Letter of Credit

Letter of Credit

I have received about 130 requests about from various bankers to have a lesson on methodology followed while fixing the LC Limit

— To fix the limit we have to find out following

1) Average amount of each LC - This depends on monthly consumption of RM/Goods & the economic ordering quantity.EOQ is estimated by examining the sources of supply, means of transportation, discount, management policies etc. For imported goods EOQ is always higher /larger compared to domestic supplies of goods(Containers).

2) Frequency of LC opening- The number of LCs to be opened in a year can be determined by dividing the Total Consumption by EOQ. The Frequency of opening LCs in a year will be = 12/The number of LCs to be opened.

3) How many LCs will be outstanding at a particular time ;- The time taken for one LC to remain in force depends upon the Lead time time = Time taken to open the LC to the shipment of goods+the transit time + usance available to purchaser from the date of receipt of goods. If the frequency of opening the LCs is less than this period, then more than one LC will remain outstanding at any point of time .

FIXING LC limit
Suppose Lead time for opening LC is 10 days,transit time 45 days, the ship has to be birthed for 15 days ,usance period is 120 days. Consumption of Imported Raw material is 80% .Total annual Consumption of RM is 12.5 Crores . EOQ Rs2.5 cr. Find Import LC limit

• The total RM imported a=Annually= 80% of 12.5Cr=Rs.10Cr

• The LC remain outstanding for a period of =

10+40+10+ 120=180 days ie 6.00* months

— Consumption of goods is Rs.10 crores & EOQ is Rs 2.5Cr

— The number of lcs to be opened = Consumption/EOQ 10/2.5=4

— The frequency of opening LCs = 3** months ! (12/4)

— Thus at any time outstanding number of LCs will be=6*/3**=2

— The Import Limit sanctioned for LC = 2 2.5 =Rs5 Crore.
I have sent a simple and small lesson in view of your engagement.

Waman Gokhale
7350901500
waman.gokhale @gmail.com