Abhinav Project Report

8/9/2019 Abhinav Project Report

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NMIMS University School of Business Management

V. L. Mehta Road, Vile Parle (West), Mumbai- 400056

Declaration

I hereby declare that the report on TRADE FINANCE that has been submitted to NMIMS

University School of Business Management and Bank of India, Sion (west), Mumbai towards

Partial Fulfillment of my Master of Business Administration Programme is my original andbonafide work

I also certify that to the best of knowledge and beliefs this work has not been worried out another

person or group of person or an

organization as a whole.

Ankita Agarwal

Project Report on[Type the document subtitle]

[Type the abstract of the document here. The

abstract is typically a short summary of thecontents of the document. Type the abstract ofthe document here. The abstract is typically ashort summary of the contents of the document.]

Punit[Pick the date]

Project Report onTRADE FINANCE carried at

[Relationship Beyond Banking]

Branch Office :MALAD (W),MUMBAI

2010

SUBMITTED BY: CORPORATE GUIDE:

ABHINAV KUMAR Mr.

M.V.RANGNEKAR

MBA,NMIMS. Chief Manager(Officiating),

BOIMALAD WEST

FACULTY GUIDE :


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ACKNOWLEDGEMENT

At the very onset, I must express my profound gratitude to Chief Manager - Mr.M.V.Rangnekar

who has given me an opportunity to carry out this project work.

I wish to express my deep sense of gratitude to my Guide, Ms. S. Nigudkar, Manager (Credit)

for his able guidance and useful suggestions, which helped me in completing the project work, in

time.

Words are inadequate in offering my thanks to the Project Trainees and Project Assistants, BOI

for their encouragement and cooperation in carrying out the project work.

I would like to express my sincere gratitude to my college for allowing me to do this project with

sufficient time.

Finally, yet importantly, I would like to express my heartfelt thanks to my beloved parents for

their blessings, my friends/classmates for their help and wishes for the successful completion of

this project.

Abhinav Kumar

2

NARSEE MONJEE INSTITUTE OF MANAGEMENT STUDIES,VILE


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EXECUTIVE SUMMARY

Banking Industry which is basically my concern industry around which my project has to be

revolved is really a very complex industry.

I am Abhinav Kumar. I did my summer training with Bank of India (www.bankofindia.com)

from April 12, 2010 to June 04, 2010.

I was assigned the task of analyzing the credit health of organizations that approach Bank of

India for credit facilities. After analyzing credit health, the credit rating is determined. On the

basis of credit rating, the interest rate guidelines circular is consulted to fix a price for the credit

facilities i.e. determine the interest rate. This would entail analysis of past and present financial

statements, Balance Sheet, Cash Flow Statements, examination of Profitability statements,

projected financial statements and CMA data.

After doing this study learned that the financial health and credit rating are theoretical methods

for determining the right interest rate. However, in practice, banks consider other factors such as

history with client, market reputation and future benefits with clients. Thus, a difference exists

between theory and practice.

I learnt a lot during the project. Firstly it provided me much needed corporate exposure (working

with team, business communication, prioritizing work). Though we are continuously given inputs

on soft skills and business communication during our program; but there is no better place to

hone these skills than the workplace.

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http://www.bankofindia.com/http://www.bankofindia.com/


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TABLE OF CONTENT

ACKNOWLEDGEMENT

EXECUTIVE SUMMARY

CHAPTER 1-INTRODUCTION TO THE INDUSTRY

1.1 BANKING INDUSTRY IN INDIA5

1.2 OVERVIEW OF BANK OF INDIA5

1.3 BANK OF INDIA7

1.4 PERFORMANCE HIGHLIGHTS FOR BANK OF INDIA9

CHAPTER 2- WORKING CAPITAL FINANCING (CREDIT DEPARTMENT)

2.1 PROJECT OBJECTIVE10

2.2 INTRODUCTION TO WORKING CAPITAL FINANCING10

2.2.1 ESTIMATING WORKING CAPITAL NEEDS14

2.2.2 WORKING CAPITAL LIMITS20

2.2.3 LOAN ASSESMENT21

2.3 METHODOLOGY22

2.4 SCHEDULE23

2.5 SCOPE OF STUDY23

2.4 LIMITATIONS23

CHAPTER 3-PROPOSAL

3.1 PENGUIN ELECTRONICS INDUSTRIES24

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3.2 COMPANY REQUEST26

3.3 COMMENTS IN BRIEF ABOUT FINANCIAL POSITION OF THE COMPANY29

3.4 ASSESMENT AND JUSTIFICATION OF PROPOSED LIMITS31

ANNEXURE

BIBLIOGRAPHY

AUTHORS PROFILE

CHAPTER 1-INTRODUCTION TO THE INDUSTRY

Banking Industry In India

There have been major structural changes in the financial sector since banking sector reforms

were introduced in India in 1992. Since then Banks have been lending aggressively providing

funds towards infrastructure sector. Major policy measures include phased reductions in statutory

pre-emption like cash reserve and statutory liquidity requirements and deregulation of interest

rates on deposits and lending, except for a select segment. The diversification of ownership of

banking institutions is yet another feature which has enabled private shareholding in the public

sector banks, through listing on the stock exchanges, arising from dilution of the Government

ownership. Foreign direct investment in the private sector banks is now allowed up to 74 per

cent.

The co-existence of the public sector, private sector and the foreign banks has generated

competition in the banking sector leading to a significant improvement in efficiency and

customer service.

Overview of Bank of India

Background

Bank of India was founded on 7th September, 1906 by a group of eminent businessmen from

Mumbai. The Bank was under private ownership and control till July 1969 when it was

nationalized along with 13 other banks.

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Beginning with one office in Mumbai, with a paid-up capital of Rs.50 lacs and 50 employees, the

Bank has made a rapid growth over the years and blossomed into a mighty institution with a

strong national presence and sizable international operations. In business volume, the Bank

occupies a premier position among the nationalized banks.

Manpower is the key factor for the success of any organization. Bank of India has a dedicated

family of about 40155 qualified / skilled employees who will and always will be delighted to

extend their services to the customers with heartfelt efforts. The Bank is a Public Sector Unit

with 64.47% Share Capital held by the Government of India. The Bank came out with its Initial

Public Offer (IPO) in 1997. Presently 35.53 % of Share Capital is presently held by Institutions,Individuals and Others.

The Bank has over the years earned the reputation of being a techno-savvy Bank and is one of

the front runners amongst public sector bank in the field of technology. It is one of the pioneer

public sector banks, which have Core Banking Solution implemented in 2593 branches covering

95.6%of domestic business mix. Banks revamped web-site using latest Next Generation Web

2.0 technology was launched. Around 35000 ATMs made available to our card holders through

owned as well as shared ATMs network. SMS alerts for cheque book request and any debits in

accounts through any of the delivery channel like ATM, Internet Banking provided to all

customers. Solar Power System implemented at 143 locations to overcome acute power shortages

and erratic power supply as well as Banks commitment towards Go Green.

Overview of Bank

Items 2006-07 2007-08 2008-09

Business Mix 206673 264805 334440

Deposits 119882 150012 189708

Advances 86791 114793 144732

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Table 1:Overview of Bank

1.3 BANK OF INDIA

VISION

To Become The Bank Of Choice For Corporates, Medium Business AndUpmarket Retail Customers And Developmental Banking For Small Business,Mass Market And Rural Markets

MISSION

To provide superior banking service to niche markets globally, whileproviding cost effective, responsive service to others in our role as a

development bank, and in doing so, meet the requirements of ourstakeholders.

QUALITY POLICY

We ,at Bank Of India , are committed to become the bank of choice byproviding SUPERIOR, PRO-ACTIVE, INNOVATIVE, STATE-OF-THE-ART Bankingservices with an attitude of care and concern for the customers and patrons.

BRANCH NETWORK AS ON 31.03.10

Head Office Mumbai Metropolitan628

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Urban 607 Zonal Offices48

Semi Urban 701 Rural

1271

Total 3207 ( Inc.Rep.Office) 29

Extension Counters 57 Total Outlets3264

RISK MANAGEMENT

Basel II preparedness: Bank has migrated to Basel II norms as per RBIguidelines for computation of capital charge from 31.03.08.Steps havebeen initiated in preparation for advanced approaches.

Risk Management Architecture and Risk Management Policies, Toolsand Processes put in place.

Implementation of Credit Risk Management Software Project started.Validation of rating model and migration analysis done on regularbasis.

Stress Testing is carried out on half yearly basis.

CAPITAL ADEQUACY FOR BANK OF INDIA

ADEQUACY OF

CAPITAL

MARCH .

07 Mar-08 Mar-09 Mar-10

Mar-

10

BASEL I

BASE

L II

TIER 1 CAPITAL 5825 9409 12466 13843

1372

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TIER 2 CAPITAL 4667 5303 5745 7255 7218

TOTAL CAPITAL 10492 14712 18211 21098

2094

3

TOTAL ASSETS 141817 178830 225502 274966

2749

66

RISK WEIGHTED 89261 122221 139931 167008

1618

57

CRAR-TIER 1(%) 6.53 7.7 8.91 8.29 8.48

CRAR-TIER 2(%) 5.22 4.34 4.1 4.34 4.46

CRAR(%) 11.75 12.04 13.01 12.63 12.94

1.4 PERFORMANCE HIGHLIGHTS FOR BANK OF INDIA

ANNUAL ANNUAL

Mar-10 Mar-09NET PROFIT 1741.07 3007.35

OPERATING PROFIT 4704.77 5456.8

GROSS NPA(%) 2.85 1.71

NET NPA(%) 1.31 0.44CAPITAL ADEQUACY

RATIO(%)

BASEL I 12.63 13.21

BASEL II 12.94 13.01RETURN ON AVG

ASSETS(%) 0.7 1.49

COST TO INCOMERATIO(%) 43.81 36.18

TOTAL BUSINESS 401079 334440

TOTAL DEPOSITS 229762 189708

GROSS CREDIT 171317 144732

CASA RATIO(%) 32 31AVG COST OF 5.16 5.76

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of employees, to extent the credit to buyers of goods as well as to meetother day-to-day obligations. However the firm can secure part of thesefunds from its own suppliers of raw material and other needed suppliers.Therefore, from the total requirement of funds for the operational purposes,

the credit the firm can obtain from others is deducted; the difference wouldbe the amount of money the firm has to find against the working capitalrequirements.

Ratio Analysis of various factors will be done. With the help of ratio analysisliquidity and profitability of the firm is analyzed.

BALANCED WORKING CAPITAL POSITION

The firm should maintain a sound working capital position. It should haveadequate working capital to run its business operations. Both excessive aswell as inadequate working capital positions are dangerous from the firmspoint of view.

Excessive working capital means holding costs and idle funds, which earnno profits for the firm. The dangers of excessive working capital are asfollows:

It results in unnecessary accumulation of inventories. Thus, chances of

inventory mishandling, waste, theft and losses increase. It is an indication of defective credit policy and slack collection period.

Consequently, higher incidence of bad debts results, which adverselyaffects profits.

Excessive working capital makes management complacent whichdegenerates into managerial inefficiency.

Tendencies of accumulating inventories tend to make speculativeprofits grow. This may tend to make dividend policy liberal and difficultto cope with in future when the firm is unable to make speculative

profits.Inadequate working capital is also bad as it not only impairs the firmsprofitability but also results in production interrupts and in efficiencies andsales disruptions. Inadequate working has the following dangers:

It stagnates growth. It becomes difficult for the firm to undertakeprofitable projects for non-availability of working capital funds.

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It becomes difficult to implement operating plans and achieve the

firms profit target.

Operating inefficiencies creep in when it becomes difficult even tomeet day-to-day commitments.

Fixed assets are not efficiently utilized for the lack of working capitalfunds

Paucity of working capital funds render the firm unable to availattractive credit opportunities etc.

The firm looses its reputation when it is not in a position to honor itsshort-term obligations. As a result, the firm faces tight credit terms.

An enlightened management should, therefore maintain the right amount of

working capital on a continuous basis. A firms net working capital position isnot only important as an index of liquidity but it is also used as a measure ofthe firms risk. Risk in this regard means chances of the firms being unableto meet its obligation on due date. The lenders consider a positive networking capital as a measure of safety. All other things being equal, themore the net working capital a firm has, the less likely that it will default inmeeting it current financial obligations.

DETERMINANTS OF WORKING CAPITAL

Nature of business:

The working capital requirement of the firm is closely related to the nature of

its business. A service firm, like an electricity undertaking or a transportcorporation, which has a short operating cycle and which sells predominantlyon cash basis, has a modest working capital requirement. On the other hand,a manufacturing concern like a machine tools unit, which has a longoperating cycle and which sells largely on credit, has a very substantialworking capital requirement.

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Seasonality of operations:

Firms, which have marked seasonality in their operations usually, have highlyfluctuating working capital requirements. If the operations are smooth andeven through out the year the working capital requirement will be constantand will not be affected by the seasonal factors.

Production policy:

A firm marked by pronounced seasonal fluctuations in its sales may pursue aproduction policy, which may reduce the sharp variations in working capital

requirements.

Market conditions:

The market competitiveness has an important bearing on the working capitalneeds of a firm. When the competition is keen, a large inventory of finishedgoods is required to promptly serve customers who may not be inclined towait because other manufactures are ready to meet their needs. In view ofcompetitive conditions prevailing in the market the firm may have to offer

liberal credit terms to the customers resulting in higher debtors. Thus, theworking capital requirements tend to be high because of greater investmentin finished goods inventory and account receivables. On the other hand, amonopolistic firm may not require larger working capital. It may askcustomer to pay in advance or to wait for some time after placing the order.

Conditions of Supply:

The time taken by a supplier of raw materials, goods, etc. after placing anorder, also determines the working capital requirement. If goods as soon asor in a short period after placing an order, then the purchaser will not like tomaintain a high level of inventory f that good. Otherwise, larger inventoriesshould be kept e.g. in case of imported goods.

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Business Cycle Fluctuations:

Different phases of business cycle i.e., boom, recession, recovery etc. alsoeffect the working capital requirement. In case of recession period there isusually dullness in business activities and there will be an opposite effect onthe level of wor5king capital requirement. There will be a fall in inventoriesand cash requirement etc.

Credit policy:

The credit policy means the totality of terms and conditions on which goods

are sold and purchased. A firm has to interact with two types of creditpolicies at a time. One, the credit policy of the supplier of raw materials,goods, etc., and two, the credit policy relating to credit which it extends to itscustomers. In both the cases, however, the firm while deciding the creditpolicy has to take care of the credit policy o the market. For example, a firmmight be purchasing goods and services on credit terms but selling goodsonly for cash. The working capital requirement of this firm will be lower thanthat of a firm, which is purchasing cash but has to sell on credit basis.

Operating Cycle:

Time taken from the stage when cash is put into the business up to the stagewhen cash is realized.

Thus, the working capital requirement of a firm is determined by a host offactors. Every consideration is to be weighted relatively to determine theworking capital requirement.

Further, the determination of working capital requirement is not once awhole exercise; rather a continuous review must be made in order to assessthe working capital requirement in the changing situation. There are various

reasons, which may require the review of the working capital requiremente.g., change in credit policy, change in sales volume, etc.

ISSUES IN WORKING CAPITAL MANAGEMENT

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Working capital management refers to the administration of all componentsof working capital cash, marketable securities, debtors (receivables), andstock (inventories) and creditors (payables). The financial manager mustdetermine levels and composition of current assets. He must see that right

sources are tapped to finance current assets, and that current liabilities arepaid in time.

There are many aspects of working capital management which make it animportant function of the financial manager.

Time. Working capital management requires much of the financialmanagers time.

Investment. Working capital represents a large portion of the totalinvestment in assets. Actions should be taken to curtail unnecessary

investment in current assets. Criticality. Working capital management has great significance for all

firms but it is very critical for small firms. Small firms in India face asevere problem of collecting their dues debtors. Further, the role ofcurrent liabilities is more significant in case of small firms, as, unlikelarge firms, they face difficulties in raising long-term finances.

Growth. The need for working capital is directly related to the firmsgrowth. As sales grow, the firm needs to invest more in inventories anddebtors. Continuous growth in sales may also require additionalinvestment in fixed assets.

Liquidity vs. Profitability: Risk-Return Trade-off

A large investment in current assets under certainty would mean a low rateof return on investment for the firm, as excess investment in current assetswill not earn enough return. A smaller investment in current assets, on theother hand, would mea interrupted production and sales, because offrequent stock-outs and inability to pay creditors in time due to restrictivepolicy.

Given a firms technology and production policy, sales and demandconditions, operating efficiency etc., its current assets holdings will dependupon its working capital policy. These policies involve risk-return trade-offs. Aconservative policy means lower return and risk, while an aggressive policyproduces higher return and risk.

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The two important aims of the working capital management are: profitabilityand solvency. Solvency, used in the technical sense, refers to the firmscontinuous ability to meet maturing obligations. If the fir maintains arelatively large investment in current assets, it will have no difficulty in

paying claims of creditors when they become due and will be able to fill allsales orders and ensure smooth production. Thus, a liquid firm has less riskof insolvency; that is, it will hardly experience a cash shortage or a stock-outsituation. However, there is a cost associated with maintaining a soundliquidity position. A considerable amount of the firms will be tied up incurrent assets, and to the extent this investment is idle, the firmsprofitability will suffer.

To have higher profitability, the firm may sacrifice solvency and maintain arelatively low level of current assets. When the firm does so, its profitability

will improve as fewer funds are tied up in idle current assets, but its solvencywould be threatened and would be exposed to greater risk of cash shortageand stock-out.

2.2.1 ESTIMATING WORKING CAPITAL NEEDS

Current Assets Holding Period. To estimate working capitalrequirement on the basis of average holding period of current assets

and relating them to costs based on the companys experience in theprevious years. This method is essentially based on the operating cycleconcept.

Ratio of Sales. To estimate working capital requirements as a ratio ofsales on the assumption that current change with sales

Ratio of Fixed Investment. To estimate working capitalrequirements as a percentage of fixed investment.

POLICIES FOR FINANCING FIXED ASSETS

A firm can adopt different financing policies vis--vis current assets. Threetypes of financing may be distinguished:

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Long-term Financing. The sources of long-term financing includeordinary share capital, preference share capital, debentures, long-termborrowings from financial institutions and reserves and surplus(retained earnings).

Short-Term Financing. The short-term financing is obtained for aperiod less than one year. It is arranged in advance from banks andother surplus of short-term finance in the money market. It includesworking capital funds from banks, public deposits, commercial paper,factoring of receivables etc

Spontaneous Financing. It refers to the automatic sources of short-term funds arising in the normal course of a business. Trade(suppliers) credit and outstanding expenses are examples ofspontaneous financing.

The real choice of financing current assets, once the spontaneous sources offinancing have been fully utilized, is between the long-term and short-termsources of finance.

Depending on the mix of short-term and long-term financing, the approachfollowed by a company may be refereed to as:

Matching approach

Conservative approach

Aggressive approach

Matching Approach

The firm following matching approach (also known as hedging approach)adopts a financial plan which matches the expected life of the sources offunds raised to finance assets. For e.g., a ten-year loan may be raised tofinance a plant with an expected life of ten years. The justification for theexact matching is that, since the purpose of financing is to pay for theassets, the source of financing for short-term assets is expensive, as fundswill not be utilized for the full period. Similarly, financing the long-term assets

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with short-term financing is costly as well as inconvenient as arrangement forthe new short-term financing will have to be made on a continuing basis.

Conservative approach

Under a conservative plan, the firm finances its permanent assets and also apart of temporary currents assets with long-term financing. In the periodswhen the firm has no need for temporary current assets, the idle long-termfunds can be invested in the tradable securities to conserve liquidity. Theconservative plan relies heavily on long-term financing and, therefore, thefirm has less risk of facing the problem of shortage of funds.

Aggressive approach

An aggressive approach policy is said to be followed by the firm when it usesmore short-term financing than warranted by the matching plan. The firmfinances a part of its permanent current assets with short term financing. Therelatively more use of short-term financing makes the firm more risky.

INVENTORY MANAGEMENT

INTRODUCTION: Inventories constitute the most significant part of

current assets of a; large number majority of companies in India. On anaverage, inventories are approximately 60 % of current assets in publiclimited companies in India. Because of the large size of the inventoriesmaintained by the firm, a considerable amount of funds is required tobe committed to them. It is, therefore, absolutely imperative tomanage inventories efficiently and effectively in order to avoidunnecessary investment.

Inventories are stock of the product a company is manufacturing for sale andcomponents that make up the product. The various forms in whichinventories exist in a manufacturing company are:

Raw materials are those basis inputs that re converted into finishedproduct through the manufacturing process. Raw materials inventoriesare those units, which have been purchased and stored for futureproductions.

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Work-in-progress inventories are semi-manufactured products. They

represent those products that need more work before they becomefinished products for sale.

Finished goods inventories are those completely manufactured

products, which are ready for sale. Stocks of the raw materials andwork-in-process facilitate production, while stock of finished goods isrequired for smooth marketing operations. Thus the inventories serveas a link between the production and the consumption of goods.

The levels of the three kinds of inventories for the firm depend on the natureof the business. A manufacturing firm will have substantially high level offinished goods inventories and no raw material and work-in progressinventories within manufacturing firm, there will be differences.

THE OPERATING CYCLE AND WORKING CAPITAL

The working capital requirement of a firm depends, to a great extent up onoperating cycle of the firm. The operating cycle may be defined as the timeduration starting from the procurement of goods or raw material and endingwith the sales realization the length and nature of the operating cycle maydiffer from one firm to another depending on the size and nature of the firm.

The investment in working capital is influenced by four key events in theproduction and sales cycle form:

Purchase of raw materials

payment of raw materials

sale of finished goods

collection of cash for sales

Operating cycle period: the firm begins with the purchase of raw material,which are paid for after a delay, which represents the accounts payableperiod. The firm converts raw material into finished goods and then sell thesame. The time that, elapses between the purchase of raw material and thecollection of cash for the sales is referred to as the operating cycle. Thelength or time duration of the operating cycle of any firm can be defined as

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the sum of its inventory conversion period and the receivables conversionperiod.

A) Inventory Conversion period (ICP): The time lag between the

purchase of raw material and the sale of finished goods is theinventory conversion period. In the manufacturing firm ICPconsists of raw materials conversion period (RPCP), work-in-progress conversion period (WPCP), and the finished goodsconversion period (FGCP).

RMCP refers to the period for which the raw material is generallykept in stores before it is used by the production department. TheWPCP refers to the period for which the raw material remains in theproduction process before it is taken out s a finished product. TheFGCP refers to the period for which finished goods remain in stores

before being sold to a customer.

B) Receivables conversion period (RCP): It is the time required to convertthe credit sales into cash realization. It refers to the period between the occurrenceof credit sales and collection from debtors.

The total of ICP and RCP is also known as Total Operating Cycle period (TOCP). Thefirm might be getting some credit facilities from the supplier o a material, wageearners, etc. this period for which the payment of these parties are deferred ordelayed is known as Deferral Period (DP). The Net Operating Cycle (NOC) of the firmis arrived at by deducting the DP fro the TOCP. NOC is also known as cash cycle.

RMCP = (AVG. raw material stock/ Total raw materials stock)*365

WPCP = (avg. work-in process/ Total work-in-process)*365

FGCP = (Avg. finished goods/ Total cost of goods sold)*365

RCP = (Avg. receivables / Total credit purchase)*365

DP = (Avg. creditors / Total credit purchase)*365

In respect of these formulations, the following points are note worthy:

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a) The Average value in the numerator is the average of opening balance and

closing balance of the respective item. However, if only the closing balance isavailable, then even the closing balance may be taken as the Average.

b) The figure 365 represents number of days in a year. It may also be taken as360 for the ease of calculation.

c) The total figure in the denominator refers to the total value of the item in aparticular year.

d) In the calculation of RMCP, WPCP, ad FGCP. The denominator is calculated atcost-basis and the profit margin has been excluded. The reason big that thereis no investment of funds in profit as such.

2.2.2 WORKING CAPITAL LIMITS

FUND BASED CREDIT LIMITS

1. CASH CREDIT/PACKING CREDIT:The cash credit facility is similar to the overdraft arrangement. It is the most poplarmethod of bank finance for working capital in India. Under the cash credit facility, aborrower is allowed to withdraw funs from the bank up to the cash credit limit. He isnot required to borrow the entire sanctioned credit once, rather, he can drawperiodically to the extent of his requirement and repay by depositing surplus fundsin his cash credit account. Cash credit is sanctioned against the security of current

assets. Cash credit is the most flexible arrangement from the borrowers point ofview.

2. DISCOUNTING OF BILLSUnder the purchase or discounting of bills, a borrower can obtain credit from a bankagainst its bills. The bank purchase or discounts the borrowers bills. He amountprovided under this agreement is covered within the overall cash credit or overdraftlimit

Before purchasing or discounting the bills, the bank satisfies itself as creditworthiness of the drawer. Though, the item bills purchased implies that the bankbecomes owner of the bill. In practice, bank hold bills as security for the credit.When a bill is discounted, the borrower is paid he discounted amount of the bills,(visa, full amount of bill minus the discount charged by the bank). The bank collectsfull amount on maturity. The major part of bank borrowings comes throughDiscounting Bills. On this firm has to pay interest of 12%.

NON-FUND BASED

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1. LETTER OF CREDITCommonly used in international trade, the letter o credit is now used in domestictrade as well. A letter of credit, or L/C, is used by a bank on behalf of itscustomers (buyer) to the seller. As per this document, the bank agrees to honor

drafts on it for the supplies made to the customer if the seller fulfills theconditions laid down in the L/C.

The L/C serves several useful functions:

(i) It virtually eliminates credit risk, if the bank has a good standing.(ii) It reduces uncertainty, as the seller knows the conditions that should be

fulfilled receive payment..

2. BANK GUARANTEE

Bank Guarantee is very similar to Letter of Credit but it is provided for muchlonger period compared to letter of credit. Very small portion of working capitalis funded by Bank Guarantee.

The firm is having low credit holding period it can try to increase is sothat, those funds can remain with it for a longer period n can be utilizedfor fulfilling the working capital requirements. For this purpose firm can belittle strict credit standards it can also adopt discount policy.

LOAN ASSESSMENT

Steps in loan processing :

Submission of Project Report along with the Request Letter.

Carrying out due diligence

Preparing Credit Report

Determining Interest Rate

Preparing and submission of Loan Sheet

If not approved if approved

Preparation of proposal

Submission of Proposal to designated authority

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If No queries raised If queries raised

Project Rejected Solve the queries

Credit Report and Credit Rating

The credit report is an important determinant of an individual's financial credibility. They are

used by lenders to judge a person's creditworthiness. They also help the person concerned to

narrow down on the financial problem areas.

Credit report is a document, which comprises detailed information about the credit payment

history of an applicant. It is mostly used by the lenders to determine the credit worthiness of an

applicant.The business credit reports provide information on the background of a company. This

assists one to take crucial business related decisions. People can also assess the amount of

business risk associated with a company and then decide whether they would be comfortable in

providing them with credit facilities. The degree of interest that would be shown by investors in

their company can also be gauged from the business credit reports as they can get an idea of the

conception of their customers regarding themselves. Since these records are updated at regular

intervals of time they enable people to identify the risk levels associated with a business as well

as its future. These reports also allow businesses to get detailed information about the financial

status of business partners and suppliers.

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Sanction of proposal on

various on Terms & condition

Communication of Sanction

Acknowledgement of Sanction

on various Terms & Condition

Application to comply with Sanction Terms &

Condition & execution of Loan Documents

Disbursement


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2.3 METHODOLOGY

The methodology to be adopted for the project is explained as under:

1. The initial step of the project was studying about the company andthen evaluating the financial position of the company on the basis ofratio analysis.

2. Comparing the firms financial position with the help of followingratios-

Liquidity ratios

Solvency/Leveraging ratios

Coverage ratios

Activity/turnover ratios

Profitability ratios

Investors ratios

3. The project will focus on the study of overall working capitalmanagement at the organizations, for which the following study andanalysis will be undertaken:

This project is aimed to estimate the operating plan for the year 2010-2011

This will also include the calculations and analysis of the operating

cycle for the company. Study of CMA form and to prepare for the current year.

It will also include the ratio analysis of the financial statement so thatthe profitability and liquidity trade off can be analyzed.

2.4 SCHEDULE

The complete project will be for duration of 8 weeks. The study of companysfinancial position by doing ratio analysis of the financial statement so that

the profitability and liquidity condition of the organization can be studied.Here the operating plan will be prepared and the study and analysis of the CM A form will be done. This will include the estimation of working capitalrequirement for 2008-2009, forecasting for 2009-2010 .

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2.5 SCOPE OF THE STUDY

Studying working capital management of the Penguin Industries ltd anddeciding its credibility.

2.6 LIMITATIONS

In spite of my continued efforts to make the project as accurate and wide inscope as possible, certain limitations are becoming evident whileimplementing the project. These limitations cannot be removed and have tobe accepted as permanent constraints in implementing the project.

Some limitations, which have been identified, by me are:

1. Generalizations and calculated assumptions had to be made insome areas while analyzing the financial statements, ratios etc.due to non-availability of complete information and not all theinformation are provided as per the rules of the ban

CHAPTER 3 PROPOSAL

3.1 PENGUIN INDUSTRIES

BORROWER PROFILE

NAME OF THE ACCOUNT M/SPENGUIN ELECTRONICS LIMITED(PEL)-(SME A/C)

CONSTITUTIONUNLISTED PRIVATE LIMITEDCOMPANY

BUSINESS ACTIVITYMANUFACTER OF CONSUMER ELECTRONICS PRODU,DOMESTIC APPLIANCES

ESTABLISHED IN 1983ADVANCE SINCE 1 1987

PRESENT PROPOSEDRISK RATING LC1 LC1PRICING RATING LC1 LC1

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EXTERNAL CREDIT RTINGASSET CODE 11(STANDARD)

GROUP

NO MAJOR GROUP

AFFILIATION

KEY PERSONMR RAKESH N.GARODIA

CONSORTIUM NOFINANCIALS BELOWPOSITION OF ACCOUNTS ANNEXURE 1LAST SANCTION AUTHORITY: DY GM.LIMIT FBL -6 CRORES.NFBL: 0.4

CPA

NO CPA RELATED TO LAST SANCTION OF 31.03.09 I

APPLICABLE AS THERE IS NO ENHANCEMENT IN THE

LAST INSPECTION 09.01.2010,SATISFACTORY

CORPORATE OFFICE

4, Piramal Industrial Estate

S. V ROAD, GOREGOAN (WEST), MUMBAI

MANAGEMENT

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Crisil Rating for bank facilities of

Penguin Electronics ltd

sl no FacilityRated

Amount Rating

1 Cash credit 45 BBB/stable2 Long term loan 11 BBB/stable3 Bills discounting 15 P3+4 Letter of credit 3.5 P3+5 Bank guarantee 0.5 P3+

FINANCIALS2007 -2008

AUDITED

2008- 2009

AUDITED

PAID UP CAPITAL 1 1NET WORTH(EXCLD REVALUATIONRESERVE) 14.85 14.87NET SALES 46.01 34.86OTHER INCOME 1.43 1.17GROSS PROFIT/LOSS 1.57 0.86NET PROFIT/LOSS 1.37 0.14RATIOS

27

MANAGEMENT

MR.ASHOKN

.GARODIA

CHIEFEXECUTIVE

MR RAKESHN.

GARODIA

DIRECTOR

MR. ARUNN.

GARODIA

DIRECTOR

MR. V G.DESHPAND

E

DIRECTOR

KUSUMA.GARODIA

DIRECTOR

GAYATRIDEVIN.GARODIA

DIRECTOR


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CURRENT RATIO 1.28 1.35DEBT /EQUITY 0.8 0.6PROFITABILITY 2.98 0.4DSCR - -

INTEREST COVERAGE 2.85 1.28

FINANCIAL INDICATORS

Finnancial indicatorsAudited31.03

.07Est.31.03

.07Audited31.03.08

Estd.31.03.09

Proj31.03.1

Paid up capitala)Equity 1 1 1 1 1b)Preference share

Tangible net worth 13.62 14.26 14.85 15.45 16.13Investment in companies 3.42 6 5.72 6.18 6.18Adjusted TNW -Capital employed 16.83 15.45 16.26 16.13 16.53Net block 6.22 5.05 7.22 5.54 5.17Net sales 59.03 40 46.01 33 34.65

Total sales 59.03 40 46.01Other income 0.59 0.35 1.43 0.61 0.61EBITA/PBITA 2.9 2.89 2.97 2.35 2.45Interest 0.57 0.96 0.55 0.7 0.7Gross profit/loss 2.33 1.93 2.42 1.65 1.75

Taxes 0.28 0.28 0.31 0.18 0.2Cash Accruals 2.05 1.65 2.11 1.47 1.55Depreciation 0.69 0.9 0.74 0.75 0.75Net profit/Loss 1.36 0.75 1.37 0.72 0.8Net profit/Capitalemployed% 8.08 4.85 8.43 4.46 4.84Current assets 16.55 14.13 16.6 14.01 14.37Currrent liabilities 9.36 9.73 13.28 9.6 9.19RatiosCurrent Ratios 1.77 1.45 1.25 1.46 1.56

Debt /Equitya) Term LIAB/TNW 0.24 0.08 0.09 0.04 0.02b)Tol/TNW 0.92 0.77 0.99 0.67 0.59(Profitability- PAT) /Netsales 2.3 1.88 2.98 2.18 2.31DSCR-Company as awhole Avg 2.51 Avg 2.51 Avg 2.51 Avg 2.51 Avg 2.5

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Interest coverage 4.6 2.72 4.84 3.1 3.21(Inventory+Receivables)/sales% 30 27 19 33 17

COMMENTS IN BRIEF

The company has submitted audited balance sheet for 2008-2009.The selected financialindicator above reveals satisfactory financial position except Low profitability and declinein sales and ISCR during 08-09.Net worth shown a increased trend with retension of profitsand is Rs 14.87 cr as on 31.03.10. ISCR is at 1.28 and is not above the acceptable level of 1.5

3.2 COMPANY REQUEST- PENGUIN

ELECTRONICS LIMITED

SALESHitherto our business module mainly compromised ofmanufacture of audio Products for Philips India Ltd. keeping inview the market trends and the likely orders to be placed byour buyers we have concentrated on production of domestichome appliances. In the current year 09 -10 sales of 2790.07lacs have been achieved. The expected sales are expected to

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be 3150 lacs for the current year sales in the next financialyear is projected to be 3250 lacs on conservative basis.

PROFITABILITY

EBITA has been estimated at around 5 % with PAT estimatedat 2 %

CURRENT RATIO

Has been estimated at benchmark level keeping in view ofstipulated working capital continued towards Working capital.

TRADERS CREDITORS RATIO

Creditors level would be endeavored to be kept at minimum ofupto 8 days level so far.

DEBT EQUITY RATIO

Debt/ Equity ratio is kept at 1:1.

INTEREST

Request for interest at 9.5 % on Bills Discounting Limit.

3.3 COMMENTS IN BRIEF ON FINANCIAL POSITION OF PENGUIN

ELECTRONICS LIMITED.

PAID UP CAPITAL / TNW

Paid Up Capital of the company is maintained at Rs 1 crore and is estimated toremain at the same level during the current and ensuing year. The Net Worth ofthe company has gone up from 13.62 crores as at 14.85. Company has paidinterim dividend of Rs 10 lakhs during 2007-08.

NET SALES

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Company has achieved the sale of Rs 46.01 crores as on 31.03.08 as theestimates of Rs 40 crores. Hence company is considered doing well.

OTHER INCOME

Company has other income of Rs 1.43 crores which comprises of profit ofsale of investments of Rs 0.74 crore, rent from its leased property atDaman of Rs 0.41 crores. Interest of deposits and MF of Rs 0.20 crores.

PROFITS/PROFITABILITY

Company has earned profits of Rs 1.37 crores during 2007-08.As theyhave closed their audit unit at Daman and are operating from their newunit set up at Baddi, Himachal Pradesh. Profitabilty at 2.18% for the yearended 31.03.09 would be slightly lower than as compared to 2.98% forthe year 31.03.08.the lower profitability was explained due to thinmargins in electronics industry due to stiff competition.

INVESTMENTS

Company has invested in some Blue Chip Companies to the tune of Rs 4.76

crores and in MF of Rs 0.76 crores as on 31.03.08.CURRENT RATIO

Current Ratio was at 1.25 as on 31.03.08 and is estimated to improve to 1.46as on 31.03.09. Current ratio is above the benchmark level and henceacceptable.

DEBT-EQUITY RATIO

THE DER was 0.99 as on 31.03.08 and is slated to improve to 0.67 and to0.59 during next two years. The same is acceptable levels.

INTEREST SERVICE COVERAGE RATIO

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ISCR as on 31.03.08 was at 4.84 .The estimated ISCR at 3.10 and projectedat 3.21 as on 31.03.09 and 31.03.10 respectively.

NET BLOCK

Company net block was Rs 7.22 crores as on 31.03.08. As the company hasshifted to Baddi, they have sold their plant and machinery. There was anadjustment in depreciation on account of sale of plant and machinery whichhas amounted to reduction in net block to Rs 5.54 crores as on 31.03.09.

CONTINGENT LIABILITY

Company has no contingent liability.

STATUTORY AUDITORS REMARKS

Company audited financials as on 31.03.08 are unqualified.

INTER COMPANY COMPARISION

NAME OF

COMPANY YEAR SALES

PBT/SA

LES

TOL/TN

W CRPENGUIN

ELECTRONICS

2207-

08 46.01 3.6 0.99 1.67PACIFIC

ELECTRONICS

2007-

08 29.23 6.32 3.06 1.13

FAVOURABLE CONDITIONS

The products manufactured by the company are supplied to MNCslike Philips India limited and Legrand private ltd. The companyenjoys brand equity of these MNCs without any additional costs.

3.4 ASSESMENT / JUSTIFICATION OF PROPOSED LIMITS

TERM LOAN ASSESMENT

Company was granted TERM LOAN of Rs 2.50 crores for partfunding of this project cost of Rs 3.85 crore for setting up

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manufacturing unit at Baddi. The average DSCR for the balancerepayment period works out to be 2.51 which is very comfortable.

WORKING CAPITAL ASSESMENT

Company has estimated sales of 40 crores for 07-08 againstwhich they achieved 46.01 crores. Comapny has been enjoyingstar Channel Credit of Rs 6 crores within the WC limit.

JUSTIFICATION

Companys WC has been reduced from 10 crores to 6 crores at

their request as they have closed their unit at Daman.

Company has been granted term loan of rs 2.5 cr towards partfunding for setting up unit at Baddi. The Term Loan is repayed in20 equvalent quarterly repayments.

NON FUND BASED LIMITS

Compant has been granted LC-DP OF Rs 0.35 crore nad LC DA 90days limit of RS 0.10 crores subject to maximaum of rs 0.35 croreand Bank guarantee limit of Rs 0.05 crore.

ANNEXURE

A ) BENCHMARK RATIOS FOR PERFORMANCE OF COMPANY:

RATIO ANALYSIS USUAL NORM

EFFICIENCY RATIOS:

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Net Sales / Total Tangible Assets (Times) >1.50

PBT / TTA (%) >5.00%

Operating Cost / Net Sales (%)


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Bank Finance Turnover (Times) >5.00

Current Assets Turnover (Times) >3.00

PROFITABILITY RATIOS: Net Profit Margin after tax (%) >5.00%

Net Income to Assets Ratio (%) >10.00%

Return on Investment (%) [PBDIT/TTA] >20.00%

Return on Equity (%) >18.00%

Operating Profitability (%) >20.00%

Pre-Tax Profitability (%) >15.00%

PBT / TTA (%) >10.00%

STRUCTURAL RATIOS:

Retained Profit (%) >20.00%

Raw Material Content (%)


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Liquid ratio or Quick ratio or Acid test ratio

Liquid ratio is a relationship of liquid assets with current liabilities. It is fairlystringent measure of liquidity.

Liquid assets are those assets which are either in the form of cash or cashequivalents or can be converted into cash within a short period. Liquid assetsare computed by deducting stock and prepaid expenses from the currentassets. Stock is excluded from liquid assets because it may take some timebefore it is converted into cash. Similarly, prepaid expenses do not providecash at all and are thus, excluded from liquid assets.

Computation. The ratio is calculated is as under:

Liquid ratio= Liquid assets

Current liabilities

Objective.

The ratio of current assets less inventories to total current liabilities.This ratio is the most stringent measure of how well the company iscovering its short-termobligations, since the ratio only considers thatpart of current assets which can be turned into cash immediately (thusthe exclusion of inventories).

The ratio tells creditors how much of the company's short term debtcan be met by selling all the company's liquid assets at very shortnotice. also called acid-test ratio.

The current ratio does not indicate adequately the ability of the

enterprise to discharge the current liabilities as and when they fall due.Liquid ratio is considered as a refinement of current ratio as non-liquidportion of current assets is eliminated to calculate the liquid assets.Thus it is a better indicator of liquidity.

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A quick ratio of 1:1 is considered standard and ideal, since for every rupee of

current liabilities, there is a rupee of quick assets. A decline in the liquid ratioindicates over-trading, which, if serious, may land the company in difficulties.

SOLVENCY/LEVERAGE RATIOS (LONG-TERM SOLVENCY)

The term solvency implies ability of an enterprise to meet its long termindebt ness and thus, solvency ratios convey the long term financialprospects of the company. The shareholders, debenture holders and otherlenders of the long-term finance/term loans may be basically interested inthe ratios falling under this group.

Following are the different solvency ratios:

Debt-equity Ratio

The debt-equity ratio is worked out to ascertain soundness of the long termfinancial policies of the firm. This ratio expresses a relationship between debt(external equities) and the equity (internal equities).

Debt means long-term loans, i.e., debentures, public deposits, loans (longterm) from financial institutions. Equity means shareholders funds, i.e.,preference share capital, equity share capital, reserves less losses and

fictitious assets like preliminary expenses.

Computation. Te ratio is calculated as under:

Debt-Equity Ratio = Debt (Long-term Loans)

Equity (shareholders funds)

Objective.

The objective of this ratio is to arrive at an idea of the amount ofcapital supplied to the concern by the proprietors and of assetcushion or cover available to its creditors on liquidation of theorganization equity.

It also indicates the extent to which the firm depends upon outsidersfor its existence. In other words, it portrays the proportion of totalfunds acquired by a firm by way of loans.

A high debt-equity ratio may indicate that the financial stake of thecreditors is more than that of the owners. A very high debt-equity ratio

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may make the proposition of investment in the organization a riskyone.

While a low ratio indicates safer financial position, a very low ratio maymean that the borrowing capacity of the organization is being

underutilized. The debt/equity ratio also depends on the industry in which the

company operates. For example, capital-intensive industries such asauto manufacturing tend to have a debt/equity ratio above 2, whilepersonal computer companies have a debt/equity of under 0.5.

The readers of financial management may remember that to borrowthe funds from outsiders is one of the best possible ways to increasethe earnings available to the equity shareholders, basically due to tworeasons:

a) The expectations of the creditors in the form of return on their investment

are comparatively less as compared to the returns expected by the equityshareholders.

b) The return on investment paid to the creditors is a tax-deductibleexpenditure.

Total Assets to Debts Ratio

The total asset to debt ratio establishes a relationship between total assetsand the total long-term debts.

Total assets include fixed as well as current assets. However, fictitiousassets like preliminary expenses, underwriting commission, share issue

expenses, discount on issue of shares/debentures, etc., and debit balance ofprofit and loss account are not included. Long-term debts refer to debtsthat will mature after one year. It includes debentures, bonds, and loans fromfinancial institutions.

Computation. This ratio is computed as under:39


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Total Assets to Debt Ratio = Total Assets

Long-term debts

Objective.

This ratio is computed to measure the safety margin available to theproviders of long-term debts. It measures the extent of coverageprovided to long term debts by the assets o the firm.

A higher ratio represents higher security to lenders for extending the long-term loans to the business. On the other hand, a low ratio represents a riskyfinancial position as it means that the business depends on outside loans forits existence.

Total Debt Ratio Total debt ratio is a relationship of Total Debt of a firm to its CapitalEmployed.

Computation. This ratio is calculated as under.

Total Debt Ratio = Debt

Capital Employed

Objective.

A ratio that indicates what proportion of debt a company has relative toits assets. The measure gives an idea to the leverage of the companyalong with the potential risks the company faces in terms of its debt-load.

A debt ratio of greater than 1 indicates that a company has more debtthan assets, meanwhile, a debt ratio of less than 1 indicates that acompany has more assets than debt. Used in conjunction with othermeasures of financial health, the debt ratio can help investors

determine a company's level of risk.

Fixed Assets to Capital Employed Ratio

Fixed assets to Capital employed ratio gives the amount of fixed assets as apercentage of the capital employed of the company.

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Computation. This ratio is calculated as follows:

Fixed Assets to Capital Employed = Net Fixed assets x 100

Capital Employed

Objective.

This ratio indicates the extent to which the long term funds are sunkinto fixed assets.

It has been an accepted principle of financial management that notonly fixed assets should be financed by way of long-term loans but alsoa part of current assets or working capital should be financed by way oflong-term funds, and this part may be in the form of permanentworking capital.

A very high trend of this ratio may indicate that a major portion of longterm funds is utilized for the purpose of fixed assets leaving a smallproportion for the investment in the current assets or working capital.

A very low trend of this ratio coupled with a constant declining trend ofcurrent ratio may indicate an urgent for the introduction of long-termfunds for financing the working capital in the business.

Inventory to Net Working Capital Ratio

Inventory to Net working Capital Ratio tells how much of a companys fundsare tied up in inventory.

Computation. The formula is as under:

Inventory to Net Working Capital = Inventory

Net Working Capital

Objective.

Keeping track of inventory levels is crucial to determine the financialhealth of a business.

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It is preferable to run a business as little inventory as possible on hand,

while not affecting potential sales opportunities. If this ratio is high compared to the average for the industry, it could

mean that the business is carrying too much inventory.

Proprietary Ratio

The proprietary ratio establishes a relationship between proprietors fund andtotal assets.

Proprietors fund means share capital plus reserves and surplus both ofcapital and revenue nature. Loss, if any, should be deducted. Funds payableto others should not be added.

Computation. This ratio is worked out as follows:

Proprietors Ratio = Proprietors Fund or Shareholders Fund

Total Assets

Objective.

This ratio throws a light on the general financial position of the

concern. It shows the extent to which shareholders own the business.This ratio is of particular importance to the creditors as it helps them

to ascertain the proportion of shareholders funds in the total assets

employed in the firm.

The higher this Proprietary ratio denotes that the shareholders have

provided the funds to purchase the assets of the concern instead of

relying on other sources of funds like bank borrowings, trade creditors

and others.

However, too high a proprietary ratio say 100% means that

management has not effectively utilize cheaper sources of financelike trade and long term creditors. As these sources of funds are

cheaper, the inability to make use of it might lead to lower earnings

and hence a lower rate of dividend payout.

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PROFITABILITY RATIOS

Profit as compared to the capital employed indicated profitability of theconcern. A measure of profitability is the overall measure of efficiency. The

different profitability ratios are as follows:

Net Profit ratio

The Net profit ratio establishes the relationship between net profit and netsales, expressed in percentage form.

Net Profit is derived by deducting administratitive and marketing expenses,finance charges and making adjustments for non-operating expenses andincomes.


Net Profit ratio = Net Profit after taxes x 100

Net Sales

Objective.

The net profit ratio determines the overall efficiency of the business.Itindicates that proportion of sales available to the owners after theconsideration of all types of expenses and costs either operating ornon-operating or normal or abnormal.

A high net profit indicates profitability of the business. Hence, higherthe ratio, the better the business is.

COVERAGE RATIOS

Interest Coverage Ratio

The interest coverage Ratio establishes the relationship between PBIT (Profitsbefore interest and taxes) and Debt interest.

Computation. It is calculated as:

Interest Coverage Ratio = Profit before Interest and Taxes

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Debt Interest

The numerator considers the profit before income tax and interest on bothterm and working capital borrowings.

The denominator considers the interest charges, which are in the form ofinterest on long-term borrowings and not the interest on working capitalfacilities.

Objective.

Interest coverage is a financial ratio that provides a quick picture of acompanys ability to pay the interest charges on its debt.

The 'coverage' aspect of the ratio indicates how many times theinterest could be paid from available earnings, thereby providing asense of the safety margin a company has for paying its interest forany period.

A company that sustains earnings well above its interest requirementsis in an excellent position to weather possible financial storms.

As a general rule of thumb, investors should not own a stock that hasan interest coverage ratio under 1.5. An interest coverage ratio below

1.0 indicates the business is having difficulties generating the cashnecessary to pay its interest obligations.

The ratio suffers from the following limitations:

a) The fixed obligations in the form of preference dividend or installmentsof long-term borrowings are not considered.

b) The funds available for meeting the obligations of interest paymentsmay not be necessarily in the form of p[profits before interest andtaxes only, as the amount of [profits so calculated may consider the

amount of depreciation debited to Profit and Loss Account which doesnot involve any outflow of funds.

ACTIVITY (TURNOVER OR PERFORMANCE) RATIOS

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Turnover indicates the speed with which capital employed is rotated in theprocess of doing business. Activity ratios measure the effectiveness withwhich a concern uses resources at its disposal. The following are theimportant activity (turnover or performance) ratios:

Capital Turnover Ratio

Capital Turnover ratio establishes between the Net Sales and the CapitalEmployed of a firm. Capital turnover ratio indicates that the firms capitalemployed is being efficiently used. This ratio indicates that the organizationis able to achieve maximum sales with minimum amount of capitalemployed.

Computation. This ratio is computed with the help of the following formula:

Capital turnover ratio = Net sales

Capital Employed

Objective.

This ratio indicates the effectives of the organization with which thecapital employed is being utilized.

A high capital turnover ratio indicates the capability of the organization

to achieve maximum sales with minimum amount of capital employed.It indicates that the capital turnover ratio better will be the situation.

Working Capital Turnover Ratio

The working capital turnover ratio indicates the number of times a unitinvested in working capital produces sale. In other words, this ratio shows theefficiency in the use of short-term funds for achieving sales.

Working capital is computed by deducting current liabilities from currentassets. A careful handling of the short-term assets and funds will mean areduction in the amount of capital employed thereby improving turnover.

Computation. The ratio is calculated as follows:

Working capital turnover ratio = Net sales

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Working capital

Objective.

A company uses working capital (current assets - current liabilities) tofund operations and purchase inventory. These operations andinventory are then converted into sales revenue for the company.

The working capital turnover ratio is used to analyze the relationshipbetween the money used to fund operations and the sales generatedfrom these operations.

In a general sense, the higher the working capital turnover, thebetter because it means that the company is generating a lot of salescompared to the money it uses to fund the sales.

A high, or increasing Working Capital Turnover is usually a positivesign, showing the company is better able to generate sales from itsWorking Capital. Either the company has been able to gain more NetSales with the same or smaller amount of Working Capital, or it hasbeen able to reduce its Working Capital while being able to maintain itssales.

As such, higher this ratio, the better will be the situation. However, avery high ratio may indicate overtrading the working capital being

meager for the scale

Inventory Turnover ratios

a) Raw Material Inventory Turnover


Raw Material Inventory Turnover Ratio = Raw Material

Consumed

Average Raw Material

Inventory

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b) Finished goods Inventory Turnover


FGIT= Net sales

Average Finished Goods Inventory

Objective.

A high inventory turnover ratio indicates that maximum sales turnover is

achieved with the minimum investment in inventory. As such, as ageneral rule, high inventory turnover ratio is desirable.

However, the high inventory turnover ratio should be viewed from somemore angles. Firstly, it may indicate that there is under investment ininventory whereby the organization may loose customer patronage f it isunable to maintain the delivery schedule. Secondly, high inventoryturnover ratio may not necessarily indicate profitable situation.

An organization, in order to achieve a large sales volume, maysometimes sacrifice on profits, whereby a high inventory turnover ratiomay not result into high amount of profits.

On the other hand, a low inventory turnover ratio may indicate overinvestment in inventory, existence of excessive or obsolete/non-movinginventory, improper inventory management, accumulation of inventoriesat the year end in anticipation of increased prices or sales volume in nearfuture and so on.

There can be no standard inventory turnover ratio which may beconsidered ideal. It may depend on nature of industry and marketingstrategies followed by the organization.

Assets Turnover Ratios

Asset turnover measures a firm's efficiency at using its assets ingenerating sales or revenue - the higher the number the better.

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It also indicates pricing strategy: companies with low profit margins

tend to have high asset turnover, while those with high profit marginshave low asset turnover.

A high Assets turnover ratio indicates the capability of the organization

to achieve maximum sales with the minimum investment in assets. Itindicates that the assets are turned over in the form of sales morenumber of times. S such, higher the ratio, better will be the situation.

a) Total Assets Turnover

Computation. This ratio is computed using the following formula:

Total Assets Turnover Ratio = Net Sales

Total Assets

b) Fixed Assets Turnover


Fixed Assets Turnover Ratio = Net Sales

Fixed Assets

Fixed assets include net fixed assets, i.e., fixed assets after providing fordepreciation.

c) Current Assets Turnover

Computation. This ratio is calculated s follows:

Current Assets turnover Ratio = Net Sales

Current Assets

Objective.

A high Assets turnover ratio indicates the capability of the organizationto achieve maximum sales with the minimum investment in assets.

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It indicates that the assets are turned over in the form of sales more

number of times. S such, higher the ratio, better will be the situation.

Debtors Turnover Ratio

Computation. The ratio will be computed as:

Debtors Turnover ratio = Net credit sales

Average sundry debtors

Objective.

This ratio indicates the speed at which the sundry debtors areconverted in the form of cash. However this intention is not correctlyachieved by making the calculations in this way.

As such this ratio is normally supported by the calculations of AverageCollection Period which is calculated as under:

a) Calculation of Daily Sales

daily sales= Net credit Sales

No of Working Day

Inference

It is highest in case of ITC followed by HUL and DS Group respectively.

b) Calculation of Average Collection Period:

ACP= Average Sundry Debtors

Daily Sales

The average collection period as computed above should be compared withthe normal credit period extended to the customers. If the average collectionperiod is more than normal credit period allowed to the customers, it may

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indicate over investment in debtors which may be the result of over-extension of credit period, liberalization of credit terms and ineffectivecollection procedures.

RETURN ON INVESTMENT

The ratios computed in this group indicate the relationship between theprofits of a firm and investment in the firm. There can be three ways in whichthe term investment may be interpreted, i.e., Assets, Capital Employed andShareholders Funds. As such, there can be three broad classifications of ROI:

Return on Assets (ROA)

Computation. This ratio is calculated as:

ROA = EBIT

Average Total Assets

Objective.

An indicator of how profitable a company is relative to its total

assets. ROA gives an idea as to how efficient management is at usingits assets to generate earnings.

The assets of the company are comprised of both debt and equity.Both of these types of financing are used to fund the operations of thecompany. The ROA figure gives investors an idea of how effectively thecompany is converting the money it has to invest into net income.

The higher the ROA number, the better, because the company isearning more money on less investment.

Return on Capital Employed (ROCE)

Computation. The ratio is calculated as:

ROCE= Profit Before Interest & Taxes x 100

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Average Capital employed

Objective.

It is used in finance as a measure of the returns that a company isrealising from its capital employed. It is commonly used as a measure for comparing the performance

between businesses and for assessing whether a business generatesenough returns to pay for its cost of capital.

ROCE measures the profitability of the capital employed in thebusiness. A high ROCE indicates a better and profitable use of long-term funds of owners and creditors. As such, a high ROCE will alwaysbe preferred.

Return on Shareholders Funds

It is calculated as:

RSF= Profit After Tax x 100

Shareholders funds

This is the most popular ratio to measure whether the firm has earnedsufficient returns for its shareholders or not. As such, this ratio is themost crucial one from the owners/shareholders point of view. Higherthe ratio better will be the situation.

INVESTOR RATIOS

Earnings per Share (EPS)

Computation. The ratio is calculated as:

EPS= Net Profit after Taxes preference Dividend

Number of Equity shares Outstanding

Objective.

It is widely used ratio to measure the profits available to the equityshareholders on a per share basis. EPS is calculated on the basis ofcurrent profits and not on the basis of retained profits.

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As such, increasing EPS may indicate the increasing trend of current

[profits per equity share. However, EPS does not indicate how much ofthe earnings are paid to the owners by way of dividend and how muchof the earnings are retained in the business.

CONCEPTS OF WORKING CAPITAL

There are two concepts of working capital Gross and Net

Gross Working Capital refers to the firms investment in currentassets. Current assets are the assets which can be converted intocash within an accounting year and include cash, short termsecurities, debtors, bills receivable (accounts receivables or bookdebts) and stock.

Net Working Capital refers to the difference between currentassets and current liabilities. Current liabilities are those claims ofoutsiders, which are expected to mature for payment within anaccounting year, and include creditors (accounts payable), bills

payable and outstanding expenses. Net working capital can bepositive or negative. A positive net working capital will arise whencurrent asset exceed current liabilities. A negative net workingcapital occurs when current liabilities are in excess of currentassets.

Focusing on management of current assets

The gross working capital concept focuses attention on two aspects ofcurrent assets management:

a) How to optimize investment in current assets?

b) How should current assets be financed?

The considerations of the level of investment in current assets should avoidtwo danger points- excessive or inadequate investment in current assets.

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Investment in current assets should be just adequate to the needs of thebusiness firm. Excessive investment in current assets should be avoidedbecause it impairs the firms profitability, as idle investment earns nothing.On the other hand, inadequate amount of working capital can threaten

solvency of the firm because of its inability to meet its current obligations. Itshould e realized that the working capital needs of the firm may befluctuating with changing business activity. The management should beprompt to initiate an action and correct imbalances.

Another aspect of the gross working capital points to the need of arrangingfunds to finance current assets. Whenever a need for working capital fundsarises due to the increasing level of business activity or for nay other reason,financing arrangement should be made quickly. Similarly, if suddenly, somesurplus funds arise they should not be allowed to remain idle, but should be

invested in short term securities. Thus, the financial manager should haveknowledge of the sources of working capital funds as well as investmentavenues where idle funds may temporarily are invested.

Focusing on Liquidity management

Net working capital is a qualitative concept. It indicates the liquidity positionof the firm and suggests the extent to which working capital needs may be

financed by permanent sources of funds. Current assets should besufficiently in excess of current liabilities to constitute margin or buffer formaturing obligations within the ordinary operating cycle of business. In orderto protect their interests, short- term creditors always like a company tomaintain current assets at a higher level than current liabilities. However, thequality of current assets should be considered in determining level of currentassets vis--vis current liabilities. A weak liquidity position possesses a threatto the solvency of the company and makes it unsafe and unsound. Anegative working capital means a negative liquidity, and may prove to beharmful for the companys reputation. Excessive liquidity is also bad. It may

be due to mismanagement of current assets. Therefore, prompt and timelyaction should be taken by management to improve and correct theimbalances in the liquidity position of the firm.

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For every firm, there is a minimum amount of net working capital, which ispermanent. Therefore, a portion of working capital should be financed withpermanent sources of funds such as equity share capital, debentures, long-term debt, preference share capital or retained earnings. Management must,

therefore, decide the extent to which the current assets should be financedwith equity capital or borrowed capital.

It may be emphasized that both gross and net concepts of working capitalare equally important for the efficient management of working capital. Thereis no precise way to determine the exact amount of gross or net workingcapital of a firm. A judicious mix of long and short term finances should beinvested in current assets. Since current assets involve cost of funds, they

should be put to productive use.

OPERATING AND CASH CONVERSION CYCLE

A firm should aim at maximizing the wealth of its shareholders, so the firmshould earn sufficient returns from its operations. Earning a steady amountof profit requires successful sales activity. The firm has to invest enough

funds in current assets for generating sales. Current assets are neededbecause sales do not convert into cash instantaneously. There is always anOperating cycle involved in the conversion of sales into cash.

There is difference between current and fixed assets in terms of theirliquidity. A firm requires many years to recover the initial investment in fixedassets such as plant and machinery or land and building. On the contrary,investment in current assets is turned over many times in a year. Investmentin current assets such as inventories and debtors (accounts receivable) isrealized during the firms operating cycle that is usually less than a year.

OPERATING CYCLE is the time duration required to convert sales,after the conversion of resources into inventories, into cash.

The operating cycle of manufacturing company involves three phases:

Acquisition of resources such as raw material, labor power and fueletc.

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Manufacture of the product which includes conversion of raw

materials into work-in-progress into finished goods.

Sale of the product either for cash or on credit. Credit sales createaccount receivable for collection.

These phases affect cash flows, which most of the time, are neithersynchronized nor certain. They are not synchronized because cash flowsusually occur before cash inflows.

Cash inflows are uncertain because sales and collections which give rise tocash inflows are difficult to forecast accurately, on the other hand, are

relatively certain. The firm is, therefore, required to invest in current assetsfor a smooth, uninterrupted functioning. It needs to maintain liquidity topurchase raw materials and pay expenses such as wages and salaries, othermanufacturing, administrative and selling expenses and taxes as there ishardly a matching between cash inflows and outflows. Cash is also held tomeet any future exigencies. Stocks of raw materials and work-in-progress arekept to ensure smooth production and to guard against non-availability ofraw material and other components. The firm holds stock of finished goods tomeet the demand of customers on continuous basis and sudden demandfrom some customers. Debtors are created because goods are sold on credit

for marketing and competitive reasons. Thus, a firm makes adequateinvestment in inventories, and debtors, for smooth, uninterrupted productionand sale.

Length of Operating Cycle

The length of the operating cycle can be calculated in two ways:

b) Gross Operating Cycle

c) Net Operating Cycle

a) Gross Operating Cycle

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The grass operating cycle of a manufacturing concern is the sum of InventoryConversion Period and debtors (receivable) conversion period. Thus, GrossOperating Cycle is gives as follows:

Inventory conversion Period + Debtors Conversion Period

Inventory Conversion Period:

The inventory conversion period is the total time needed for producing andselling the product. It is the sum of (1) raw material conversion period, (2)work-in-progress conversion period, and (3) finished goods conversion

period. Raw material conversion period

The raw material conversion period is the average time period taken toconvert material into work-in-progress. Raw material conversion perioddepends on: (a) Raw material consumption per day, and (b) Raw materialinventory. Raw material consumption par day is given by the total rawmaterial consumption divided by the number of days in the year (say 360).The raw material conversion period is obtained when raw material inventoryis divided by raw material consumption per day.

Raw material conversion period = Raw material inventory

[Raw material consumption]/360

Work-in-progress conversion period

Work-in-progress conversion period is the average time taken to completethe semi-finished or work-in-progress. It is given by the following formula:

Work-in-progress conversion period = work-in-progress inventory

[Cost of production]/360

Finished goods conversion period

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Finished goods conversion period is the average time taken to sell thefinished goods. It can be calculated as follows-

FGCP= Finished goods inventory

[Cost of goods sold]/360

Debtors conversion period:

Debtors conversion period is the average time taken to convert debtors intocash. It represents the average collection period. It is calculated asfollows:

DCP= Debtors

[Credit sales]/360

b) cash conversion or Net operating cycle

Net operating cycle is the difference between Gross operating cycle andcreditors (payables) Deferral period.

Creditors deferral period:

Creditors deferral period is the average time taken by the firm in paying its

suppliers. It is calculated as follows:CDP= Creditors

[Credit purchases]/360

In practice, a firm may acquire resources (such as raw materials) on creditand temporarily postpone payment of certain expenses. Payables, which afirm can defer, are spontaneous sources of capital to finance investment in

current assets. The creditors deferral period is the length of time the firm isable to defer payments on various resource purchases.

Net operating cycle is also referred to as cash conversion cycle. It is thenet time interval between cash collections from sale of the product and cashpayments for resources acquired by the firm. It also represents the timeinterval over which additional funds, called working capital, should be

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Bank Of India Documents

AUTHORs PROFILE

NAME : ABHINAV KUMAR

INSTITUTE : NARSEE MONJEE INSTITUTE OF

MANAGEMENT STUDIES

COMPANY : BANK OF INDIA , MALAD WEST

E MAIL : [email protected]

MOBILE : 9833737734

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