Financing of Working Capital

The capital of the running business may be evaluated with the mutual consent. It is already mentioned while discussing the traditional concept of musharakah that is not necessary, according to Imam Malik, that the capital of the musharakah is contributed in cash form. Non-liquid assets can also form part of the capital on the basis of evaluation. This view can be adopted here. In this way, the value of the business can be treated as the investment of the person who seeks finance, while the amount given by the financier can be treated as his share of investment. The musharakah may be effected for a particular period, like one year or six months or less. Both the parties agree on a certain percentage of the profit to be given to the financier which should not exceed the percentage of his investment, because he shall not work for the business. On the expiry of the term, all liquid and non-liquid assets of the business are again evaluated and the profit may be distributed on the basis of this evaluation.

Although, according to the traditional concept, the profit cannot be determined unless all the assets of the business are liquidated, yet the valuation of the assets can be treated as “constructive liquidation” with mutual consent of the parties, because there is no specific prohibition in Shar’iah against it. It can also mean that the working partner has purchased the share of the financier in the assets of his business, and the price of his share can be determined on the basis of valuation, keeping in view the ratio of the profit allocated for him according to the terms of the musharakah. For example, the total business of the value of A is 30 units. B finances another 20 units, raising the total worth to 50 units;
40% having been contributed by B, and 60% by A. It is agreed that B shall get 20% of the actual profit. At the end of the term, the total worth of the business has increased 100 units.

Now, if the share of B is purchased by A, he should have paid to him 40 units, because he owns 40% of the assets of the business. But in order to reflect the agreed ratio of profit in the price of his share, the formula of pricing will be different. Any increase in the value of business shall be divided between the parties in the ratio of 20% and 80%, because this ratio was determined in the contract for the purpose of distribution of profit. Since the increase in the value of the business is 50 units, these 50 units are divided at the ratio of 20-80, meaning thereby that 10 units will have been earned by B. These 10 units will be added to his original 20 units, and the price of his share will be 30 units.
In case of loss, however, any decrease in the total value of the assets should be divided between them exactly in the ratio of their investment, i.e., in the ratio of 40/60. Therefore, if the value of the business has decreased, in the above example, by 10 units reducing the total number of units to 40, the loss of 4 units shall be borne by B (being 40% of the loss). These 4 units shall be deducted from it’s original 20 units, and the price of his share shall be determined as 16 units.

       Sharing in the Gross Profit Only

Financing on the basis of musharakah according to the above procedure may be difficult in a business having a large number of fixed assets, particularly in a running industry, because the valuation of all its assets and their depreciation or appreciation may create accounting problems giving rise to disputes. In such cases, musharakah may be applied in another way.

The major difficulties in these cases arise in the calculation of indirect expenses, like the depreciation of the machinery, salaries of the staff etc. In order to solve this problem, the parties may agree on the principle that, instead of net profit, the gross profit will be distributed between the parties, that is, the indirect expenses shall not be deducted from the distributable profit. It will mean that all the indirect expenses shall be borne by the industrialist voluntarily, and only direct expenses (like those of raw material, direct labour, electricity etc.) shall be borne by the musharakah. But since the industrialist is offering his machinery, building and staff to the musharakah voluntarily, the percentage of his profit may be increased to compensate him to some extent.

This arrangement may be justified on the ground that the clients of financial institutions do not restrict themselves to the operations for which they seek finance from the financial institutions. Their machinery and staff etc. is, therefore, engaged in some other business also which may not be subject to musharakah , and in such a case the whole cost of these expenses cannot be imposed on the musharakah.

Let us take a practical example. Suppose a ginning factory has a building worth Rs. 22 million, plant and machinery valuing Rs. 2 million and the staff is paid Rs. 50,000/- per month . The factory sought finance of Rs. 5,000,000/- from a bank on the basis of musharakah for a term of one year. It means that after one year the musharakah will be terminated, and the profits accrued up to that point will be distributed between parties according to the agreed ratio.
While determining the profit, all direct expenses will be deducted from the income. The direct expenses may include the following:
(1). The amount spent on purchasing raw material.
(2). The wages of the labour directly involved in processing the raw material.
(3). The expenses for electricity consumed in the process of ginning.
(4). The bills for other services directly rendered for the musharakah.

So far as the building, the machinery and the salary of other staff is concerned, it is obvious that they are not meant for the business of musharakah alone, because the musharakah will terminate within one year, while the building and the machinery are purchased for a much longer term in which the ginning factory will use them for it’s own business which is not subject to this one-year musharakah . Therefore , the whole cost of the building and the machinery cannot be borne by this short-term musharakah.

What can be done at the most is that the depreciation caused to the building and the machinery during the term of the musharakah is included in its expenses. But in practical terms, it will be very difficult to determine the cost of depreciation, and it may cause disputes also. Therefore, there are two practical ways to solve this problem. In the first instance, the parties may agree that the musharakah portfolio will pay an agreed rent to the client for the use of the machinery and the building owned by him. This rent will be paid to him from the musharakah fund irrespective of profit or loss accruing to the business.

The second opinion is that, instead of paying rent to the client, the ratio of his profit is increased. From the point of view of Shar’iah, it may be justified on the analogy of mudarabah in services which is allowed in the view of Imam Ahmad bin Hanbal.