Very important calculation limits of LC

Calculation of limit of Letter of credit:


It can be worked out on the basis of following:


 Average amount of LC - It depends on monthly consumption of the material to be purchased under LC and economic order quantity (EOQ). EOQ depends upon the source of supply, means of transport etc. EOQ is larger for imports compared with the domestic material.

Frequency of opening of LC - After fixing EOQ, the no. of LCs to be opened within one year can be calculated as : Annual consumption / EOQ. Frequency = 12 / no. of LC to be opened in one year.

Amount of LCs outstanding at one point of time - Outstanding time for an LC is based on

the Lead Time (date of LC to date of shipment) + transit time + usance period from date ofa receipt of goods.

If frequency of opening of LC is less than this, bank will have more than one LC outstanding at one point of time.

Calculation : Assume the following:

Lead time = 20 days, transit time =10 days and usance period = 6 m. Total time = 7 months.

Total annual consumption = Rs.6 cr, EOQ = Rs.i. cr.

On the basis of these assumptions :

No. of Les = 6/1 = 6 and Frequency of opening LC will be every 2 month. (12 / 6).

No. of LC outstanding at any point of time = 7 1 2 = 3.5 (rounded to 4).

Limit = Rs.x cr x 4 = Rs.4 cr (amount of one LC based on EOQ x no. of LC to outstand)