Today I am covering a very important provision in bank credit (working capital limit) which almost 100% of the people (even CAs and senior bankers) treat wrongly.
Generally banks will compute drawing power (DP) in a cash credit/overdraft account by taking into consideration book debts outstanding upto 90 days. I think this concept is clear to everyone.
But, almost everyone does a mess with the concept of security viz-a-viz the computation of DP. You are all aware that banks stipulate book debts as primary security against CC/OD limit. But most of the people confuse security with DP. DP computation is different from security against the limit.
Please mind that all book debts of the entity are security and not just those outstanding for upto 90 days. But almost all the bankers confuse and wrongly stipulate under security clause as follows:
“Primary security- book debts/receivables outstanding for a period not exceeding 90 days”.
If this would be the case, the bank would have no right over the realization proceeds of those debtors which were outstanding for a period exceeding 90 days. In such case, if the account turns bad, a fraudulent customer may wilfully keep all his debtors outstanding beyond 90 days and subsequently realize them so that the bank has no right over the proceeds.
Instead, the banker should stipulate two separate clauses in sanction:
- Under security clause, he must write- “Primary Security- book debts/receivables of the firm, both present and future”
- And under general terms & conditions, he must write- “For DP calculation, book debts outstanding for a period not exceeding 90 days shall only be considered”
The same mistake is committed by professionals while preparing the proposal for submission to the bank. They show under security only those debtors outstanding for upto 90 days thus deteriorating the security coverage ratio. Entire debtors must be shown under security for favourable presentation of the proposal.
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