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Principles of Musharakah and Mudarabah

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Published: Mon, 04 Sep 2017

Musharakah and Mudarabah written in the books of Islamic fiqh generally means contracts which are formed for starting a joint venture in which all partners participate in the business from starting till end when assets are liquidated. The books of Islamic fiqh were written in an environment when there were only small trades and no large scale businesses took place. The principles of Musharakah and Mudarabah can be applied to small as well as large scale commercial enterprises. The basic principles of Musharakah and Mudarabah are as follows:

  1. Musharakah and Mudarabah financing is not interest based
  2. Financier /investor must share loss to the extent of their investment
  3. Profit is distributed according to the agreed ratio with their mutual consent, but the sleeping partner can’t claim more than the ratio of his investment
  4. Loss suffered by partner is exactly according to the proportion of his investment

For financing a project, the traditional method of Musharakah and Mudarabah can be easily applied. If a Financier wants to finance the whole project, he can use Mudarabah financing and if some parties want to finance the project jointly, they can adopt Musharakah financing.

It is very easy to evaluate the capital if the Musharakah or Mudarabah have been effected since inception of the project. In case of Musharakah if any partner wants to withdraw from the business, the other partners can purchase his share at an agreed ratio. The partner can thus either fully own the business on his own or can sell the share of the partner who withdrew his capital to other person who can substitute the withdrawing financier

Securitization of Musharakah

Musharakah financing can be securitised easily, in case of big projects a huge sum is required which a few people can’t afford. Every person investing is given a Musharakah certificate which represents the amount of money he has invested in business. After the start of the business and buying non liquid assets, the certificates can be treated as negotiable instruments which can be sold in the secondary markets. However, if all the assets of Musharakah are in liquid form, buying and selling of these certificates is not allowed because as all the assets are in liquid form and exchange of such assets means exchanging money for money, and for exchanging money for money both must be equal. Access from any side is Riba, which is prohibited in Islam

In case if the money invested is invested in non-liquid assets as land, machinery etc. the Musharakah certificate will represent the portion of ownership in those Assets. In this of assets being in non-liquid form, it will be allowed by the shari’ah to sell certificates in the secondary market on any price agreed upon by the parties with their mutual consent

In case the assets in the business are a mixture of liquid and non-liquid assets most of the schools of thoughts including shafi”i have allowed trading only if the size of non-liquid assets in the whole business is more than 50%. However, if the Hanafi view is adopted, transaction if valid even if the non-liquid assets are less than 50% but the amount must be greater than liquid assets and non-liquid assets must not be negligible

Financing of a single transaction

The principles of Musharakah and Mudarabah can be easily used for financing a single transaction. It can be applied for fulling day to day needs of small traders as well as for import and export transactions. An importer can approach financier for financing him for importing goods for a single transaction. Banks can also finance for importing goods. If the letter of credit has no restrictions, Mudarabah can be followed and if the letter of credit has restrictions, Musharakah suits for such case. After selling the imported goods, the sales proceed can be shared by the financier and the imported on an agreed ratio

When finance is required for working capital of a already running business, the principles of Musharakah can be applies in the following ways

Before investing in the running business the capital of the business can be evaluated by the mutual consent. As according to Imam Malik, non-liquid assets can also form a part of capital so, this view can be applied here. The value of the already running business will be the share of one partner and the amount of investment by the financier will be his share. The profit given to the financier is agreed upon by both the parties which should not exceed the amount of his investment. The Musharakah can be for a limited period of time like 6 months, one year, two years, after the completion of the term both the liquid and non-liquid assets are evaluated again and profit may be distributed on the basis of evaluation

Sharing of gross profit

Financing by the method above can be very difficult in case the business is big and has large number of fixed assets, because the valuation of the assets, their appreciation or depreciation may create accounting problems which can cause disputes among partners. In this case Musharakah may be applied in another way

In this scenario, difficulty arise due to calculation of indirect expenses like salary of staff, depreciation of machinery etc. For solving such problem only direct expense like raw material, labour, etc. Shall be borne by the Musharakah. It means all the indirect expenses shall be borne by the industrialist and instead of net profit, gross profit shall be shared among the partners. In order to compensate the industrialist, the percentage of his profit may be increased

Running musharakah account on the basis of daily products

Most of the financial institutions finance working capital by opening a running account from where the client draws the money at different intervals and returns surplus money. This process of credit and debit goes on and up to date of maturity. interest is calculated on the basis of daily products

For making such arrangement possible for Musharakah Financing, following procedure may be suggested

  1. A portion of the actual profit must be used for management of the business
  2. A portion of the profit must be used for paying the investors
  3. Loss must be borne by the investor in the exact ratio of their investment in the business
  4. The average of the contribution made to the musharakah account on daily basis must be treated as the share capital of the financier
  5. Profit earned at the end of the term must be calculated on daily product basis, and must be distributed among the partners accordingly

If parties allow such arrangement, it does not seem to violate any principles of Musharakah However, this needs to be looked into by the experts of Islamic jurisprudence. Practically, it means the parties have agreed to the principle that the profit earned at the end of the agreed time will be divided by the capital utilized per day. Which will lead to average of money earned on daily. The amount of money earned per day will then multiplied by the total number of days the money is invested by the partner for the calculation of his actual profit

Some of the scholars do not allow this method as this method does not reflect the calculations of the actual profit earned by a partner of the Musharakah. The business may have earned a huge profit during the time a partner had no investment at all or share of his investment would be negligible but he will be paid at par with the other partners who had invested a huge sum of money. Similarly, the business may have suffered a great loss when a particular partner had invested huge amount of money and he will pass on loss to the other partner’s despite of their no investment during the loss or having invested negligible amount of money

The answer to the argument is that it is not necessary for the partners in Musharakah that they earn profit on the amount of their investment only. Once the Musharakah takes place the profit earned by the business are earned by all the partners’ despite whether their money in invested in the business or not. This is generally true for the Hanafi school of thought,  which does not make it necessary for a Valid Musharakah that the money invested by the partners are together mixed up


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