mercantile bank working capital management

7/27/2019 Mercantile bank working capital management

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TITLE OF THE STUDY:

Working Capital Financing by a Bank:

Mercantile Bank Ltd.


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Course Title: Working Capital ManagementCourse Code:F-405

S U B M I T T E D T O

M. Shahjahan Mina (Professor)

Department of FinanceUniversity of Dhaka

S U B M I T T E D B Y

Section ABBA 16th Batch

Department of Finance

University of Dhaka

Date of Submission: 13th July, 2013


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ABOUT US

Sl No. Name Id03 Md. Sanowar Hossain 16-175

04 Md. Azizul Islam 16-260


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Executive Summary

Working capital is just like a heart of a firm and if it is weak; the business cannot prosper andsurvive, although there is a large body (investment) of fixed assets. This genre of capital

determines the funds available with a company for day to day operations. So working capital

decisions constitute a major share of a firms management concern. Determination of source of

finance of that capital captivates a bulk share of that concern. This study attempts to view

Mercantile Bank Limited as a source of working capital financing. Throughout the study it is

attempted to analyze the prime aspects of MBLs working capital financing facilities in a

qualitative approach.

The study is formally initiated with a brief yet comprehensive understanding of some major

issues regarding working capital and the importance of suck kind of financing in a business

arena. In the next step of the study the bank is formally introduced as a second generation bank

that is also a financier of working capital for business firm. In the very next stance the working

capital financing guidelines are introduced. The guidelines appeared to de well responsive to

the present context. The study then puts focus on the financing tools the firm adopts to provide

fund for working capital purposes. It was understood that the accommodated working capital

through cash credit, overdraft, letter of credit , revolving credit, loan against trust receipt and

factoring. Then it was understood that the firm manage the loanable fund from deposit and

arrangement from other bank. The bank prefers manufacturing concerns for loan advancing. In

the next move it was discussed that the bank employs separate approach for assessing loan

application for existing and new clients. It was also discussed that the loan amount to be

advanced to a certain client depends on the borrowers need, the amount sought, borrowers

integrity and risk factor. The bank employs modern credit risk management policy and

Bangladesh Banks credit manual to monitor loaned funds. The next move ofthe study involves

the point that the bank allows land, building, inventory hypothecation, lien, third part

guarantee as collateral. Then the interest aspect of the financing was discussed which reveals

that interest rate varies depending on the customers integrity and the overall risk factor and

the availability of fund too. It was then discovered in the study that banks existing clients get

some additional advantage over the new applicants which includes interest rate concessions.

The study then revels that the bank has an excellent recover rate of over 97%. The study

formally ends with the indication of repayment schedule from where it was found out that

loans are recovered generally through equal installments with adjustments for unpaid fraction

in the last month.


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Meanings of Working CapitalThe term working capital has several meanings in business and economic development finance. In

accounting and financial statement analysis, working capital is defined as the firms short-term or

current assets and current liabilities. Net working capital represents the excess of current assets over

Current liabilities and is an indicator of the firms ability to meet its short term financial obligations.

From a financing perspective, working capital refers to the firms investment in two types of assets. In

one instance, working capital means a businesss investment in short-term assets needed to operate

over a normal business cycle. This meaning corresponds to the required investment in cash, accounts

receivable, inventory, and other items listed as current assets on the firms balance sheet. In this

context, working capital financing concerns how a firm finances its current assets. A second broader

meaning of working capital is the companys overall non fixed asset investments. Businesses often need

to finance activities that do not involve assets measured on the balance sheet. For example, a firm may

need funds to redesign its products or formulate a new marketing strategy, activities that require funds

to hire personnel rather than acquiring accounting assets. When the returns for these soft costs

investments are not immediate but rather are reaped over time through increased sales or profits, then

the company needs to finance them. Thus, working capital can represent a broader view of a firms

capital needs that includes both current assets and other non-fixed asset investments related to its

operations.

In this chapter, we use this last meaning of working capital and focus on the tools and issues involved in

financing these business investments.

Business Uses of Working CapitalJust as working capital has several meanings, firms use it in many ways. Most fundamentally, working

capital investment is the lifeblood of a company. Without it, a firm cannot stay in business. Thus, the

first, and most critical, use of working capital is providing the ongoing investment in short-term assets

that a company needs to operate. A business requires a minimum cash balance to meet basic day-to-day

expenses and to provide a reserve for unexpected costs. It also needs working capital for prepaid

business costs, such as licenses, insurance policies, or security deposits. Furthermore, all businesses

invest in some amount of inventory, from a law firms stock of office supplies to the large inventoriesneeded by retail and wholesale enterprises. Without some amount of working capital finance,

businesses could not open and operate. A second purpose of working capital is addressing seasonal or

cyclical financing needs. Here, working capital finance supports the buildup of short-term assets needed

to generate revenue, but which come before the receipt of cash. For example, a toy manufacturer must

produce and ship its products for the holiday shopping season several months before it receives cash

payment from stores. Since most businesses do not receive prepayment for goods and services, they


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need to finance these purchase, production, sales, and collection costs prior to receiving payment from

customers. Figure 5.1 illustrates this short-term cash flow and financing cycle. Another way to view this

function of working capital is providing liquidity. Adequate and appropriate working capital financing

ensures that a firm has sufficient cash flow to pay its bills as it awaits the full collection of revenue.

When working capital is not sufficiently or appropriately financed, a firm can run out of cash and face

bankruptcy.

A profitable firm with competitive goods or services can still be forced into bankruptcy if it has not

adequately financed its working capital needs and runs out of cash. Working capital is also needed to

sustain a firms growth. As a business grows, it needs larger investments in inventory, accounts

receivable, personnel, and other items to realize increased sales.

New facilities and equipment are not the only assets required for growth; firms also must finance theworking capital needed to support sales growth.

A final use of working capital is to undertake activities to improve business operations and remain

competitive, such as product development, ongoing product and process improvements, and cultivating

new markets. With firms facing heightened competition, these improvements often need to be

integrated into operations on a continuous basis. Consequently, they are more likely to be incurred as


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small repeated costs than as large infrequent investments. This is especially true for small firms that

cannot afford the cost and risks of large fixed investments in research and development projects.


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About Mercantile Bank Limited:

Mercantile Bank Limited emerged as a new commercial bank to provide efficient banking services and

to contribute socio-economic development of the country. The Bank commenced its operation on June

2, 1999.

The Bank provides a broad range of financial services to its customers and corporate clients. The Board

of Directors consists of eminent personalities from the realm of commerce and industries of the

country.

Vision, Mission & Objectives:

Vision:

Would make finest corporate citizen.

Mission:

Will become most caring, focused for equitable growth based on diversified deployment of

resources, and nevertheless would remain healthy and gainfully profitable Bank.

Objectives:

Strategic objectives-

to achieve positive Economic Value Added (EVA) each year. to be market leader in product innovation.

to be one of the top three Financial Institutions in Bangladesh in terms of cost efficiency.

to be one of the top five Financial Institutions in Bangladesh in terms of market share in all

significant market segments we serve.

Financial objectives:

to achieve 20% return on shareholders' equity or more, on average.

Core values:

For the customers-

Providing with caring services by being innovative in the development of new banking

products and services.


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For the shareholders-

maximizing wealth of the Bank.

For the employees-

Respecting worth and dignity of individual employees devoting their energies for the

progress of the Bank.

For the community-

Strengthening the corporate values and taking environment and social risks and reward

into account.

New technology-

Adopting the state-of-the art technology in banking operations.

Short Term Financing

Short-term loans are used to finance inventory, account receivables or other current assets i.e. to

finance the working capital requirement. Forms of short-term loan are given below:

a. Cash Credit (CC):

Cash credit account is like a current account with a limit up to which one can withdraw from the bank.

Cash credit is normally sanctioned for a period of one year where a regular limit is sanctioned against

goods to meet day to day expenses of business.

b. Secured Overdraft (SOD-General):

Under this, a regular limit is sanctioned to meet day to day expenses of business. This form of credit is

given to the business where maintenance of stock on a regular basis is not possible. The account is

adjusted by the sale proceeds or from own source of the customer.

c. Secured Overdrat (SOD):

When overdraft is allowed against lien of FDR or other financial instruments, it is termed as Secured

Overdraft (SOD). Secured Overdraft (SOD) facility to the borrower may be allowed generally in the

following ways:


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Overdraft- against guarantee-

Overdraft-against FDR in the name of borrower

Overdraft- against FDR in the name of 3rd party

Overdraft- against savings certificate

Overdraft- against wage Earners Dev. Bond Overdraft- against DPS

d. Bill Discounted and Purchased:

Mercantile Bank gives advances to customers by discounting or purchasing their bills of exchange. Such

bills of exchange arise out of commercial transactions both in inland trade and foreign trade.


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Working Capital Management of Mercantile Bank Limited:

MBL CHALTI MULDHAN

Small and Medium Entrepreneurs need working capital at anytime to penetrate prevailing business

opportunity and to run the existing business smoothly encountering the threat as well as exploringopportunities. However, in order to help SME customers to operate their business uninterruptedly,

Mercantile Bank Limited has introduced continuous loan facility styled CHALTI MULDHAN.

Purpose

To meet up any justifiable and acceptable working capital requirements.

Loan limit

Tk 0.50 lac to Tk 50.00 lac for SE customers.

Tk 0.50 lac to Tk 500.00 lac for ME customers.

prerequisite:

Nationality- Bangladeshi

Age limit- From 21 years to 60 Years (last installment of the loan has to be deposited before the

borrower reaches the age of 60).

Note: Age bar may be relaxed/waved by the Managing Director & CEO of the Bank on acceptable

grounds.

Minimum income- Minimum income must be commensurate with the amount of loan requested.

Borrower's eligibility

The entrepreneur:

- must be literate.

- is skilled in managing his/ her business preferably 2(two) years.

- has good reputation.- 2 (two) years experience requirement may be relaxed if a SME customer fully covers the credit

facility by providing collateral security and has prior employment/business experience in the related

industry.


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Incase of proprietorship concern, the borrower must be Banglaeshi by nationality. If the borrower is a

Private Limited Company/partnership firm or a joint venture, it must be registered in Bangladesh and

majority of shares owned by Bangladeshis.

The applicant must be 100% privately owned, controlled and operated

The principal place of business must be in Bangladesh. The project must be financially, economically and commercially viable.

If the collateral security seems to be comfortable, guarantors' requirement may be relaxed on the basis

of banker customer relationship and credit worthiness of the customer case to case basis.

Successful track record and good credit history will get advantage.

Security/Collateral

Registered mortgage with Irrevocable General Power of Attorney of the property

/ownership of the space/possession right purchased.

Hypothecation of machinery, equipments, vehicles, inventories, advance payments.

Lien of cash collateral (FDR, Scheme Deposit) and competent authority approved other

encashable financial instruments.

In case of proprietorship concern, personal guarantee of the proprietor and spouse.

In case of Private Ltd Co or partnership firm, personal guarantee of all directors/partners

and their spouses to be obtained.

In case of third party personal guarantee, guarantors must be subject to the same credit

assessment as made for the principal borrower and acceptable to bank.

Usual charges documents.

Others as applicable in compliance with the policy of the Bank.


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Documentation

o Valid trade license of the applicant along with 2 years old trade license preferable.o Registered partnership deed (In case of partnership firm).o Copy of Memorandum and articles of association, certificate of incorporation duly

certified by RJSC and Board resolution, List of latest directors attested by MD/CEO incase of private limited company.

o Attested copy of passport/national voter ID/ citizenship certificate from wardcommissioner/Up chairman of the proprietor / partners.

o Photograph of the proprietor/partners/a/c signatory attested by the applicant andverified by the relationship manager.

o Deposit a/c statements for latest 12 months.o Statement of all loan accounts.o Latest clean/standard CIB report.o Net worth statements of all borrowers and guarantors.o Rental/lease/possession deed as applicable.o Drug/Homeopathic/Explosive/BSTI/Import/Export license as applicableo Clearance certificate from Department of Environment if applicableo Original title deed(s) of the property along with the related documents in original such

as Bia-Deeds, Mutation, DCR, CS/RS/SA Khatian, up to date Khajna Receipt, Non-

Encumbrance Certificates etc.

o Others as applicable in compliance with the policy of the Bank.

Insurance-

Fire & Other insurance coverage as applicable

Interest rate-

The interest rate is subject to change based on the market conditions and policy of the

Bank.

Penal interest rate-

2 % higher over the prescribed rate on overdue amount or as per policy of the Bank.

Other fees & Charges-

As per policy and scheduled charges of our Bank.

Interest applied-

Quarterly/Monthly rest basis.


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Tenure of the loan-

1(One) Year on revolving basis.

Repayment method-

By depositing daily sales proceeds in the loan account.

Full and final adjustment by depositing sales proceed or from own sources of the

customer on or before the expiry.

Every drawing to be adjusted by 90 days.

MBL SINGLE PAYMENT LOAN

Seasonal products/crops as well as religious and cultural festivals create short-term additional business

opportunity for Small and Medium Entrepreneurs of our country. As such, they require special business

arrangements in addition to conduct day to day business activities to cope up with seasonal demand

that increase sale and profit. In order to patronize SME customers for capturing this seasonal business

opportunity, Mercantile Bank Ltd has introduced SINGLE PAYMENT LOAN facility.

Customer segment-

Any eligible SME Customers

Purpose-

To meet up legitimate short-term working capital requirements of business entity.

Loan limit-

Tk 0.50 lac to Tk 50.00 lac.

Borrower's eligibility -

- The entrepreneur:

- must be literate.

- is skilled in managing his/ her business preferably 2(two) years.

- has good reputation.

In case of proprietorship concern, the borrower must be Banglaeshi by nationality. If the borrower is a

Private Limited Company/partnership firm or a joint venture, it must be registered in Bangladesh and

majority of shares owned by Bangladeshis.


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The applicant must be 100% privately owned, controlled and operated

The principal place of business must be in Bangladesh.

The project must be financially, economically and commercially viable.

If the borrower is unable to provide collateral security but can arrange 02(two) personal guarantors [

01(one) third party + 01(one) Family member and guarantors should be subject to the same credit

assessment as made for the principal borrower and acceptable to the bank], he may avail certain

amount of term loan. However, the loan amount is to be fixed as per Banks own policy.

If the borrower is able to provide collateral security, guarantors requirement may be relaxed on the

basis of banker customer relationship and case to case basis. Successful track record and good credit

history will get advantage.

Security/Collateral-

o Valid trade license of the applicant along with 2 years old trade license preferable.o Registered partnership deed (In case of partnership firm).o Copy of Memorandum and articles of association, certificate of incorporation duly

certified by RJSC and Board resolution, List of latest directors attested by MD/CEO in

case of private limited company.

o Attested copy of passport/national voter ID/ citizenship certificate from wardcommissioner/Up chairman of the proprietor / partners/directors.

o Photograph of the proprietor/partners/a/c signatory attested by the applicant andverified by the relationship manager.

o Deposit a/c statements for latest 12 months.o Statement of all loan accounts.o Latest clean/standard CIB report.o Net worth statements of all borrowers and guarantors.o Rental/lease/possession deed as applicable.o Drug/Homeopathic/Explosive/BSTI/Import/Import license as applicableo Clearance certificate from Department of Environment if applicableo Original title deed(s) of the property along with the related documents in original such

as Bia-Deeds, Mutation, DCR, CS/RS/SA Khatian, up to date Khajna Receipt, Non-

Encumbrance Certificates etc.

o Others as applicable in compliance with the policy of the Bank.

Insurance-

Fire & Other insurance coverage as applicable


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Interest rate-

The interest rate is subject to change based on the market conditions and policy of the

Bank.

Penal interest rate-

1 % higher over the prescribed rate on overdue amount or as per policy of the Bank.

Other fees & Charges-

As per policy and scheduled charges of our Bank.

Interest applied-

Monthly rest basis

Tenure of the loan-

Maximum 09 (Nine) months.

Repayment method-

Service interest on monthly basis.

Entire outstanding loan amount will be repaid on or before the expiry date of the loan.

Term Loan:

Industrial / Manufacturing Project 14.00%

Other Term Loans 14.00%

Working Capital Financing:

Industrial / Manufacturing Project 14.00%

Work Order / Supply Order 15.50%

Export Loan (PC) 7.00%*

Trade Financing/Business Loans 15.50%

Import financing of rice, oil, etc. 14.00%


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Interest rate structureMBLs interest structure on working capital depends on various current banking industry norms and

business trends. Major macroeconomic variables are also considered in determining interest rate. MBL

normally charges 14%- 15% interest rate on working capital. The rate may be adjusted on the basis ofmoney market condition and call money rate. And yet, it should be borne in mind that rate of interest in

the reflection of risk in the transaction. The higher the risk, the higher is the interest rate.

Other aspects of interest rate

Interest on various lending categories will depend on the level of risk and type of

security offered.

Interest may be reviewed at least once in 6 month and more often when appropriate

fixed interest rate should be discouraged.

All rates should vary with cost of funds fluctuation based on a spread of profit.

Effective yield can be enhanced to the extent the borrowers are required to

maintain deposits to support borrowing activities.

Yield should be further improved by commitment fee and Service charges where

possible.

All pricing of loans should however have relevance with the market condition and be

approved by the Executive committee / Managing Director from time to time.

Where repayment and interest servicing performance of a credit deteriorates it shall be

identified at an early state and closely monitored in order to avoid loan losses.

Other charges

Except the interest rate the bank, in occasions, charges accidental fees like the following:

Overdue charge (Time nonpayment): the bank charges punitive fees to a customer if

he fails to pay due installment payment within a stipulated date. The rate of this

punitive fee widely varies depending on the quantum of the payment and the period

of time for which the amount remains unpaid. MBL, however, strongly demotivates

such kind of deeds.

Parcelcharge: The bank charges a fee for parcel transaction by a customer.


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The Effective Interest Rate:

The effective interest rate, effective annual interest rate, annual equivalent rate (AER) or simply

effective rate is the interest rate on a loan or financial product restated from the nominal interest rate

as an interest rate with annual compound interest payable in arrears.

It is used to compare the annual interest between loans with different compounding terms (daily,

monthly, annually, or other). The effective interest rate differs in two important respects from the

annual percentage rate (APR):

1. the effective interest rate generally does not incorporate one-time charges such as front-end

fees;

2. the effective interest rate is (generally) not defined by legal or regulatory authorities (as APR is

in many jurisdictions).

By contrast, the effective APR is used as a legal term, where front-fees and other costs can be included,

as defined by local law.

Annual percentage yield or effective annual yield is the analogous concept used for savings or

investment products, such as a certificate of deposit. Since any loan is an investment product for the

lender, the terms may be used to apply to the same transaction, depending on the point of view.

Effective annual interest or yield may be calculated or applied differently depending on the

circumstances, and the definition should be studied carefully. For example, a bank may refer to the yield

on a loan portfolio after expected losses as its effective yield and include income from other fees,

meaning that the interest paid by each borrower may differ substantially from the bank's effective yield.

Calculation:

The effective interest rate is calculated as if compounded annually. The effective rate is calculated in the

following way, where r is the effective annual rate, i the nominal rate, and n the number of

compounding periods per year (for example, 12 for monthly compounding):

For example, a nominal interest rate of 6% compounded monthly is equivalent to an effective interest

rate of 6.17%. 6% compounded monthly is credited as 6%/12 = 0.005 every month. After one year, the

initial capital is increased by the factor (1 + 0.005)12 1.0617.

The yield depends on the frequency of compounding:

Given a collection of pairs (time, cash flow) involved in a project, the internal rate of return follows from

the net present value as a function of the rate of return. A rate of return for which this function is zero is

an internal rate of return.


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Effective Interest Rate (EIR) is a special kind of Internal Interest Rate (IIR):

Given the (period, cash flow) pairs (n,Cn) where n is a positive integer, the total number of periods N,

and the net present valueNPV , the internal rate of return is given by r in:

NPV

For Example: Mercantile Banks Initial Expense/investment and Cash Flows-

Year (n) Cash flow (Cn)

2009 -123400

2010 36200

2011 54800

2012 48100

NPV = 0 = - Initial Investment +

+

+

=> 0 = - 123400 + +

+

; at which value of r, the NPV is zero.

By manual Input:

r = 5% ; the NPV= $2,331.99

r = 7%; the NPV = ($2,439.85)

Average NPV = (2,331.99 2,439.85)/2 = 53.93

So, IIR or EIR = (5 + 7)% 2 = 6%


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Bibliography

www.mercantilebank.com

www.en.wikipidia.com

Financial management, I M Pandey (ninth Edition)

www.researchexamples.com/finance/working-capital-management
http://www.dutchbanglabank.com/http://www.dutchbanglabank.com/http://www.en.wikipidia.com/http://www.en.wikipidia.com/http://www.en.wikipidia.com/http://www.dutchbanglabank.com/

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