Islamic Banking Way

33B (i) PRACTICAL APPLICATION

a) How to calculate sale price and monthly instalment for fixed profit rate financing?


Using EXCEL formula as per Table 1 , you can calculate the sale price and also the monthly instalment. The formula is typed under column G12 in Table 2.

Table 1 - Calculation Formula

The BBA amortization table as per Table 2 must have column for original purchase price, deposit, amount financed, profit rate, financing period in no. of years, financing period in no. of months (x 12) and the monthly instalment column. The result will be as follows:-

Original Purchase Price :  MYR 100,000.00

Deposit : MYR 20,000.00 (20% down payment)

Amount Financed : MYR 80,000.00

Monthly Instalment : MYR 7,033.27 (using formula Table 1)

Unearned Income : MYR 4,399.25 (profit to Bank or termed as unearned income)

Total Sale Price : MYR 84,393.25

Table 2 - Amortization Table
 
 

Formula to calculate monthly profit is as follows:

1. Monthly profit  : Outstanding principal amount (H18 or 80,000) x profit rate (G9 or 10.00) x Days in the month (D19 or 31 ) divide by 36500 = 679.45 for month 1. To calculate reducing principal amount or cost (iv), take monthly instalment of 7,033.27 minus profit of 679.45 equal to 6,353.82.
2. On line 30, there is extra payment that goes to principal portion (credit 19.20). Since the total sale price is MYR 84,399.25, you can transfer the balance in credit to profit on the final month so the sale price balance will be zerorized.
3. You can copy the formula down all through line C-J18 and C-J30 but make sure you key-in dollar symbol for column   [ $G$9  ] since the profit rate is a fixed constant.

The above tables can be used for manual calculation of profit where income recognition is on cash basis. For cash accounting, the calculation of profits is very straight forward i.e. calculate when you received the payment. 

However, it should be noted that MOST Islamic banks now are using accrual income recognition method where profits shall continue to be calculated (must use system) on the outstanding principal balances bu the UNPAID PROFITS CANNOT BE COMPOUNDED.

Under conventional term loan, whenever monthly instalment is overdue, the unpaid interest portion will be compounded as principal amount (we will show some example in later part of this section)

(b) How to calculate sale price and monthly instalment for FLEXI financing rate structure.

Under Flexi structure, the sale price is also calculated based on fixed profit rate but the pricing is structured where the profit rate is calculated using combination of two (2) pricing components i) BFR - base financing rate; and plus ii) credit spread.

For example, if the BFR is 6.0% and the credit spread is 4.0%, the fixed profit rate to calculate the sale price is 10.0% per annum (known as CPR - contracted profit rate). There is no limit on the credit spread but normal maximum credit spread offered in the market (applicable to Malaysia) is about 4.0% per annum. 

To calculate actual profit , the bank will use EPR (effective profit rate) comprising BFR and agreed credit spread of say, 1-2% per annum (which is normally benchmark against conventional loan in order for the Islamic bank to remain competitive).

One advantage under this structure (which is similar to method (a)), the sale price (based on CPR-contracted profit rate) is also fixed thus, in term of pricing, it is better than the variable interest rate pricing under conventional loan.

On maturity of the financing facility (in most situation), the principal portion will be repaid earlier compared to the (i) unearned income; and (ii) the sale outstanding amount. To close the account, the unearned income need to be rebated (reverse) to zerorise the outstanding sale price (principal balance + balance of unearned income)

To have better understand of the above, let's examine Table 3 below.:

Table 3

Based on Table 3, details of the calculation are as follows:

Amount Financed : RM 100,000.00

Monthly Instalment : RM 3,133.64 (based on EPR)
Unearned Income : RM 16,161.87
Total Sale Price : RM 116,161.87
Flexi Pricing (fixed rate) : BFR 6.0% + 4.0% = 10.0 % per annum
Effective Profit rate (EPR) : 8% p.a. (Y1), 7.75% p.a. (Y2) and 7.50% p.a. (Y3)
Rebate on maturity : RM 3,627.73


(c) Calculation of Sale Price using Flat Rate formula (or Rule 78)

The formula used in computing the monthly installment (if calculation is done manually) as follows:

R = P + (P + I x N)
       ---------------
               N x 12

where   R =  Monthly Installment Payment
            P =  Financing Amount
            I  =  Agreed profit rate
            N =  Financing period

For example

Financing Amount (purchase price) = RM100,000
Financing Period                            =  2 years
Agreed Profit rate                          =  5.0% flat p.a.

Applying the formula:

Monthly Installment =  RM 100,000 + (RM 100,000 x 0.10 x 2)
                                   ------------------------------------------
                                                     2 x 12

                               =  RM 100,000 + RM 10,000
                                   -----------------------------
                                                  24

                                = RM 4, 583.33
                                   ==========


Profit earning calculation:

i) Under Rule of 78 profit earning method, we need to use a formula to calculate the factor that we will use to determine the profit earned for the month out of the total unearned income (i.e.profits due to the Bank).

Formula to calculate factor = 24 x (24+1)/2 = 24 x 25 = 600/2 = 300


Table 4 - Flat Rate %

ii) To calculate the profit profit, we need to calculate the rebate for the remaining months using the following formula:

Every month, similar formula is used to calculate monthly profit. The only changes need to be done is the remaining months.

iii) Profit for the month, for this example; month 1  shall be RM 10,000 - RM 9,200 = RM 800.00

One interesting about flat profit rate calculation is that the above 5.0% p.a. flat profit calculation is actually 9.73% per annum. So, when one wanted to seek financing, always ask whether the profit is calculated on flat rate basis or on monthly rest basis. Simple calculation to determine the effective rate is using this formula

        Profit                                  No. of Days in a Year

-------------------    x   100  x   ----------------------

Financing Amount                       No. of Days in a month

  RM800.00                                    365

-----------------       x  100  x     ------------    = 9.73

RM 100,000.00                              say, 30

There is another profit rate calculation method known as multi-tier profit rates but for this blog, the Writer will not show any example, as the above three (3) profit calculation methods are considered sufficient for the readers to understand on how bank calculates profits on its financing account or loan as known under conventional banking.

The issue here, how or when the profit calculation formula come about? Was it during Prophet Muhammad time or during the time of the shahabat or is it based on conventional formula interest calculation? The obvious answer is that the Islamic banks are using the same formula to calculate their profits. Of course, the Musharakah and Mudharabah financing profit calculation is an exception and we will examine the profit calculation method once we discuss on that subject matter.

We need to answer issues on why Shaikh Imran N. Hosein said that Islamic banks are operating "back-door riba" and why Shiekh Umar Vadillo, known as the father of modern day Islamic gold dinar said that Islamic banking is "triple riba". There are also hadiths that said that it will come a time when modern era Muslim, will find a way to make the riba halal!  Astaqfirullah ! We hope and pray we are not in that era mentioned!  

We shall not discuss the above issues mentioned now but Insha'Allah, we will touch on these issues at later session.

ALLAH KNOWS BEST.