future cash flow stream is going to be.
Quasi-equity financing is used when debt financing and share capital are not possible options of financing. Quasi-equity is dissimilar to a loan in the sense that quasi-equity financing is dependent upon how the company performs in the years to come.
If the company fails to reach the expected performance benchmark, the investor receives a significantly lower return. However, if the company goes through a more profitable growth stretch than expected, the investor receives greater financial return.
Quasi-Equity Financing is dependent upon how the company does in the future, which means the investors must have as much data as possible in order to minimize the risk that is possible when investing in a company.
It is also possible to place a ceiling on the possible return, if a company does exceptionally well in the future years there will be a payment cap that does not allow the investor to receive anything more than what the capis regardless of how well the business preforms. Quasi-equity financing is beneficial to companies that are not looking for a direct bank or equity loan.
Advantages of Non-Fund Facilities
When the lending bank does not pledge any outflow of funds in the physical form, it is called as non-fund-based lending. These are the Contingent Liability of the Banks. So, the banks do not deal in cash transactions or funds. The benefits of these types of loans is that there is no immediate outlay of funds, easy monitoring comparatively, less cost to the banker, low probability of default, and contingent deployment of funds.
Letter of Credit:
A written undertaking given by a bank on behalf of its customer who is a purchaser, to the supplier promising to pay a specific amount of money is called a Letter of Credit (LC). It works as a loan provided the supplier complies with the loan amount and conditions mentioned in the LC. This type of loan is basically required when both the parties dealing in the import or export are unknown and do not feel safe while trading. It is done to safeguard the interests of both the parties involved.
Types of Letters of Credit
The ‘Letters of Credit’ may be divided in two broad categories as under:
Revocable letter of credit. This may be amended or cancelled without prior warning or notification to the beneficiary. Such letter of credit will not offer any protection and should not be accepted as beneficiary of credit.
Irrevocable letter of credit. This cannot be amended or cancelled without the agreement of all parties thereto. This type of letter of credit is mainly in use and offers complete protection to the seller against subsequent development against his interest.
Letter of Comfort:
A communication from a party to a contract to the other party that shows an initial willingness to enter into obligations without the elements of a legally enforceable contract is called a letter of comfort. It is also referred to as a Letter of Intent. It is a mere reassurance of performance and is used widely in commercial transactions.
Standby Letter of Credit:
A guarantee made by a bank on behalf of a client is called a Standby Letter of Credit or SBLC. This guarantee ensures that even if the client is not able to fulfill the payment, the bank will pay on its behalf. It is actually never meant to be used but only kept as last resort payment from the banks based on requirement.
The customers often call their banks for issuing a variety of bank guarantees on their behalf. An undertaking from a bank stating that if the buyer fails to honor or make repayments to its vendor, the bank will compensate on the buyer’s behalf to the vendor. The main advantage of a bank guarantee is that it allows the business to make the purchasing that they are otherwise not able to. At the same time, it reduces the credit risk of the vendors.
An unsecured loan type for meeting your current financial needs is called as a personal loan. In this case, the lender gives you the flexibility to use the funds as per your requirement. One does not need to pledge any collateral or security for availing a personal loan. These loans do not require much documentation and hence, are relatively quick.
A loan collateral is kept in terms of real estate or property is called a mortgage loan. There is a risk for the borrower in accepting these loans because a failure to pay will lead to a complete loss of the asset. At the same time, there is no guarantee that the borrower will be able to make the payment in the future.
The management of financial decisions and money for a family or a person including investments, budgeting, retirement planning, and investments is called personal finance. The future life events and financial risks are kept into consideration while making important financial decisions. This helps to develop a balanced plan for meeting financial goals with various techniques such as proper tax planning, careful budgeting, and prudent spending. Proper personal finance management leads to an increase in cash flow and a subsequent rise in capital.
Assessment of LC limits
The assessment LC/LG limits are fixed by banks based on annual consumption of raw material to be purchased against LC or LG. The raw material holding in terms of consumption is worked out as under.
Ascertain from customer the requirement of Consumption of Material (CM) per annum, which is to be purchased under LC or LG.
Find out Procurement Time or lead time (PT) for importing the materials.
(Procurement Time or Lead time means the time taken in revving the goods including transit period after the LC is opened)
If the material is purchased under credit, add usance period or Credit Period (CP) to procurement time.
We get Total Time (TT) when we add credit period to procurement period. TT=PT+CP
If CM is Annual Consumption of Material to be purchased against LC or LG
We can compute the LG or LC limit required to the company by dividing the annual consumption of raw material to be purchased against LC or LG and same is divided by 12 and multiplied by total time. (i.e. Monthly purchases ×total time) . Note: Purchase value of goods for assessment of LC is done on the basis of CIF (cost, insurance and freight) of goods What is EOQ-economic order quantity which is calculated by source of supply, means of transport and any discount.
Thus, the formula for LC/LG Limit=CM×TT ÷ 12
However, if minimum quantity (EOQ-economic order quantity) to be procured is more than the limit arrived, such request should be considered. This equation is to be adapted for LC under DA terms as well as for inland LG. (The EOQ-economic order quantity is calculated taking into account of source of supply, means of transport and any discount for order of larger quantity etc.).
Bills Purchase/ Discounting under LC
Process flow of Letter of credit:
Terms of Contract: When both the parties agree, they determine the nature of business and type of goods the seller should supply to the buyer. Given the contract, a letter of credit is being issued between buyer and seller.
Issuance of LC: Buyer approaches the issuing bank to issue the LC in favor of seller and sellers bank i.e. confirmation bank which will pay to the seller on behalf of the buyer.
Documents and payment: As per LC terms, the seller will submit documents to confirmation bank, for the payment which includes Bill of Exchange, packing list, e-way bill. Then these documents are forwarded to issuing bank if there is no discrepancy in the documents the issuing bank will honor the LC. Finally, the documents are submitted to the buyer, only if the payment is made by the buyer.
If the above process is clear, what if the seller requires funds immediately and not on the due date. In that case, the discounting of LC becomes a great tool. LC discounting is a short- term credit facility provided by the bank to the seller. In this case, LC issuing bank confirms all the original documents and provide acceptance to the confirming bank. After the due diligence from the bank, the seller will get the credit amount after deducting the discount. The bill discounting is categorized into two types namely sales and purchase. If the discounting is done by the seller, it is the sales side and the buyer will be called purchase side bill discounting. The rates of discounting vary depending upon the amount, period and creditworthiness of the client.
Advantages of LC Discounting
- It speeds up the cash flow and helps in the smooth flow of the working capital
- LC discounting takes away the risk and gives assurance to the seller for the funds
- It is customizable and both the parties can mutually arrive at the list of clauses for the payment
- LC assists in boosting the business through various geographies.
Disadvantages of LC Discounting
- In LC discounting, there is no physical verification of the quantity and quality of goods.
- There is a set of documentation which needs to be followed by both seller and buyer, which can be tedious due to non-availability for the same.
- The final amount which is credit is less, due to being discounted by the bank.