The Exporter's Working-Capital Choice
Tiruppur Knits has a confirmed order worth ₹1.20 crore from an investment-grade European buyer, payable 90 days after shipment. Production takes 25 days, and the firm needs ₹40 lakh immediately for yarn and job work. Three financing routes are available. (1) Bank packing credit at 9.5% per annum, floating with the repo rate; sanction may take 12 days, so the firm would bridge the first 12 days with its cash-credit overdraft at 11% per annum. (2) The buyer will pay 10 days after shipment instead of 90 days if the exporter gives a 2% discount on the invoice. (3) A bill-discounting firm will discount the shipping documents at 8.2% per annum after shipment. The promoter wants the cheapest reliable funding, not the lowest headline rate. The banker asks for the effective annualized cost of the buyer's discount and a recommendation that accounts for the cash conversion cycle.
1. Calculate the effective annualized cost of the buyer's 2% discount on the funds the firm actually needs. What is the common error in this comparison?
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The discount is 2% of the full invoice, not of the ₹40 lakh financing need. 2% of ₹1.20 crore = ₹2.4 lakh. The buyer's offer accelerates receipt by 80 days: normal payment is 90 days after shipment, the offer is 10 days after shipment. Relative to the ₹40 lakh the firm needs, the cost is ₹2.4 lakh ÷ ₹40 lakh = 6% for 80 days. Annualised: 6% × 365/80 = 27.4%. The common error is to treat the 2% as a two-percent annual rate or to apply it only to ₹40 lakh, which gives 2% × 365/80 = 9.1% and makes the offer look competitive with bank credit. That is wrong because the discount is paid on the whole invoice while only ₹40 lakh of financing is avoided.
2. Compare the cheapest bank/bill route with the discount route. Which is cheaper and by how much? Assume the firm borrows only what it needs and uses bill discounting after shipment.
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Bank/bill route: overdraft for the first 12 days at 11% = ₹40 lakh × 11% × 12/365 = ₹14,466. Packing credit from day 12 to shipment day 25, 13 days at 9.5% = ₹40 lakh × 9.5% × 13/365 = ₹13,534. Bill discounting from day 25 to day 115, 90 days at 8.2% = ₹40 lakh × 8.2% × 90/365 = ₹80,877. Total ≈ ₹1,08,877. Discount route: borrow for 35 days (12 overdraft days plus 23 packing-credit days) = ₹14,466 + ₹23,945 = ₹38,411, plus the ₹2,40,000 discount = ₹2,78,411. The bank/bill route is cheaper by about ₹1,69,534. The discount is expensive because it is charged on the full invoice, while the financing avoided is only ₹40 lakh for 80 days.
3. What non-financial factors and one contract feature should the exporter consider? How would a repo-rate increase affect the choice?
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Non-financial factors include the reliability of the packing-credit sanction, the buyer's credit standing, the bill-discounting firm's recourse terms, and foreign-exchange risk if the invoice is in euros. A contract feature that reduces risk is a cap or fixed rate on the packing credit, or a clause letting the exporter switch to bill discounting without penalty. A repo-rate increase raises the floating packing-credit cost, but the rate would have to rise far above 9.5% to make the 27.4% effective discount attractive; the ranking is robust unless bank credit becomes unavailable. The bigger risk is sanction delay, which is why the 12-day overdraft bridge and a backup bill-discounting line matter. Do not take the discount merely because 2% looks small.