Vinu: Hi Manu, I have a question about how banks apply margin on the Current Assets (CA) like inventory and receivables when computing Drawing Power (DP) in Cash Credit (CC) accounts. Can you help me understand?

Manu: Of course, Vinu! When it comes to DP in CC accounts, banks apply a margin on CA, which includes inventory (finished goods) and receivables. This margin acts as a buffer or collateral for the bank to cover potential risks. They calculate a certain percentage of the value of these assets and deduct it while determining the available DP.

Vinu: That makes sense. Now, I'm curious about how banks ensure that the inventory on hand doesn't include any unpaid stock, such as suppliers' credit. How do they identify this?

Manu: Banks usually rely on the documentation provided by the borrower to determine if the inventory includes any unpaid stock. They review invoices, purchase orders, and other records to establish the existence and ownership of the inventory. Additionally, they may verify the supplier's credit terms and payment history to ensure there are no outstanding liabilities related to the inventory.

Vinu: I see. And what about checking the genuineness of receivables during the cover period? How do banks go about doing that?

Manu: Banks employ various methods to assess the genuineness of receivables during the cover period. Here are some common practices:

First, they review the invoices issued to customers to ensure they are properly documented and aligned with standard accounting practices. They also perform an aging analysis to determine the average collection period and compare it with industry standards or the borrower's historical performance.

Furthermore, banks may reach out to select customers directly or through third-party confirmations to verify the existence and authenticity of outstanding receivables. They also consider the borrower's payment history and track record with customers, as well as any credit insurance or guarantees obtained for the receivables.

Vinu: That's helpful, Manu. It seems like there are several checks and verifications involved to ensure the accuracy of the inventory and receivables. Thank you for explaining it so clearly!

Manu: You're welcome, Vinu! I'm glad I could help. Indeed, banks take these measures to mitigate risks and ensure the accuracy of the borrower's financial position. If you have any more questions, feel free to ask. If you're interested in delving deeper into this fascinating subject or exploring other aspects of finance, I recommend checking out online courses of CA Raja Classes. They offer a wide range of courses under Banking & Finance. Explore & Enroll - Credit and Financial Analysis Mastery Bundle (SME & Corporate Credit) Keep learning and growing! Good luck on your journey!