Summer Internships 2010PGDM 2009-11

Summer Internship Project ReportOn

“Working Capital Finance”Undertaken at

SHREE CEMENT LTD.

Beawar

Prepared By:(Hitesh Nandwana)

(19)

Company Guide Faculty Guide (Mr. N.C Jain) (Dr. Pawan Gupta)(Assist. Vice president, finance) (Prof. Finance)

1

Certificate of Approval

The following Summer Internship Report titled "Working Capital Finance" is hereby

approved as a certified study in management carried out and presented in a manner

satisfactory to warrant its acceptance as a prerequisite for the award of Post-Graduate

Diploma in Business Management for which it has been submitted. It is understood that

by this approval the undersigned do not necessarily endorse or approve any statement

made, opinion expressed or conclusion drawn therein but approve the Summer Internship

Report only for the purpose it is submitted.

Summer Internship Report Examination Committee for evaluation of Summer Internship

Report

Organizational Guide : Signature ………………………………

: Name Mr. N. C Jain

: Designation Assist. Vice President, Finance

: Address: Bangur Nagar, post box no -33, Beawar

305901, Rajasthan, INDIA

: Tel No 09214337403

: Email jainnc@shreecementltd.com

2

Acknowledgement

At the outset, I offer my sincere thanks to SHREE CEMENTS LTD. for giving me an

opportunity to work on the project titled, “Working Capital Finance”.

It’s a moral responsibility of each individual to acknowledge the help of each individual

who has made your journey smoother for you. I would first like to thank my project guide

Mr. N.C. Jain (Assist. vice president, Finance) without whose support this report would

not have been possible. I appreciate him of giving me an option of selecting such a

wonderful project. The learning has been immense for me from this project.

I am highly grateful to the management at Shree Cement for giving me this opportunity

to work on a dream project and in the process harness myself with the huge learning on

all aspects.

Hitesh Nandwana

3

Executive summary

Objective

The main objective of this project is to get the practical knowledge of working capital management in the organization.

The aim of the project was to identify the working capital need of the company and various ways to finance it.

To get a good insight of cement industry.

To know the significance of proper working capital management.

To get the practical experience of industrial environment.

The scope of the project undertaken was:

Study of identification of working capital requirement of company.

Study various methods of financing working capital requirement.

Analysis of the findings and observations of the study.

Recommendations based on observations.

4

Table Of Contents

Executive summary..................................................................................................

The Indian Cement Industry...................................................................................

PORTLAND CEMENT...........................................................................................

The Cement Industry Structure...............................................................................

Major Cement Plants:.............................................................................................

Mini Cement Plants:...............................................................................................

Characteristics of Cement Industry........................................................................

Major Demand Drivers............................................................................................

Shree Cements Ltd...................................................................................................

Origin of the Company.............................................................................................

PRODUCTS..............................................................................................................

POLICIES.................................................................................................................

SWOT Analysis for Shree Cements........................................................................

AWARDS and recognition…………………………………………………………

A Brief about working Capital Financing ………………………………………..

Inventory Management ……………………………………………………………

Comparison with competitors……………………………………………………...

Forms of working capital fianacing………………………………………………..

RBI Guidelines about working capital financing…………………………………

Other modes of financing…………………………………………………………...

Computation of Working Capital Requirement of Shree Cement………………

5

Comparisions and analysis of net sale, net profit, current ratio from 2007-08 to

2011-12.

Various other modes available for the company…………………………………..

- Cash Credit & Overdraft facility……………………………………………….

- Term loans……………………………………………………………………….

- Preferred stocks………………………………………………………………….

- Right Issue……………………………………………………………………….

- FCNR (B) Loans………………………………………………………………….

- MIBOR linked Loans…………………………………………………………….

Results and conclusions………………………………………………………………

Some other Recommendations ………………………………………………………

References……………………………………………………………………………..

Exhibit…………………………………………………………………………………

6

THE INDIAN CEMENT INDUSTRY

The Indian Cement Industry dates back to 1914, with first unit were set up at Porbandar

with a capacity 1000 tonnes. Currently the Indian Cement Industry with a total capacity

of around 213 million tonnes (excluding mini plants) in FY 08-09, has surpassed

developed nations like USA and Japan and has emerged as the second largest market

after China. Although consolidation has taken place in the Indian Cement Industry with

the top 5 players almost 50% of the capacity, the remaining 50% of the capacity remains

pretty fragmented. India’s average consumption is still low and the process of catching up

with international averages will drive future growth. Infrastructure spending (particularly

on roads, ports and airports), a spurt in housing construction and expansion in corporate

production facilities is likely to spur growth in this area. South-East Asia and the Middle

East are potential export markets. Low cost technology and extensive restructuring have

made some of the Indian cement companies the most efficient across global majors.

Despite some consolidation, the industry remains somewhat fragmented and merger and

acquisition possibilities are strong. Investment norms including guidelines for foreign

direct investment (FDI) are investor-friendly. All these factors present a strong case for

investing in Indian market.

Now, the Indian cement industry was on a roll till the previous year but the slowdown in

India has also impacted the cement industry. Riding on increased activity in real estate,

the cement production in the year 2007-08 registered a growth of around 9.5% but in the

year 2008-09 it is around 7.5%.

During the Tenth Plan, the industry, which is ranked second in the world in terms of

production, is expected to grow at 10 percent per annum adding a capacity of 40-55

million tonnes, according to the annual report of the Department of Industrial Policy and

7

Promotion (DIPP). The report reveals that this growth trend is being driven mainly by the

expansion of existing plants and using more fly ash in the production of cement.

2.1 THE CEMENT INDUSTRY STRUCTURE

Presently the total installed capacity of Indian Cement Industry is more than 200 million

tonnes per annum, with a production around 184 million tonnes. The whole cement

industry can be divided into Major cement plants and Mini cement plants.

MAJOR CEMENT PLANTS:

Plants: 140

Typical installed capacity

Per plant: Above 1.5 mntpa

Total installed capacity : 195 mntpa

Production 08-09: 178 mntpa

All India reach through multiple plants

Export to Bangladesh, Nepal, Sri Lanka, UAE and Mauritius

Strong Marketing network, tie-ups with customers, contractors

Wide spread distribution network

Sales primarily through the dealer channel

8

MINI CEMENT PLANTS:

Nearly 300 plants located in Gujarat, Rajasthan, MP mainly

Typical installed capacity

Installed capacity around 9 mntpa

Production around : 6 mntpa

Mini plants were meant to tap scattered limestone reserves

Most of the plants use vertical kiln technology

Production cost / tonne – Rs 1,000 to Rs 1,400

Presence of these plants limited to the state

REGIONAL DIVISION

The Indian cement industry has to be reviewed in terms of five regions:-

North – Punjab, Delhi, Haryana, Himachal Pradesh, Rajasthan, Chandigarh, J&K

and Uttaranchal

West – Maharashtra and Gujarat

South – Tamil Nadu, Andhra Pradesh, Karnataka, Kerala, Pondicherry, Andaman

& Nicobar and Goa

East – Bihar, Orissa, West Bengal, Assam, Meghalaya, Jharkhand and

Chhattisgarh, and

Central – Uttar Pradesh and Madhya Pradesh

9

CENTRAL14%

EAST15%

WEST15%

NORTH23%

SOUTH33%

REGIONWISE CEMENT PRODUCTION

2.2 INDUSTRY CURRENT SCENARIO

SECTOR OUTLOOK

Indian Cement Industry is set to increase production capacity by 28.3 mt in FY09E, 41.4

mt in FY10E and 18.9 mt in FY11E. This will take the aggregate installed capacity to

~288 mt. In FY08, 21 mt of capacity was added. The Industry planned this massive

capacity expansion of 108 mt because they had never seen such a good run till FY2006.

During this period, the capacity utilization rate of the Industry reached an all time high

level of ~99% in FY08. In the period FY05 to FY08, cement demand grew at a CAGR of

10

10.5% and average retail price increased by a whopping 41% to Rs 230 per bag. Cement

manufacturers made huge profits and the Industry average per tonne of operating profits

crossed Rs 1100. Driven by theses profitability levels, average RoCE level of the

Industry crossed the 25% mark.

FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09E FY10E FY11E0

5

10

15

20

25

30

35

40

45

15.27.8

3.47.6 6.0 7.7

21.028.3

41.4

18.9

CAPACITY ADDTION (MTPA)

Cement Industry is set to add ~89 mn tonnes of capacity between FY09-FY11E, which

accounts for ~48% of FY08 installed capacity. We expect ~21 mt of capacity addition in

Q4FY09, followed by 41 mt of additional capacity in FY10 and 18.9 mt in FY11. Of the

new capacities, ~ 41 mt (~50%) is expected to be commissioned in the South, followed

by 13.3 mt (~16.4%) in the North and 13 mt (16.1%) in the East.

11

SHARE OF CAPACITY ADDITION (REGION-WISE AND TOP 5 GROUPS)

12

ANTICIPATED GROWTH IN CEMENT DEMAND

Housing construction accounts for around 60-65% of the total cement demand and the

balance comes from infrastructure sectors including roads, railways, ports and power,

among others. The demand for cement is directly linked to economic activity and has a

high correlation with GDP growth. Infrastructure investments and construction

activities, which are the major drivers of cement demand, are also key components of

GDP. Further, rural housing, which is a determinant of cement demand, depends on

agricultural productivity, which again is a key component of GDP.

Historical data of last 12 yrs shows that cement demand in India has increased at the rate

of 1.27x the growth rate of GDP. It is expected that cement consumption growth would

shrink over the next two years due to uncertain economic conditions and slowdown in

real estate construction activities. Cement demand will consequently grow by 8.7%, 7.6%

and 8.9% in FY09, FY10 and FY11 respectively.

FY05 FY06 FY07 FY08 FY09E FY10E FY11E0%

20%

40%

60%

80%

100%

120%

86.1%91.5%

97.0% 98.7%

87.6% 84.5%79.5%

CAPACITY UTILIZATION (%)

13

CAPACITY EXPANSION TO WEAKEN PRICING POWER

It is believed that the capacity expansion program will only weaken the pricing power

and profitability of the companies in the future. In a scenario where oversupply is

inevitable, companies could try to increase their market share by decreasing their prices,

leading to a possible price war.

Economic Analysis

-Key Economic Indicators

World GDP, also known as world gross domestic product or GWP - gross world product,

calculated on a nominal basis, was estimated at $65.61 trillion in 2007 by the CIA World

Fact book. While the US is the largest economy, growth in world GDP of 5.6% was led

by China (11.9%) and India (7.2%)

14

Inflation worldwide

The recessionary pressures felt across the globe resulted in a massive decline in the supply of money. This, in turn, affected commodity prices, resulted in low inflation rates

15

Higher degrees of inflation, particularly in two digits, will defeat all business planning, lead to cost escalations and squeeze on profit margins. These will adversely affect the performance of industry and companies.

Unemployment Rates:

16

Interest rates: the rate offered on overnight deposits by the Central Bank or other authority

17

If interest rates increase across the board, then investment decreases, causing a fall in national income.

CEMENT MANUFACTURING

RAW MATERIAL PREPARATION

Limestone of differing chemical composition is freely

available in the quarries. This limestone is carefully

blended before being crushed. Red mineral is added to the

limestone at the crushing stage to provide consistent

chemical composition of the raw materials. Once these

18

materials have been crushed and subjected to online chemical analysis they are blended

in a homogenized stockpile. A bucket wheel reclaimer is used to recover and further

blend this raw material mix before transfer to the raw material grinding mills.

Transport belt conveyor transfers the blended raw materials to ball mills where it is

ground. The chemical analysis is again checked to ensure excellent quality control of the

product. The resulting ground and dried raw meal is sent to a homogenizing and storage

silo for further blending before being burnt in the kilns.

FUELS

The heat required to produce temperatures of 1,800°C at the

flame is supplied by ground and dried petroleum coke and/or

fuel oil. The Petcoke is imported via the companies' internal

wharf, stored and then ground in dedicated mills. Careful

control of the mills ensures optimum fineness of the Petcoke

and excellent combustion conditions within the kilns system.

BURNING

The raw meal is fed into the top of a pre-heater tower

equipped with four cyclone stages. As it falls, the meal is

heated up by the rising hot gases and reaches 800°C. At this

temperature, the meal dehydrates and partially decarbonizes.

The meal then enters a sloping rotary kiln, which is heated

by a 1,800°C flame, which completes the burning process of the meal. The meal is heated

19

Fig 2: Inside of Kiln

Fig 3: Central Control Room

to a temperature of at least 1,450°C. At this temperature the chemical changes required to

produce cement clinker are achieved. The dry process kiln is shorter than the wet process

kiln and is the most fuel-efficient method of cement production available.

COOLER UNITS

The clinker discharging from the kiln is cooled by air to a

temperature of 70°C above ambient temperature and heat

is recovered for the process to improve fuel efficiency.

Some of the air from the cooler is de-dusted and supplied

to the coal grinding Plant. The remaining air is used as

preheated secondary air for the main combustion burner in

the kiln. Clinker is analyzed to ensure consistent product quality as it leaves the cooler.

Metal conveyors transport the clinker to closed storage areas.

FILTERS

Dedicated electrostatic precipitators dedust the air and gases used in the Clinker

Production Line Process. In this way, 99.9% of the dust is collected before venting to the

atmosphere. All dust collected is returned to the process.

CONSTITUENTS

Different types of cement are produced by mixing and weighing proportionally the

following constituents:

Clinker

20

Fig 4: Cement Plant

Gypsum

Limestone addition

Blast Furnace Slag

Fig 5: Cement manufacturing from the quarrying of limestone to the bagging of cement.

TYPES OF CEMENT:

Cements are of two basic types – grey cement and white cement. Grey cement is used only for construction purposes while white cement can be put to a variety of uses. It is used for mosaic terrazzo flooring and certain cements paints. It is used as a primer for

21

paints besides has a variety of architectural uses. The cost of white cement is approximately three times that of grey cement. White cement is more expensive because its production cost is more and excise duty on white cement is also higher. Shree Cement does not manufacture white cement at present.

Pozzolona used in the manufacture of Portland cement is burnt clay of fly ash generated

at thermal power plants. PPC is hydraulic cement. PPC differs from OPC on a number of

counts. Pozzolona during manufacturing consumes lot of hydration heat and forms

‘cementious gel’. Reduced heat of hydration leads to lesser shrinkage cracks. An

additional gel formation leads to lesser pores in concrete or mortar. It also minimizes

problem of leaching and efflorescence.

22

CEMENT

GREY WHITE

PORTLAND POZZOLONA ORDINARY PORTLAND

Cement Value Chain

23

Proportioning and mixing of

raw material

Crushing

Raw MaterialGri

nding

Homogenizing and

Blending SiloPre-

heater

Kiln

ClinkerCooler

Clinker Grinding

and Cooling

Packaging

DUST

DUST

DUST(chimney)

NOISE

Fuel gases

Fuel gases

DUST

DUST

NOISE(work place)

DISTRIBUTION MODEL OFCEMENT :

24

INDUSTRY

MAIN DISTRIBUTION

CENTRE

REGIONAL DISTRIBUTION CENTRE

WARE HOUSE-PUNE

DHAKKA,KHADKI DHAKKA,LONI

DHAKKA.

DISTRIBUTORS

DEALERS

Primary distribution

End users

Characteristics of Cement Industry

This section describes the basic economic characteristics of the cement industry by

following the classical approach which consists of successively examining demand,

supply and market structure. On the basis of these characteristics are described the main

economic stakes in the sector.

Demand &Market

Demand in the cement industry is typically that of an activity which is mature, cyclical

and with low price elasticity. It is also characterized by a high degree of horizontal

differentiation in terms of location and a low degree of vertical differentiation in terms of

quality.

Cement is an homogeneous product. Most of its sales concern about half a dozen

commercial varieties, of which Portland cement is by far the leader. No brand name

exists, so that one supplier’s products can easily be substituted for another. Cement is,

however, an experience good; its quality is guaranteed by standards with which the

supplier has to comply. These standards are often national but in most cases the products

of one country can easily be approved in neighbouring countries. Standards therefore do

not constitute trade barriers as such, even if they may hinder trade.

The demand for cement is geographically widely dispersed and corresponds

roughly to population density. Although cement is an upstream industry, it differs from

other basic industries such as aluminium, steel or glass, for which demand id

concentrated both geographically and in terms of the number of customers. In the cement

industry demand is by, by contrast, dispersed in multiple zones of consumption, each of

which comprises numerous customers. Geographical factors thus determine the structure

of the market.

25

a) Maritime Model b) Land Model

The above figure adapted from Tanguy (1987), illustrates this phenomenon. On the left,

producers compete on a major market; on the right, each producer is relatively isolated on

its natural market. These two extreme cases – called the maritime and the land model,

respectively, by Dumez and Jeunemaitre (2000), as well as all the possible intermediate

forms, constitute the playing field of the cement industry. The traditional playing field is

the land model, but the maritime model takes over when communication over vast

distances becomes possible.

Supply

Two economic considerations are important a priori in structuring supply in a market

characterized by strong horizontal differentiation:

The trade-off between fixed costs and transport costs which, depending on the

economic size of the factories, gives an initial idea of the density of the network of

production units covering the territory, in relation to the density of demand

The level of investment costs and the life-span of facilities which determine the

rigidity and the duration of the network.

26

Major Demand Drivers

Present Demand drivers

Infrastructure & construction sector the major demand drivers. Some demand

determinants

 Economic growth

 Industrial activity

 Real estate business

 Construction activity

 Investments in the core sector

Growth in mortgage business in retail housing

Higher surplus income of household

Opportunities

growth in the housing sector

central road fund established for national  highways and railway over bridges to

provide the necessary impetus

expansion plans, Greenfield projects on the anvil

Demand – supply balance expected in the next 12 – 15 months

Encouraging trend in demand due to pick-up in rural housing demand and industrial

revival

Industry likely to grow at 8-10% in the next few years.

27

MAJOR PLAYERS IN CEMENT INDUSTRY:

SHREE CEMENT LTD

Shree Cement Ltd is a Rajasthan based company, located at Beawar. The company has

installed capacity of 10.2 mn tonnes per annum in Rajasthan. It is a leading cement

manufacture company in North India and has been participating in the infrastructure

transformation of India for over two decades now. It started operations in the year 1985

and has been growing ever since. Its manufacturing units are located at Beawar, district

Ajmer, and Ras, district Pali, in Rajasthan. It also has grinding units at Khushkhera,

district Alwar in Rajasthan, near Gurgaon.. It has three brands under its portfolio viz.

Shree Ultra Jung Rodhak Cement, Bangur Cement and Rockstrong Cement. The multi-

brand strategy makes Shree the number one cement player in Rajasthan, Haryana and

Delhi. The company has also established two grinding units one at Suratgarh (Rajasthan)

and another at Roorke (Uttaranchal),.

GUJARAT AMBUJA CEMENT LIMITED

GACL was set up in 1986 with 0.7 million tonnes. The capacity has grown 25 times since

then to 18.5 million tonnes. GACL exports as much as 15 percent of its production. 35%

of the company products transported are by sea which is the cheapest mode. It has earned

the reputation of being the lowest cost producer in the cement industry. Ambuja cement

is one of GACL’s well established brands. The company plans to increase capacity by 3-

4 million tonnes in the near future.

ACC LIMITED

28

Being formed in 1936, ACC has a capacity of 22.40 million (0.53 million tonnes of

Damodar Cement and Slag and 0.96 million tonnes of Bargarh Cement). ACC Super is

one of the company’s well established brands. It is planning to expand the capacity of its

wholly-owned subsidiary Damodar Cement and Slag at Purulia in West Bengal. This is

aimed at increasing its presence in the eastern region.

THE ADITYA BIRLA GROUP

The Aditya Birla Group is the world’s eight largest cement producer. The first cement

plant of Grasim, the flagship of the Aditya Birla Group, at Jawad in Madhya Pradesh

went on stream in 1985. In total, Grasim has five integrated grey cement plants and six

ready-mix concrete plants. The company is India’s largest white cement producer with a

capacity of 4 lakh tonnes. It has one of the world’s largest white plants at Kharia Khangar

(Rajasthan). Shree Digvijay Cement, a subsidiary of Grasim, which was acquired in

1998, has its integrated grey cement plant at Sikka (Gujarat). Finally Grasim acquired

controlling stake in Ultra Tech Cement Limited (Ultra Tech), the demerged cement

business of L&T. Grasim has a total cement capacity of 31 million tonnes and eyeing to

increase it to 48 MT by FY 09. Grasim has a portfolio of national brands which include

Birla Super, Birla Plus, Birla White and Birla Ready mix and also regional brands like

Vikram Cement and Rajshree Cement.

BINANI CEMENT

A fierce competition with a 2.2 MTPA plant is located at Binanigram, Pindwara, a village

in Sirobi in the state of Rajasthan. It’s a tough nut player which is outside CMA (Cement

Manufacturer’s Association) and is prime reason for driving prices low in markets. Offers

a good quality product at cheap rates and has very good brand image. Sales are focused in

the North India, Gujarat and Rajasthan. It holds around 14% of the Rajasthan market.

29

JK

An entrenched competitor that has brands across the price spectrum with JK Nembahera

leading the pack. Also operates in the white cement market with Birla as its only

competitor. It lost significant market when Ambuja came to Rajasthan.

Others

Other players like Shriram have insignificant share and are highly localized. Shriram has

a small presence and that too largely in southern Rajasthan. There are various mini plants

operating too which supply cheap cement which has no ISI certification and does not

confirm BIS standards. Quite often they are supplied in other established brand’s cement

bags. L&T is a strong player nationally and regarded as quality product. It has a footprint

but not a foothold in Rajasthan market

ABOUT THE ORGANISATION

C O M P A N Y P R O F I L E

COMPANY Shree Cement Ltd.

INCORPORATION YEAR 1979

REGISTERED OFFICEBangur Nagar, Beawar, Ajmer

(Rajasthan)

CORPORATE OFFICE 21, Strand Road, Kolkata

INDUSTRY Cement Manufacturing

CHAIRMAN B.G. Bangur

MANAGING DIRECTOR H.M. Bangur

30

EXECUTIVE DIRECTOR M.K. Singhi

Shree Cements Ltd.

Shree Cements Ltd. is a Rajasthan based company, located at Beawer. The company has

installed capacity of 10.2 mtpa tones per annum in Rajasthan.. For the last 18 years, it has

been consistently producing many notches above the nameplate capacity. The company

retains its position as north India’s largest single-location manufacturer. Shree’s principal

cement consuming markets comprise Rajasthan, Delhi, Haryana, Punjab, Uttar Pradesh

and Uttranchal. Shree manufactures Ordinary Portland Cement (OPC) and Portland

Pozzolana Cement (PPC). Its output is marketed under the Shree Ultra Ordinary Portland

Cement’ and ‘Shree Ultra Red Oxide jung rodhak Cement’ brand names.

THE SHREE VISION

Vision “To drive and sustain industry leadership Within a global context - by developing individual Competencies at every level, through a robust Trust, support, innovation and reward”

Guiding Principles Enforce good corporate governance practices Encourage integrity of conduct Ensure clarity and unambiguity in communication Remain accountable to all stakeholders Encourage socially responsible behavior

Mission

To harness sustainability through low carbon philosophy To sustain its reputation as one of the most efficient manufacturers globally. To continually have most engaged team

31

To drive down cost through innovative practices To continually add value to its products and operations meeting expectations of all its stakeholders To continually build and upgrade skills

And competencies of its human resource for growth To be a responsible corporate citizen with total commitment to communities in which it operates and society at large

Marketing

Shree caters to cement demand arising in Rajasthan, Delhi, Haryana, UP and Punjab.

What is strategic for SCL is that it is located in central Rajasthan so it can cater to the

entire Rajasthan market with the most economic logistics cost. Also, Shree Cement is the

closest plant to Delhi and Haryana among all cement manufacturers in its state and

proximity to these profitable cement markets renders the company an edge over other

cement companies of the company in terms of lower freight costs. SCL has a 160 MW

captive thermal power plant, which has achieved over 90 per cent load factor. In 2000-01,

the company has succeeded in substituting conventional coke with 100 per cent pet coke,

a waste from refineries, as primary fuel resulting in lower inventory and input costs. In

the past two years the price of coal has gone up. Earlier dependent on good quality

imported coal, the company's switch to pet coke could not have come at a better time.

The company also replaced indigenous refractory bricks with imported substitutes,

reducing its consumption per tonne of clinker. The company has one of the most energy

efficient plants in the world. The captive plant generates power at a much lower cost of

Rs 2.5 per unit (excluding interest and depreciation) as compared to over Rs 5 per unit

from the grid. In appreciation of its achievements in Energy sector, the Company has

been awarded the prestigious 'National Energy Conservation Award" various times. Shree

is rated best by Whitehopleman, an international agency specializing in the rating of

cement plants.

32

PRODUCTS

Following are the various products of Shree Cements Ltd.

1 Shree Ultra Red Oxide Jung Rodhak Cement (ROC)

2 Shree OPC

3 Bangur Cement

4 Rockstrong Cemento

POLICIES:

Quality Policy:

To provide products conforming to national standards and meeting customers

requirements to their total satisfaction.

To continually improve performance and effectiveness of quality management

system by setting and reviewing quality objectives for –

a) Customer satisfaction

b) Cost effectiveness

Energy Policy :

To reduce to the maximum extent possible the consumption of energy without

impairing productivity which should help in:

Increase in the profitability of the company

Conservation of Energy

33

Reduction in Environmental pollution at Energy producing areas.

Environment Policy :

To ensure:

Clean, green and healthy environment

Efficient use of natural resources, energy, plant and equipment

Reduction in emissions, noise, waste and greenhouse gases

Continual improvement in environment management

Compliance of relevant environment legislation

Water Policy :

To provide sufficient and safe water to people and plant as well as to conserve

water, we are committed to efficient water management practices viz.

Develop means and methods for water harvesting

Treatment of waste discharge water for reuse

Educate people for effective utilization and conservation of water

Water audit and regular monitoring of water consumption

Health and Safety Policy :

To ensure good health and safe environment for all concerned by:

Promoting awareness on sound health and safe working practices

Continually improving health and safety performance by regularly setting and

reviewing objectives and targets

Identifying and minimizing injury and health hazards by effective risk control

measures

Complying with all applicable legislations and regulations

Human Resource Policy:

Shree Cement is committed to:

34

Empower people

Honour individuality of every employee

Non discrimination in recruitment process

Develop Competency

Employees shall be given enough opportunity for betterment

None of the person below the age of 18 shall be engaged to work

Incidence of Sexual harassment shall be viewed seriously

To follow Safety & Health, Quality, Environment, Energy policy

ADVERTISING

Need for Advertising:-

Cement has evolved into a highly commoditized product category. Due to

competitive pricing within the industry, there was not much differentiation among

the various brands on offer.

People too did not pay much attention to this product unless there was a need felt.

Hence people who were currently making their houses or were soon to embark on

such a project became the target market.

Because of the product being commoditized, there was a need for differentiation

for which there were some changes made to the product.

Shree Cement Ltd was not advertising its products for the past few years but looking at

the competitive market and opportunities ahead it introduced a new ad campaign which

was targeted to differentiate its products from other cement brands. It introduced an ad

campaign showing the anti rusting capability of the Red Oxide Cement of the company.

But still the presence of the company has not been as intense as other brands have like

Ambuja and Grasim etc.

35

for govt infrastructure buildingGovt. Housing ProjectsRailwaysAirportsCement RoadsBridgesDamsCanalsThese are all bulk requirements

Shree Cement and its

market

Trade and Non-

Trade Networks

There are two types of Networks: Trade and Non-trade

a) Non-trade Network Non-trade Network:

36

Govt. Non-trade Private Non-trade

- for Group housing / retail housing

- Contractor’s projects on behalf of govt.

- Any industrial projects taken up by the private sector like bridges, roads etc.

b) Trade Network

Company Handling Agent Stockiest Retailers

Consumers

SWOT ANALYSIS

Strength and weaknesses are essentially internal to the organization and relate to the matterConcerning resources, programmes and organization in key areas such as• Sales• Marketing• Capacity• Manufacturing cost etc

Opportunity and Threat are external to the organization and can exist or develop in thefollowing areas• Size & Segmentation• Growth pattern and maturity• International dimensions• Relative attractive of segments• New Technologies etc

STRENGTH Company is established in Beawar where most of the land is rocky and

material is suitable for the production of cement, thus it is closely bound to the resources.

Specific chemical composition which makes it co erosion free and also have very Good chemical recovery efficiency.

Company has its own electricity production unit thus need not to depend on the Availability of power n dependency on electricity department.

Well transport facility; it has its own railway track. Leading brand in north India. Thus people give preference to the brand. Maintain a very good customer loyalty and relationship. A very superior production quality thus customer is always satisfied.• Upper level of management is too skillful.

37

Weakness• Poor access of distribution.• Very less advertising thus in other part of country it’s not as popular.• Technical knowledge is less at lower level of employee, which is draw back for

Achieving maximum profit.• It’s difficult for them to change to an alternate line o production with existing

Machinery.

Opportunities• Changing customer taste, thus they may get the market from the switchers.• Liberalization of geographic works, thus they can enter into different market.• Huge land available for expansion of business in future.• Govt. is planning for betterment on infra structure thus there will be huge

demand for cement.• Booming real estate sector.• Good relation with bankers thus for expansion of business they need not to

look too far.

Threats• Changing customer taste, any time they may switch to other.• Advancement in technology.• Entry of new player.• Few major players are situated near the main plant thus market share is difficult to

Increase.• Change in Govt. policy as they may increase the tax.• Non availability on raw material.• Labor and higher technical personnel may switch to another plants.

AWARDS OF THE COMPANY

4 star rating from Whitehopleman UK, an International Cement Consultants, since 2000 (No one in world has been rated 5 star!!

Reckoned as 2nd fastest growing mid sized Company in 2006 by “Business Today” a national level magazine (6 May 07 edition

38

Golden Peacock Award - 2007 for Excellence in Corporate Governance

Golden Peacock Award - 2007 in recognition of excellent Environment Management practices

National Awards for Energy Conservation from Ministry of Power, Govt of India

CII National Award for Excellence in Energy Management 2006

National Safety Award awarded by the Honorable President of India, Smt. Pratibha Patil

Best Annual Report Award by Rajasthan Chamber of Commerce and Industry in 2007

“Amity Corporate Excellence Award” by Amity International Business School, Noida.

ICWAI National Award 2005 for excellence in cost management

Green-Tech Environment Excellence Award

Golden Peacock Award for Combating Climate Change

Corporate Excellence Award by Rajasthan Chamber of Commerce & Industry (RCCI) in all four categories namely Corporate Governance & Capital Market, Financial Performance & Analysis, Business & Qualitative Aspects and Annual Report Presentation as well as Management

SILVER CIO Award by the CIOL Dataquest Enterprise Connect Awards 2008.

Note: Recently their name is registered for Limca book of Records (National Records 2010), for the completion of 1 new mtpa plant in a record 12 months –from march 23, 2008 to march 24, 2009.

A Brief about ‘Working Capital’ –

39

The term working capital has several meanings in business and economic

development finance.

• In accounting and financial statement analysis, working capital is defined as the firm’s

short-term or current assets and current liabilities. Net working capital represents the

excess of current assets over current liabilities and is an indicator of the firm’s ability

to meet its short-term financial obligations.

• From a financing perspective, working capital refers to the firm’s investment in two

types of assets. In one instance, working capital means a business’s investment in

short-term assets needed to operate over a normal business cycle. This meaning

corresponds to the required investment in cash, accounts receivable, inventory, and

other items listed as current assets on the firm’s balance sheet. In this context, working

capital financing concerns how a firm finances its current assets.

• Another broader meaning of working capital is the company’s overall non-fixed asset

investments. Businesses often need to finance activities that do not involve assets

measured on the balance sheet. For example, a firm may need funds to redesign its

products or formulate a new marketing strategy, activities that require funds to hire

personnel rather than acquiring accounting assets. When the returns for these “soft

costs” investments are not immediate but rather are reaped over time through increased

sales or profits, then the company needs to finance them. Thus, working capital can

represent a broader view of a firm’s capital needs that includes both current assets and

other non-fixed asset investments related to its operations.

In this study, the last meaning of working capital has been used and the tools and

issues involved in financing these business investments have been focussed.

Uses of Working Capital in businesses-

40

Just as working capital has several meanings, firms use it in many ways. Most

fundamentally, working capital investment is the lifeblood of a company. Without it, a

firm cannot stay in business.

• Thus, the first, and most critical, use of working capital is providing the ongoing

investment in short-term assets that a company needs to operate.

A business requires a minimum cash balance to meet basic day-to-day expenses

and to provide a reserve for unexpected costs. It also needs working capital for prepaid

business costs, such as licenses, insurance policies, or security deposits. Furthermore, all

businesses invest in some amount of inventory, from a law firm’s stock of office supplies

to the large inventories needed by retail and wholesale enterprises. Without some amount

of working capital finance, businesses could not open and operate.

• A second purpose of working capital is addressing seasonal or cyclical financing

needs.

Here, working capital finance supports the build-up of short-term assets needed to

generate revenue, but which come before the receipt of cash. For example, a cement

manufacturer must produce and ship its products for the construction season several days

before it receives cash payment from the dealers. Since most businesses do not receive

prepayment for goods and services, they need to finance these purchase, production,

sales, and collection costs prior to receiving payment from customers. Figure below

illustrates this short-term cash flow and financing cycle.

41

CASHAR converted to cash

Another way to view this function of working capital is providing liquidity. Adequate and

appropriate working capital financing ensures that a firm has sufficient cash flow to pay

its bills as it awaits the full collection of revenue. When working capital is not

sufficiently or appropriately financed, a firm can run out of cash and face bankruptcy. A

profitable firm with competitive goods or services can still be forced into bankruptcy if it

has not adequately financed its working capital needs and runs out of cash.

Working capital is also needed to sustain a firm’s growth. As a business grows, it

needs larger investments in inventory, accounts receivable, personnel, and other items to

realize increased sales. New facilities and equipment are not the only assets required for

growth; firms also must finance the working capital needed to support sales growth.

• A final use of working capital is to undertake activities to improve business operations

and remain competitive, such as product development, ongoing product and process

improvements, and cultivating new markets.

42

SALES ORDER

PRODUCE GOODS OR SERVICES

COLLECTS A/C RECEIVABLES

DELIVERS GOODS OR SERVICES

CASH CONVERTED TO PREPAID EXPENSES AND INVENTORY

Goods or Services converted to

Accounts

With firms facing heightened competition, these improvements often need to be

integrated into operations on a continuous basis. Consequently, they are more likely to be

incurred as small repeated costs than as large infrequent investments. This is especially

true for small firms that cannot afford the cost and risks of large fixed investments in

research and development projects or new facilities. Ongoing investments in product and

process improvement and market expansion, therefore, often must be addressed through

working capital financing.

Permanent and Cyclical Working Capital –

Firms need both a long-term (or permanent) investment in working capital and a

short-term or cyclical one. The permanent working capital investment provides an

ongoing positive net working capital position, that is, a level of current assets that

exceeds current liabilities. This allows the firm to operate with a comfortable financial

margin since short-term assets exceed short-term obligations and minimizes the risk of

being unable to pay its employees, vendors, lenders, or the government (for taxes).

To have positive net working capital, a company must finance part of its working

capital on a long-term basis. Since total assets equal total liabilities and owner’s equity,

when current assets exceed current liabilities, this excess is financed by the long-term

debt or equities. Following figure demonstrates this point graphically.

Part of Current Assets Financed by Short term loans

43

Current Assets (CA)

Part of Current Assets Financed by long term loans

Part of long term loans Financed by long term loans

For current assets to be greater than current liability, long-term debt and equity must

finance part of area CA. Beyond this permanent working capital investment, firms need

seasonal or cyclical working capital. Few firms have steady sales and production

throughout the year. Since the demand for goods and services varies over the course of a

year, firms need to finance both inventories and other costs to prepare for their peak sales

period and accounts receivable until cash is collected. Cyclical working capital is best

financed by short-term debt since the seasonal build-up of assets to address seasonal

demand will be reduced and converted to cash to repay borrowed funds within a short

predictable period. By matching the term of liabilities to the term of the underlying

assets, short-term financing helps a firm manage inflation and other financial risks. Short-

term financing is also preferable since it is usually easier to obtain and priced lower than

long-term debt.

Working capital financing is a key financing need and challenge for small firms.

Small businesses have less access to long-term sources of capital than large businesses,

including limited access to equity capital markets and fewer sources of long-term debt.

Thus, many small firms are heavily dependent on short-term debt, much of which is tied

to working capital. However, limited equity and reliance on short-term debt increases the

44

Long term Assets

demand on a firm’s cash flow, reduces liquidity, and increases financial leverage—all of

which heighten the financial risks of extending credit. Consequently, small firms may

have trouble raising short-term debt while at the same time facing obstacles to securing

the longer-term debt necessary to improve their financial position and liquidity, and

lessen their credit risk. Development finance has an important role in addressing this

problem, either by offering working capital loans when private loans are not available or

by providing debt terms that reduce a firm’s financial risk and help it access private

working capital financing.

Working Capital Management

Working capital management is a managerial accounting strategy focusing on

maintaining efficient levels of both components of working capital, current assets and

current liabilities, in respect to each other. Working capital management ensures a

company has sufficient cash flow in order to meet its short-term debt obligations and

operating expenses.

Implementing an effective working capital management system is an excellent way for

many companies to improve their earnings. The two main aspects of working capital

management are

1. Ratio analysis and

2. Management of individual components of working capital.

A few key performance ratios of a working capital management system are the working

capital ratio, inventory turnover and the collection ratio. Ratio analysis will lead

management to identify areas of focus such as inventory management, cash management,

accounts receivable and payable management.

45

Working Capital Cycle

Cash flows in a cycle into, around and out of a business. It is the business's life

blood and every manager's primary task is to help keep it flowing and to use the cashflow

to generate profits. If a business is operating profitably, then it should, in theory, generate

cash surpluses. If it doesn't generate surpluses, the business will eventually run out of

cash and expire.

The faster a business expands the more cash it will need for working capital and

investment. The cheapest and best sources of cash exist as working capital right within

business. Good management of working capital will generate cash will help improve

profits and reduce risks. The cost of providing credit to customers and holding stocks can

represent a substantial proportion of a firm's total profits.

There are two elements in the business cycle that absorb cash –

Inventory (raw material, work-in-progress and finished goods) and

Receivables (debtors owing you money).

The main sources of cash are

Payables (your creditors) and

Equity and Loans.

If you can get money to move faster around the cycle (e.g. collect monies due from

debtors more quickly) or reduce the amount of money tied up (e.g. reduce inventory

levels relative to sales), the business will generate more cash or it will need to borrow

less money to fund working capital. As a consequence, you could reduce the cost of bank

interest or you'll have additional free money available to support additional sales growth

or investment. Similarly, if you can negotiate improved terms with suppliers e.g. get

46

longer credit or an increased credit limit, you effectively create free finance to help fund

future sales.

Cash Conversion Cycle

The cash conversion cycle is a measure of working capital efficiency, often giving

valuable clues about the underlying health of a business. The cycle measures the average

number of days that working capital is invested in the operating cycle. It starts by adding

days inventory outstanding (DIO) to days sales outstanding (DSO). This is because a

company "invests" its cash to acquire/build inventory, but does not collect cash until the

inventory is sold and the accounts receivable are finally collected.

Receivables are essentially loans extended to customers that consume working

capital; therefore, greater levels of DIO and DSO consume more working capital.

However, days payable outstanding (DPO), which essentially represent loans from

vendors to the company, are subtracted to help offset working capital needs. In summary,

the cash conversion cycle is measured in days and equals DIO + DSO – DPO:

Handling Receivables (Debtors)

47

Cashflow can be significantly enhanced if the amounts owing to a business are

collected faster. Every business needs to know.... who owes them money.... how much is

owed.... how long it is owing.... for what it is owed. Slow payment has a crippling effect

on business; in particular on small businesses who can least afford it. If you don't manage

debtors, they will begin to manage your business as you will gradually lose control due to

reduced cashflow and, of course, you could experience an increased incidence of bad

debt. The following measures will help manage the debtors:

Have the right mental attitude to the control of credit and make sure that it gets the

priority it deserves.

Establish clear credit practices as a matter of company policy.

Make sure that these practices are clearly understood by staff, suppliers and

customers.

Be professional when accepting new accounts, and especially larger ones.

Check out each customer thoroughly before you offer credit. Use credit agencies,

bank references, industry sources etc.

Establish credit limits for each customer... and stick to them.

Continuously review these limits when you suspect tough times are coming or if

operating in a volatile sector.

Keep very close to your larger customers.

Invoice promptly and clearly.

Consider charging penalties on overdue accounts.

Consider accepting credit /debit cards as a payment option.

Monitor your debtor balances and ageing schedules, and don't let any debts get too

large or too old.

Recognize that the longer someone owes you, the greater the chance you will never get

paid. If the average age of your debtors is getting longer, or is already very long, you may

need to look for the following possible defects:

48

weak credit judgement

poor collection procedures

lax enforcement of credit terms

slow issue of invoices or statements

errors in invoices or statements

customer dissatisfaction

Debtors due over 90 days (unless within agreed credit terms) should generally demand

immediate attention. Look for the warning signs of a future bad debt. For example.........

longer credit terms taken with approval, particularly for smaller orders

use of post-dated checks by debtors who normally settle within agreed terms

evidence of customers switching to additional suppliers for the same goods

new customers who are reluctant to give credit references

receiving part payments from debtors.

Managing Payables (Creditors)

Creditors are a vital part of effective cash management and should be managed carefully

to enhance the cash position. Purchasing initiates cash outflows and an over-zealous

purchasing function can create liquidity problems. Consider the following:

Who authorizes purchasing in the company - is it tightly managed or spread

among a number of (junior) people?

Are purchase quantities geared to demand forecasts?

Do you use order quantities which take account of stock-holding and purchasing

costs?

Do you know the cost to the company of carrying stock?

49

Do you have alternative sources of supply? If not, get quotes from major suppliers

and shop around for the best discounts, credit terms, and reduce dependence on a

single supplier.

How many of your suppliers have a returns policy?

Are you in a position to pass on cost increases quickly through price increases to

your customers?

If a supplier of goods or services lets you down can you charge back the cost of

the delay?

Can you arrange (with confidence !) to have delivery of supplies staggered or on a

just-in-time basis

Inventory Management

1.0 Definition of Inventory:

The Dictionary meaning of Inventory is 'a list of goods'. In a wider sense,

inventory can be defined as an idle resource which has an economic value. It is

however, commonly used to indicate various items of stores kept in stock in order

to meet future demands.

o In any organization, there may be following four types of inventory:

(a) Raw materials & parts-- These may include all raw materials,

components and assemblies used in the manufacture of a product;

(b) Consumables & Spares -- These may include materials required for

maintenance and day-to-day operation;

(c) Work in progress -- These are items under various stages of production

not yet converted as finished goods;

(d) Finished Products -- Finished goods not yet sold or put into use.

50

1.1 Need for Inventory: Many of the items needed for day-to-day maintenance

and operation are required to be specially manufactured. The time to procure these

materials, therefore, is longer due to various reasons and it is not possible to

procure these materials when instantaneously required. It is, therefore, necessary

to keep stocks of such items.

Even for those items which are readily available in the market, it

may not be economical to buy these items every time as buying in

piecemeal involves additional costs to the administration. Therefore,

we may find it cheaper to buy in bulk and to stock some of these

items and supply our indentors through such stocks.

There are always some fluctuations in demand as well as

fluctuations in the time within which material can be procured. It is

therefore, not possible to forecast our requirements exactly and time

the purchases in such a way so that the materials will arrive just

when they are physically required. It, therefore, becomes necessary

to maintain stocks of these items.

1.2 Basic Problems of Inventory Management : From the above discussions, it

will be seen that on the one hand inventories are idle and valuable resource i.e.

capital remains locked up in the inventories which can be used for other

productive purposes but on the other hand, they are desirable to satisfy

manufacturing, maintenance or operation requirement of the organization. Hence

basic problem of inventory management is to optimize the stock levels of different

materials so that their stocks are maintained at optimum levels without affecting

the production or day-to-day maintenance. Three basic problems associated with

this optimization of stocks are;

(a) When to initiate purchase of the materials

51

(b) How much quantities are to be purchased at a time and

(c) What should be the stock levels of different items.

2.0 Various Costs Related To Inventory Management :

2.1 Costs of Ordering or Costs of Acquisition: For a large organization, it

becomes necessary to have a separate purchase office to purchase thousands of

items. The demands received are technically scrutinized and for purchasing them,

inquiries are issued, tenders are received and evaluated, orders are progressed,

materials are received and inspected and lastly, the payments are arranged. All

these mean additional costs to the organization. All these costs together constitute

what is called cost of ordering or cost of acquisition.

o But it is necessary that for a given stores organization, total number of

purchases are ascertained and average cost per purchase order worked out.

When we work out the costs, we may find that some costs are fixed while

some are variable. We should be interested in knowing the variable costs.

o Three major systems of purchasing are advertised tender, limited tender and

cash purchase systems. It is advisable to work out the ordering costs for

these three different procedures of purchasing.

o Thumb rules used in the industry for these costs are as follows:

Cash Purchase Rs.50 to Rs.100 per purchase

Limited Tender Purchase Rs.300 to Rs.600 per purchase

Advertised Tender Purchase Rs.1000 to Rs.2000 per purchase

o These are just approximate and may vary considerably depending upon

various factors. Every company should establish these costs from time to

time so that they can be used in designing proper inventory models.

52

2.2 Inventory Carrying Costs: The very fact that the items are required to be

kept in stock means additional expenditure to the organization. The different

elements of costs involved in holding inventory are as follows:

(a) Interest on capital / cost of capital / opportunity costs: When

materials are kept in stock, money representing the value of materials is

blocked. In a developing economy, capital is extremely scarce and as such,

the real value of capital is much higher than the nominal rate of interest.

The money which is blocked up is not available to the organization to do

more business or to use it for alternative productive investment. This

opportunity to earn more profits which we lose can be expressed as

opportunity cost.

o While working out the inventory carrying cost in an organization, the

higher of the three factors viz., interest, cost of capital or opportunity cost

should, be taken into consideration. This may be roughly 20% per annum.

(b) Obsolescence and depreciation: The costs because of obsolescence

and depreciation are very important even though they are very difficult to

assess. This factor is relatively higher for spare parts inventory as against

raw material inventory. Larger the stock we keep more the risk of

obsolescence and as such, the costs are expressed as the percentage costs to

the average inventory holding and can be between 2 to 5%.

(c) The cost of storage, handling and stock verification: There are

additional costs because of the clerical work involved in handling of

materials in the ward, in stock verification, in preservation of materials as

well as the costs because of various equipments and facilities created for

the purpose of materials. A part of this cost is of a fixed nature. The major

portion of the cost including the cost of staff, however, can be treated as

53

variable costs at least in the long run. This cost can be roughly 3 to 5% of

the inventory holding.

(d) Insurance Costs: Materials in stocks are either insured against theft, fire etc., or we may have to employ watch & ward organization and also fire fighting organizations. Cost of this may also be 1 to 2%. The average inventory carrying costs can, therefore, be as follows:

Interest/costs of capital/opportunity cost 15 to 25%

Obsolescence and depreciation cost          2 to 5%

Storage, handling etc.                      3 to 5%

Insurance costs                             1 to 2%

Total                                        21 to 37%

In the Cement Industry, the reasonable assessment of inventory

carrying costs shall be about 20 to 25% per year of the average

inventory holding. It is again clarified here that these costs are not

normally reflected in accounting system and as such are required to

be established by the industry.

2.3 Shortage or Stock out Costs: Whenever an item is out of stock and as such

cannot be supplied, it means that some work or the other is delayed and this, in

turn, leads to financial loss associated with such stoppage or delay of work.

o For example, if a locomotive remains idle for want of spare parts, the

earning capacity of the locomotive is lost for the duration of this period. On

the other hand, the spare parts required will have to be purchased on

emergency basis or have to be specially manufactured resulting in

additional costs.

54

o Stock out costs can vary from item to item and from situation to situation

depending upon the emergency action possible. No attempt therefore, is

normally made to evaluate a stock out cost of an item. Nevertheless, it is

important to understand the concept of stock out costs, even though the

actual quantification is not possible. We should have a rough grading of the

items depending upon the possible stock out costs.

2.4 Systems Costs: These are the costs which are associated with the nature of the

control systems selected. If a very sophisticated model of the relationship between

stockout costs, inventory holding cost and cost of ordering is used and operated

with the help of a computer, it may give the theoretical minimum of the other costs

but the cost of such control system may be sufficiently high to offset the

advantages achieved.

o In most of the situations, however, there is no substantial increase in costs

because of the proposed control system and in such cases, these costs can

be overlooked.

3.0 Inventory Management - Constrains & Problems:

Problems of inventory management vary from organization to organization

depending upon various variables; some of them are as under:

(a) Whether the demand for the goods is one time (static) or of repetitive

nature (dynamic). In many industries, all the non-stock items are treated of

static nature and stock items of dynamic nature.

(b) In case of demands of dynamic (repetitive) items, whether future

requirements can be assessed with certainty or uncertainty or under risk

(probability). Also, whether the demand is fixed over a time or is variable.

55

(c) Whether the material is manufactured in house or is to be purchased

through outside suppliers.

(d) Whether the lead time during which material can be arranged is fixed or

is variable.

4.0 Economic Order Quantity:

Depending upon various variables, different inventory models have been

developed. Different models take different costs into account. One of the popular

models developed for items of repetitive nature (dynamic), future demands for

which can be projected with certainty is Economic Order Quantity (EOQ) model.

o In addition to factors mentioned above, this model assumes that price of the

material remains constant with time and also does not vary with order

quantity. This model can be developed mathematically by differentiating

total cost of inventory (ordering cost + inventory carrying cost) with respect

to Quantity. The formula so derived is given below :

Economic Order Quantity (EOQ) = Sq. Rt. {2xAxCo / (Cu x

Ci) }

Where,

A = Annual Consumption

Quantity

Co = Cost of placing one order

56

Ci = Annual inventory carrying

cost represented as fraction

Cu = Unit Cost (Rate/Unit) of the

material

4.1 EOQ model and various other models and systems of recoupments the answers

of two basic questions of inventory management

--When to purchase?

--How much to purchase?

5.0 Measuring Efficiency of Inventory Management:

5.1 Efficiency of an inventory management system is generally measured by two

measures;

(a) Service level: This is the percentage of compliance of demands of user.

This level is set by the top management who knows that cost of providing

100% service level (i.e. meeting with all demands for materials at all times)

is prohibitively high.

o Therefore, it is attempted to attain a service level between 90 to 98%

depending upon criticality of the items.

(b) Inventory turnover ratio: This is a measure of average stocks held in

stock at a time. This is measured in percentage by the following formula:

Average value of stock of all materials held in stock

T/O ratio = ----------------------------------------------------------------------

57

Total value of issues made during the year

o As per accounting system for working out inventory turnover ratio, debit

balances outstanding in all above suspense heads are divided on 31st March

of the year by total issues made from 1st April to 31st March. This ratio is

multiplied by 100 to get percentage

(c) As overstock and inactive items are not contributing towards inventory

turnover, we should control their balances.

6.0 Inventory Control :

Inventory Control is the art and science of maintaining the stock level of a given

group of items, incurring the least total cost, consistent with other relevant targets

and objectives set by the management. Generally, this is measured in terms of

service level which is measured in terms of percentage of compliance of demands

(requisitions for materials) of user departments and Inventory Turnover ratio as

explained above.

6.1 Inventory Control Techniques: Various techniques employed for controlling

stock levels are;

(a) Selective Management :- In this technique, various items of stores are

classified in various classifications depending upon their consumption,

value, unit price, criticality for the organization, source of supply,

purchasing problems, rate of withdrawal from stores, seasonality and stores

balances on a particular date. Different approaches of control are being

followed for different types of items.

58

(b) Management by exception-- In this technique, items with certain

exceptions is tackled on different points of time. For example, overstock

items, surplus items and inactive items may require more attention.

(c) Designing of recoupments policies -- Recoupments policies are

designed in such a manner that average stocks of materials are optimum.

(d) Rationalization :- Techniques of standardization and variety reduction

are used to minimize lead time of the material, and reduce unnecessary

inventory carrying costs.

(e) Value Analysis: - Functions performed by the materials are analyzed

and alternative designs/raw materials are suggested to achieve the same

function at minimum cost.

(f) Computerization: - Computer Outputs can be used for scientific

forecast of demand to solve many inventory models, providing optimum

safety stocks and for controlling funds.

6.2 A-B-C Analysis :This analysis is based upon Pareto Principle according to

which in many situations, majority of the activity (70 to 80%) is governed by very

few (10 to 20) attributes.

Hence if all the stock items are analyzed in terms of their annual

consumption value, major part of total consumption value (about 70-

80%) is of only few high consumption value items (say 10 to 20%).

These items may be classified as A category.

15 to 20% of total consumption is represented by another 15 to 20%

items which may be classified as B category.

59

Remaining 5 to 10% consumption is represented by a large no. of

small consumption value items which may be classified as C

category.

o Actual ABC classification depends upon management decision. Generally,

All high consumption value items which represent 70% of total

issues, will be classified as A category,

Items which represent 20% of total issue will be classified as B

category.

All remaining items will be C category.

o This analysis is done on the computer as explained below:

(a) First of all annual issue values of all the items which were issued from

all the depots are added together to find total issues (in rupees) of the

company;

(b) Then all the items are sorted in descending sequence of their issue value

on the entire company (i.e. after adding issues of individual depots);

(c) Then go on counting the items adding issue value of the item to a

'cumulative issue value' counter. When the value in this counter represents

70% of total issue- value worked out in step (a), after reading a particular

item, all the items from top to this item are classified as 'A' category items;

(d) The reading of items is further continued when after reading a particular

item and adding its issue value to 'cumulative issue value' counter, value in

the counter is equal to 90% of total issues, mark all items from item next to

last A category item to this item as B category item;

(e) All remaining items are classified as C category items.

60

o For the purpose of Inventory Control, A category items are most important.

Therefore, they are closely monitored at highest level at very frequent

intervals.

o In companies, their stock levels, consumption forecast etc. are monitored at

the level of COS/CMM every month. B category items are monitored at the

level of CMM/Dy. COS every quarter or every six month.

o Stock verification

of A category items is carried out every six months;

for B category items every year and

Once in two years for C category items.

o To achieve better inventory turn over ratio, we intend to keep average

stocks of 3 months, 6 months and 12 months of A, B and C category items

respectively.

6.3 V-E-D Classification: A-B-C Classification is on the basis of consumption

value of an item and does not give any importance to the criticality of the item and

therefore, only A-B-C Classification is not adequate. Classification done on the

basis of criticality of the item is known as V-E-D, where the items are classified as

Vital, Essential and Desirable.

Vital items are those items which are very critical for the operations

and do not permit any corrective time i.e. they cannot be procured

off the shelf if they are not available.

Essential items are comparatively less vital and work without them

cannot be managed for few days.

All remaining items are known as Desirable items.

6.4 A-B-C / V-E-D Matrix : Tackling the items on the basis of their consumption

value and also criticality improves the service to the customer as well as we are

able to control the inventory.

61

o We can design the stock levels in such a manner that

Maximum service is provided for C category vital items

While for A category Desirable items service can be minimum

desirable.

For remaining items, service levels can be in between these two

levels and average stock holdings can be designed accordingly.

Tackling the items on the basis of their consumption value and also

criticality improves the service to the customer as well as we are

able to control the inventory.

  Classification A B C

Vital 4 2 1

Essential 7 5 3

Desirable 9 8 6

   

      Numbers indicate the focus priority for best results both in terms of

service as well as resources required We can design the stock levels in such

a manner that maximum service is provided for C category vital items

which provide high satisfaction levels at very little cost, while for A

category Desirable items service can be minimum desirable as the require

large resources and provide very low satisfaction. For remaining items,

service levels can be in between these two levels and average stock

holdings can be designed accordingly.

62

Managing inventory is a juggling act. Excessive stocks can place a heavy burden

on the cash resources of a business. Insufficient stocks can result in lost sales, delays for

customers etc.

The key is to know how quickly your overall stock is moving or, put another way,

how long each item of stock sit on shelves before being sold. Obviously, average stock-

holding periods will be influenced by the nature of the business. For example, a fresh

vegetable shop might turn over its entire stock every few days while a motor factor would

be much slower as it may carry a wide range of rarely-used spare parts in case somebody

needs them.

Nowadays, many large manufacturers operate on a just-in-time (JIT) basis

whereby all the components to be assembled on a particular today, arrive at the factory

early that morning, no earlier - no later. This helps to minimize manufacturing costs as

JIT stocks take up little space, minimize stock-holding and virtually eliminate the risks of

obsolete or damaged stock. Because JIT manufacturers hold stock for a very short time,

they are able to conserve substantial cash. JIT is a good model to strive for as it embraces

all the principles of prudent stock management.

The key issue for a business is to identify the fast and slow stock movers with the

objectives of establishing optimum stock levels for each category and, thereby, minimize

the cash tied up in stocks. Factors to be considered when determining optimum stock

levels include:

What are the projected sales of each product?

How widely available are raw materials, components etc.?

How long does it take for delivery by suppliers?

Can you remove slow movers from your product range without compromising best

sellers?

63

Comparison of Shree Cement’s Inventory Position With its Competitors:

(All the figures correspond to the financial year 2007-08 & are in Rs. Cr.)

Description Shree Cement Ambuja Cement ACC

Sales 2468.44 6469.68 7848.32

Inventory 176.57 (7.15%) 581.60 (8.99%) 730.86 (9.31%)

Sundry Debtors 49.39 (2.0%) 145.68 (2.25%) 289.29 (3.69%)

Cash Equivalents 467.43 (18.93%) 650.79 (10.06%) 743.48 (9.47%)

Raw Material 7.20 (0.29%) 53.05 (0.82%) 88.54 (1.13%)

Material-in-process 22.23 (0.90%) 85.94 (1.32%) 146.71 (1.87%)

Finished Goods 22.15 (0.90%) 53.44 (0.83%) 81.26 (1.04%)

From above table, it is evident that the Shree Cement’s performance is comparable

with that of Industry leaders in Inventory management. It surpasses them in management

of many components of current assets such as raw material, Consumable spares, and

material-in-process and sundry debtors. The only factor in which it is lagging is Cash

equivalents. The cash equivalents of Shree Cement are almost 18.93 % as compared to its

sales. It has to bring down it to the half of the current size so as match it with industry

standards.

Forms of Working Capital Financing –

Working capital financing comes in many forms, each of which has unique terms

and offers certain advantages and disadvantages to the borrower. There are five major

64

forms of debt used to finance working capital each having its own relative advantages. A

firm can design its short term loan in the different ways as per the demand of the

situation.

Line of Credit

A line of credit is an open-ended loan with a borrowing limit that the business can

draw against or repay at any time during the loan period. This arrangement allows a

company flexibility to borrow funds when the need arises for the exact amount required.

Interest is paid only on the amount borrowed, typically on a monthly basis.

A line of credit can be either unsecured, if no specific collateral is pledged for

repayment, or secured by specific assets such as accounts receivable or inventory. The

standard term for a line of credit is 1 year with renewal subject to the lender’s annual

review and approval. Since a line of credit is designed to address cyclical working capital

needs and not to finance long-term assets, lenders usually require full repayment of the

line of credit during the annual loan period and prior to its renewal. This repayment is

sometimes referred to as the annual cleanup.

Two other costs, beyond interest payments, are associated with borrowing through

a line of credit. Lenders require ‘a fee for providing the line of credit’, based on the line’s

credit limit, which is paid whether or not the firm uses the line. This fee, usually in the

range of 25 to 100 basis points, covers the bank’s costs for underwriting and setting up

the loan account in the event that a firm does not use the line and the bank earns no

interest income. A second cost is the requirement for a borrower to maintain ‘a

compensating balance’ account with the bank. Under this arrangement, a borrower must

have a deposit account with a minimum balance equal to a percentage of the line of

credit, perhaps 10% to 20%. If a firm normally maintains this balance in its cash

accounts, then no additional costs are imposed by this requirement. However, when a

firm must increase its bank deposits to meet the compensating balance requirement, then

65

it is incurring an additional cost. In effect, the compensating balance reduces the

business’s net loan proceeds and increases its effective interest rate.

Consider a line of credit for Rs.10 lakhs at a 10% interest rate with a 20%

compensating balance requirement. When the company fully draws on the line of credit,

it will have borrowed Rs.10 lakhs but must leave Rs.200, 000 on deposit with the lender,

resulting in net loan proceeds of Rs.800, 000. However, it pays interest on the full Rs.10

lakhs drawn. Thus, the effective annual interest rate is 12.5% rather than 10% (one year’s

interest is Rs.100, 000 or 12.5% of the Rs.800, 000 in net proceeds).

Like most loans, the lending terms for a line of credit include financial covenants

or minimal financial standards that the borrower must meet. Typical financial covenants

include a minimum current ratio, a minimum net worth, and a maximum debt-to-equity

ratio.

The advantages of a line of credit are twofold. First, it allows a company to

minimize the principal borrowed and the resulting interest payments. Second, it is simpler

to establish and entails fewer transaction and legal costs, particularly when it is

unsecured.

The disadvantages of a line of credit include the potential for higher borrowing

costs when a large compensating balance is required and its limitation to financing

cyclical working capital needs. With full repayment required each year and annual

extensions subject to lender approval, a line of credit cannot finance medium-term or

long-term working capital investments.

Accounts Receivable Financing

Some businesses lack the credit quality to borrow on an unsecured basis and must

instead pledge collateral to obtain a loan. Loans secured by accounts receivable are a

common form of debt used to finance working capital.

66

Under accounts receivable debt, the maximum loan amount is tied to a percentage

of the borrower’s accounts receivable. When accounts receivable increase, the

allowable loan principal also rises. However, the firm must use customer payments

on these receivables to reduce the loan balance.

The borrowing ratio depends on the credit quality of the firm’s customers and the

age of the accounts receivable. A firm with financially strong customers should be

able to obtain a loan equal to 80% of its accounts receivable. With weaker credit

customers, the loan may be limited to 50% to 60% of accounts receivable.

Additionally, a lender may exclude receivables beyond certain age (e.g., 60 or 90

days) in the base used to calculate the loan limit. Older receivables are considered

indicative of a customer with financial problems and less likely to pay.

Since accounts receivable are pledged as collateral, when a firm does not repay the

loan, the lender will collect the receivables directly from the customer and apply it

to loan payments. The bank receives a copy of all invoices along with an

assignment that gives it the legal right to collect payment and apply it to the loan.

In some accounts receivable loans, customers make payments directly to a bank-

controlled account (a lock box).

Firms gain several benefits with accounts receivable financing. With the loan limit

tied to total accounts receivable, borrowing capacity grows automatically as sales grow.

This automatic matching of credit increases to sales growth provides a ready means to

finance expanded sales, which is especially valuable to fast-growing firms. It also

provides a good borrowing alternative for businesses without the financial strength to

obtain an unsecured line of credit. Accounts receivable financing allows small businesses

with creditworthy customers to use the stronger credit of their customers to help borrow

funds.

One disadvantage of accounts receivable financing is the higher costs associated

with managing the collateral, for which lenders may charge a higher interest rate or fees.

Since accounts receivable financing requires pledging collateral, it limits a firm’s ability

67

to use this collateral for any other borrowing. This may be a concern if accounts

receivable are the firm’s primary asset.

Factoring –

Factoring entails the sale of accounts receivable to another firm, called the factor,

who then collects payment from the customer. Through factoring, a business can shift the

costs of collection and the risk of non-payment to a third party. In a factoring

arrangement, a company and the factor work out a credit limit and average collection

period for each customer. As the company makes new sales to a customer, it provides an

invoice to the factor. The customer pays the factor directly, and the factor then pays the

company based on the agreed upon average collection period, less a slight discount that

covers the factor’s collection costs and credit risk.

In addition to absorbing collection risk, a factor may advance payment for a large

share of the invoice, typically 70% to 80%, providing the company with immediate cash

flow from sales. In this case, the factor charges an interest rate on this advance and then

deducts the advance amount from its final payment to the firm when an invoice is

collected.

Factoring has several advantages for a firm over straight accounts receivable

financing.

First, it saves the cost of establishing and administering its own collection system.

Second, a factor can often collect accounts receivable at a lower cost than a small

business, due to economies of scale, and transfer some of these savings to the

company.

Third, factoring is a form of collection insurance that provides an enterprise with

more predictable cash flow from sales.

68

On the other hand, factoring costs may be higher than a direct loan, especially when the

firm’s customers have poor credit that lead the factor to charge a high fee. Furthermore,

once the collection function shifts to a third party, the business loses control over this part

of the customer relationship, which may affect overall customer relations, especially

when the factor’s collection practices differ from those of the company.

Inventory Financing –

As with accounts receivable loans, inventory financing is a secured loan, in this

case with inventory as collateral. However, inventory financing is more difficult to secure

since inventory is riskier collateral than accounts receivable. Some inventory becomes

obsolete and loses value quickly, and other types of inventory, like partially

manufactured goods, have little or no resale value.

Firms with an inventory of standardized goods with predictable prices, such as

automobiles or appliances, will be more successful at securing inventory financing than

businesses with a large amount of work in process or highly seasonal or perishable goods

like cement bags. Loan amounts also vary with the quality of the inventory pledged as

collateral, usually ranging from 50% to 80%. For most businesses, inventory loans yield

loan proceeds at a lower share of pledged assets than accounts receivable financing.

When inventory is a large share of a firm’s current assets, however, inventory

financing is a critical option to finance working capital. Lenders need to control the

inventory pledged as collateral to ensure that it is not sold before their loan is repaid. Two

primary methods are used to obtain this control:

1) warehouse storage; and

2) Direct assignment by product serial or identification numbers.

Under one warehouse arrangement, pledged inventory is stored in a public

warehouse and controlled by an independent party (the warehouse operator). A

69

warehouse receipt is issued when the inventory is stored, and the goods are released only

upon the instructions of the receipt-holder. When the inventory is pledged, the lender has

control of the receipt and can prevent release of the goods until the loan is repaid.

Since public warehouse storage is inconvenient for firms that need on-site access

to their inventory, an alternative arrangement, known as a field warehouse, can be

established. Here, an independent public warehouse company assumes control over the

pledged inventory at the firm’s site. In effect, the firm leases space to the warehouse

operator rather than transferring goods to an off-site location. As with a public

warehouse, the lender controls the warehouse receipt and will not release the inventory

until the loan is repaid. Direct assignment by serial number is a simpler method to control

inventory used for manufactured goods that are tagged with a unique serial number. The

lender receives an assignment or trust receipt for the pledged inventory that lists all serial

numbers for the collateral. The company houses and controls its inventory and can

arrange for product sales. However, a release of the assignment or return of the trust

receipt is required before the collateral is delivered and ownership transferred to the

buyer. This release occurs with partial or full loan repayment.

While inventory financing involves higher transaction and administrative costs

than other loan instruments, it is an important financing tool for companies with large

inventory assets. When a company has limited accounts receivable and lacks the financial

position to obtain a line of credit, inventory financing may be the only available type of

working capital debt. Moreover, this form of financing can be cost effective when

inventory quality is high and yields a good loan-to-value ratio and interest rate.

Term Loan –

While the four prior debt instruments address cyclical working capital needs, term

loans can finance medium-term non-cyclical working capital.

70

A term loan is a form of medium-term debt in which principal is repaid over

several years, typically in 3 to 7 years. Since lenders prefer not to bear interest rate risk,

term loans usually have a floating interest rate set between the prime rate and prime plus

300 basis points, depending on the borrower’s credit risk. Sometimes, a bank will agree

to an interest rate cap or fixed rate loan, but it usually charges a fee or higher interest rate

for these features. Term loans have a fixed repayment schedule that can take several

forms.

Level principal payments over the loan term are most common. In this case, the

company pays the same principal amount each month plus interest on the

outstanding loan balance.

A second option is a level loan payment in which the total payment amount is the

same every month but the share allocated to interest and principle varies with each

payment.

Finally, some term loans are partially amortizing and have a balloon payment at

maturity.

Term loans can be either unsecured or secured; a business with a strong balance

sheet and a good profit and cash flow history might obtain an unsecured term loan, but

many small firms will be required to pledge assets. Moreover, since loan repayment

extends over several years, lenders include financial covenants in their loan agreements

to guard against deterioration in the firm’s financial position over the loan term. Typical

financial covenants include minimum net worth, minimum net working capital (or current

ratio), and maximum debt-to-equity ratios. Finally, lenders often require the borrower to

maintain a compensating balance account equal to 10% to 20% of the loan amount.

The major advantage of term loans is their ability to fund long-term working

capital needs. Businesses benefit from having a comfortable positive net working capital

margin, which lowers the pressure to meet all short-term obligations and reduces

bankruptcy risk. Term loans provide the medium-term financing to invest in the cash,

accounts receivable, and inventory balances needed to create excess working capital.

71

They also are well suited to finance the expanded working capital needed for sales

growth. Furthermore, a term loan is repaid over several years, which reduces the cash

flow needed to service the debt.

However, the benefits of longer term financing do not come without costs, most

notably higher interest rates and less financial flexibility. Since a longer repayment

period poses more risk to lenders, term loans carry a higher interest rate than short-term

loans. When provided with a floating interest rate, term loans expose firms to greater

interest rate risk since the chances of a spike in interest rates increase for a longer

repayment period. Due to restrictive covenants and collateral requirements, a term loan

imposes considerable financial constraints on a business. Moreover, these financial

constraints are in place for several years and cannot be quickly reversed, as with a 1-year

line of credit. Despite these costs, term loans can be of great value to small firms,

providing a way to supplement their limited supply of equity and long-term debt with

medium-term capital.

* RBI Guidelines about Working Capital Financing

Background

In the context of rapid growth of primary (urban) co-op. banks (PCBs), qualitative

aspects of lending, such as adequacy of lending to meet credit requirements of their

borrowers and effective supervision and monitoring of advances have assumed

considerable importance. Previously working capital finance provided by the banks to

trade and industry was regulated by the Reserve Bank of India through a series of

guidelines/instructions issued. There were various quantitative and qualitative restrictions

on bank’s lending. The banks were also expected to ensure conformity with the basic

financial disciplines prescribed by the RBI from time to time under Credit Authorisation

Scheme (CAS).

72

1.2 However, consistent with the policy of liberalisation and financial sector reforms,

several indirect measures to regulate bank credit such as exposure norms for lending to

individual/group borrowers, prudential norms for income recognition, asset classification

and provisioning for advances, capital adequacy ratios, etc. were introduced by RBI and

greater operational freedom has been provided to banks in dispensation of credit.

1.3 Banks are now expected to lay down, through their boards, transparent policies and

guidelines for credit dispensation, in respect of each broad category of economic activity,

keeping in view the credit exposure norms and various other guidelines issued by the

Reserve Bank of India from time to time. Some of the currently applicable guidelines are

detailed in the following paragraphs.

Working Capital Requirements ABOVE Rs. 1 crore

3.1 Method of Assessment

3.1.1 The revised guidelines in respect of borrowers other than SSI units, requiring

working capital limits above Rs.1 crore and for SSI units requiring fund based working

capital limits above Rs.5 crore, from the banking system bestow greater level of

flexibility to the primary (urban) co-operative banks in their day-to-day operations

without diluting the prudential norms for lending as prescribed by Reserve Bank of India.

3.1.2 The earlier prescription regarding Maximum Permissible Bank Finance (MPBF),

based on a minimum current ratio of 1.33:1, recommended by Tandon Working Group

has been withdrawn. Banks are now free to decide on the minimum current ratio and

determine the working capital requirements according to their perception of the

borrowers and their credit needs.

73

3.1. 3 Banks may evolve an appropriate system for assessing the working capital credit

needs of borrowers whose requirement are above Rs.1 crore.  Banks may adopt any of the

under-noted methods for arriving at the working capital requirement of such borrowers.

a). The turnover method, as prevalent for small borrowers may be used as a tool of

assessment for this segment as well,

b). Since major corporates have adopted cash budgeting as a tool of funds management,

banks may follow cash budget system for assessing the working capital finance in respect

of large borrowers.

c). The banks may even retain the concept of the MPBF with necessary modifications.

3.2 Norms for Inventory/Receivables

3.2.1 In order to provide flexibility in the assessment of credit requirements of borrowers

based on a total study of borrowers' business operations, i.e., taking into account the

production/processing cycle of the industry as well as the financial and other relevant

parameters of the borrower, the banks have also been permitted to decide the levels of

holding of each item of inventory as also of receivables, which in their view would

represent a reasonable build-up of current assets for being supported by bank finance.

3.2.2. Reserve Bank of India no longer prescribes detailed norms for each item of

inventory as also of receivables.

3.3 Classification of Current Assets and Current Liabilities

3.3.1 With the withdrawal of MPBF, inventory norms and minimum current ratio, the

classification of current assets and current liabilities ceases to be mandatory. The banks

74

may decide on their own as to which items should be included for consideration as

current assets or current liabilities.

3.3.2 Banks may also consider evolving suitable internal guidelines for accepting the

projections made by their borrowers relating to the item "Sundry Creditors (Goods)"

appearing as an item under "Other Current Liabilities" in the balance sheet.

3.4 Bills Discipline

In respect of borrowers enjoying fund-based working capital credit limits of Rs. 5 crore

and more from the banking system, the banks are required to ensure that the book-debt

finance does not exceed 75 per cent of the limits sanctioned to borrowers for financing

inland credit sales. The remaining 25 per cent of the credit sales may be financed through

bills to ensure greater use of bills for financing sales.

3.5 Grant of Ad hoc Limits

To meet the contingencies, banks may decide on the quantum and period for granting ad

hoc limits to the borrowers based on their commercial judgement and merits of individual

cases. While granting the ad hoc limits the banks must ensure that the aggregate credit

limits (inclusive of ad hoc limits) do not exceed the prescribed exposure ceiling.

3.6 Commitment Charge

The levy of commitment charge is not mandatory and it is left to the discretion of the

financing banks/ consortium/syndicate. Accordingly, banks are free to evolve their own

guidelines in regard to commitment charge for ensuring credit discipline.

3.7 Consortium Arrangement

The mandatory requirement of formation of consortium for extending working capital

finance under multiple banking arrangements has been withdrawn.

75

3.8 Syndication of Credit

The syndication of loans is an internationally practised model for financing credit

requirements. The banks are free to adopt syndication route, irrespective of the quantum

of credit involved, if the arrangement suits the borrower and the financing banks.

3.9 Loan System for Delivery of Bank Credit

3.9.1 Background

In order to bring about an element of discipline in the utilisation of bank credit by large

borrowers, instill efficiency in funds management, loan system for delivery of bank credit

was been introduced for borrowers enjoying working capital credit limits of Rs.10 crore

and above from the banking system and the minimum level of loan component for such

borrowers was fixed at 80 per cent. These guidelines have been revised by RBI, in the

light of current environment of short-term investment opportunities available to both the

corporates and the banks. In case any primary (urban) co-operative bank is having

borrowers with MPBF of Rs. 10 crore and above where it has participated under

consortium/syndication, it should ensure strict compliance with the under-noted

guidelines.

3.9.2 Loan Component and Cash Credit Component

i. Banks may change the composition of working capital by increasing the cash

credit component beyond 20 per cent or to increase the loan component beyond 80

per cent, as the case may be, if they so desire. 

ii. Banks are expected to appropriately price each of the two components of working

capital finance, taking into account the impact of such decisions on their cash and

liquidity management.

76

iii. If a borrower so desires, higher loan component can be granted by the bank; this

would entail corresponding pro-rata reduction in the cash credit component of the

limit.

iv. In the case of borrowers with working capital (fund based) credit limit of less than

Rs. 10 crore, banks may persuade them to go in for the Loan System by offering

an incentive in the form of lower rate of interest on the 'loan component' as

compared to the 'cash credit component' The actual percentage of 'loan component'

in these cases may be settled by the bank with its borrower clients.

v. In respect of certain business activities which are cyclical and seasonal in nature or

have inherent volatility, the strict application of loan system may create difficulties

for the borrowers. Banks, may with the approval of their respective Boards,

identify such business activities which may be exempt from the loan system of

credit delivery.

3.9.3 Ad hoc Credit Limit

The release of ad hoc/additional credit for meeting temporary requirements may be

considered by the financing bank only after the borrower has fully utilised/exhausted the

existing limit.

3.9.4. Sharing of Working Capital Finance

i. The ground rules for sharing of cash credit and loan  components may be laid

down by the consortium, wherever formed, subject to the stipulations contained in

Para. 3.9.2 above.

ii. The level of individual bank's share shall be governed by the norm for single /

group borrowers’ credit exposure.

77

3.9.5 Rate of Interest

Banks are allowed to fix separate lending rates for 'loan component' and 'cash credit

component'.

3.9.6 Period of Loan

The minimum period of the loan for working capital purposes may be fixed by banks in

consultation with borrowers. Banks may decide to split the loan component according to

the need of the borrower with different maturity bases for each segment and allow roll

over.

3.9.7 Security

In regard to security, sharing of charge, documentation, etc., banks may themselves

decide on the requirements, if necessary, in consultation with the other participant banks.

3.9.8 Export Credit

Export credit limit would be allowed in the form hitherto granted. The bifurcation of the

working capital limit into loan and cash credit components, as stated in paragraph 3.9.2

(i) above, would be effected after excluding the export credit limits (pre-shipment and

post-shipment).

3.9.9 Bills Limit

Bills limit for inland sales may be fully carved out of the 'loan component'. Bills limit

also includes limits for purchase of third party (outstation) cheques/bank drafts. Banks

must satisfy themselves that the bills limit is not mis-utilised.

78

3.9.10 Renewal/Roll-over of Loan Component

The loan component, may be renewed/rolled over at the request of the borrower.

However, banks may lay down policy guidelines for periodical review of the working

capital limit and the same may be scrupulously adhered to.

3.911 Provision for Investing Short Term Surplus Funds of Borrowers

The banks, at their discretion, may permit the borrowers to invest their short

term/temporary surpluses in short-term money market instruments like Commercial

Paper (CP), Certificates of Deposit (CDs) and in Term Deposit with banks, etc.

3.9.12 Applicability

The loan system would be applicable to borrowal accounts classified as 'standard' or 'sub-

standard'.

4.6.2 Post-Sanction Monitoring

i. It is the primary responsibility of banks to be vigilant and ensure proper end use of

bank funds /monitor the funds flow. It is, therefore, necessary for banks to evolve

such arrangements as may be considered necessary to ensure that drawals from

cash credit/overdraft accounts are strictly for the purpose for which the credit

limits are sanctioned by them. There should be no diversion of working capital

finance for acquisition of fixed assets, investments in associate

companies/subsidiaries, and acquisition of shares, debentures, units of Unit Trust

of India and other mutual funds, and other investments in the capital market. This

has to be so, even if there is sufficient drawing power/undrawn limit for the

purpose of effecting drawals from the cash credit account.

79

ii. Post sanction follow-up of loans and advances should be effective so as to ensure

that the security obtained from borrowers by way of hypothecation, pledge, etc.

are not tampered with in any manner and are adequate.

iii. Drawals against clearing cheques should be sanctioned only in respect of first

class customers and even in such cases the extent of limits and the need therefor

should be subjected to thorough scrutiny and periodical review. Banks should not

issue banker’s cheques/pay orders/demand drafts against instruments presented for

clearing, unless the proceeds thereof are collected and credited to the account of

the party.  Further, banker’s cheques /pay orders/ demand drafts, should not be

issued by debit to cash credit /over draft accounts which are already overdrawn or

likely to be overdrawn with the issue of such instruments.

iv. Drawals against clearing instruments should be normally confined to bank drafts

and government cheques and only to a limited extent against third party cheques.

v. (v) Cheques against which drawals are allowed should represent genuine trade

transactions and strict vigilance should be observed against assisting kite-flying

operations.

vi. Drawals against cheques of allied /sister concerns should not be permitted and the

facility of drawal against clearing cheques should normally be of temporary nature

and should not be allowed on a regular basis without proper scrutiny and appraisal.

vii. Bills of accommodation nature should never be purchased and the officials

responsible for purchase of such bills should be punished suitably..

viii. In case a borrower is found to have diverted finance for the purposes, other than

for which it was granted, banks must recall the amounts so diverted. In addition,

banks may charge penal interest on the amount diverted.

Where borrowers fail to repay the amounts diverted from cash credit accounts for

uses other than for which the limit was sanctioned, banks should reduce the limits

to the extent of amount diverted. The above aspects relating to safe guards are only

illustrative in nature and not exhaustive.,

80

The group (headed by Sh. Prakash Tandon) was appointed in July 1974 which was

to frame guidelines for follow-up of bank credit and submitted its final report during

1975 and gave following recommendations, applicable to borrowers availing fund based

working capital limits of Rs. 10 lac or more:

Norms for inventory and receivables

Norms for 15 major industries proposed by the committee now have more than 50

disintegrated industry groups. Normally the borrower would not be allowed deviations

from norms except in case of bunched receipt of raw material, power cuts, strikes,

transport delays, accumulation of finished goods due to non-availability of shipping space

for exports, build up of finished goods stocks due to failure on the part of purchasers. For

those units which are not covered by the norms, past trends to be made the basis of

assessment of working capital. (Discretion given to individual banks for deviations in

norms)

Approach to lending

The committee suggested three methods of lending out of which RBI accepted two

methods for implementation. According to First Method, the borrower can be allowed

maximum bank finance upto 75% of the working capital gap (working capital gap

denotes difference between total current assets required and amount of finance available

in the shape of current liabilities other than short term bank borrowings). The balance

25% to be brought by the borrower as surplus of long term funds over the long term

outlay.

As per Second Method of lending, the contribution of the borrower has to be 25%

of the total current assets build-up instead of working capital gap. (Method of lending as

per Vaz Committee will now apply to borrowers availing working capital fund based

81

limits of Rs. 100 lac or more only)

Methods of lending

Like many other activities of the banks, method and quantum of short-term finance that

can be granted to a corporate was mandated by the Reserve Bank of India till 1994. This

control was exercised on the lines suggested by the recommendations of a study group

headed by Shri Prakash Tandon.

The study group headed by Shri Prakash Tandon, the then Chairman of Punjab National

Bank, was constituted by the RBI in July 1974 with eminent personalities drawn from

leading banks, financial institutions and a wide cross-section of the Industry with a view

to study the entire gamut of Bank's finance for working capital and suggest ways for

optimum utilisation of Bank credit. This was the first elaborate attempt by the central

bank to organise the Bank credit. The report of this group is widely known as Tandon

Committee report. Most banks in India even today continue to look at the needs of the

corporates in the light of methodology recommended by the Group.

As per the recommendations of Tandon Committee, the corporates should be discouraged

from accumulating too much of stocks of current assets and should move towards very

lean inventories and receivable levels. The committee even suggested the maximum

levels of Raw Material, Stock-in-process and Finished Goods which a corporate

operating in an industry should be allowed to accumulate These levels were termed as

inventory and receivable norms. Depending on the size of credit required, the funding of

these current assets (working capital needs) of the corporates could be met by one of the

following methods:

First Method of Lending:

Banks can work out the working capital gap, i.e. total current assets less current liabilities

other than bank borrowings (called Maximum Permissible Bank Finance or MPBF) and

82

finance a maximum of 75 per cent of the gap; the balance to come out of long-term funds,

i.e., owned funds and term borrowings. This approach was considered suitable only for

very small borrowers i.e. where the requirements of credit were less than Rs.10 lacs

Second Method of Lending:

Under this method, it was thought that the borrower should provide for a minimum of

25% of total current assets out of long-term funds i.e., owned funds plus term

borrowings. A certain level of credit for purchases and other current liabilities will be

available to fund the build up of current assets and the bank will provide the balance

(MPBF). Consequently, total current liabilities inclusive of bank borrowings could not

exceed 75% of current assets. RBI stipulated that the working capital needs of all

borrowers enjoying fund based credit facilities of more than Rs. 10 lacs should be

appraised (calculated) under this method.

Third Method of Lending: Under this method, the borrower's contribution from long

term funds will be to the extent of the entire CORE CURRENT ASSETS, which has been

defined by the Study Group as representing the absolute minimum level of raw materials,

process stock, finished goods and stores which are in the pipeline to ensure continuity of

production and a minimum of 25% of the balance current assets should be financed out of

the long term funds plus term borrowings.

(This method was not accepted for implementation and hence is of only academic

interest).

As can be seen above, the basic foundation of all banks' appraisal of the needs of

creditors is the level of current assets. The classification of assets and balance sheet

analysis, therefore, assumes a lot of importance. RBI has mandated a certain way of

analysing the balance sheets. The requirements of this break-up of assets and liabilities

differs slightly from that mandated by the Company Law Board (CLB). The analysis of

balance sheet in CMA data is said to give a more detailed and accurate picture of the

affairs of a corporate. The corporates are required by all banks to analyse their balance

sheet in this specific format called CMA data format and submit to banks. While most

83

qualified accountants working with the firms are aware of the method of classification in

this format, professional help is also available in the form of Chartered Accountants,

Financial Analysts for this analysis.

Other major recommendations of the committee were:

No slip back in current ratio, normally.

Classification guidelines for Current assets and current liabilities.

Identification of excess borrowing.

Information system, which was modified by Chore Committee Recommendations.

Bifurcation of limits into loan and demand component.

All instructions relating to maximum permissible bank finance withdrawn by RBI as per

Credit Policy announced on 15.04.1997)

Clarifications in regard to Assessment of

Working Capital Limits

  Issues raised by banks Clarifications

  (1) (2)

(i) Whether banks should sanction

working capital limits

computed on the basis of a

minimum of 20 per cent of the

projected annual

turnover/output value or

The assessment of working capital credit limits

should be done both as per projected turnover

basis and traditional method. If the credit

requirement based on production/ processing

cycle is higher than the one assessed on

projected turnover basis, the same may be

84

whether it is intended that

banks should also arrive at the

requirement based on the

traditional approach of

production/processing cycle

and thereafter decide the

quantum of need-based finance.

If the traditional approach is

followed the working capital

finance arrived at could be

either more than or less than 20

per cent. In case it is less than

20 per cent, whether banks

should still give 20 per cent ?

sanctioned as RBI guidelines stipulate bank

finance at minimum of 20 per cent of the

projected turnover. On the other hand if the

assessed credit requirement is lower than the one

assessed on projected turnover basis, while the

credit limit can be sanctioned at 20 per cent of

the projected turnover, actual drawals may be

allowed on the basis of drawing power to be

determined by banks after excluding unpaid

stocks. In the case of Selective Credit Control

commodities the drawing power should be

determined as indicated in the RBI directive.

(ii) Whether projected turn

over/output value basis 'gross

sales'

The projected turnover/output value may be

interpreted as projected 'Gross Sales' which will

include excise duty also.

(iii) Whether the 5 per cent

promoter's stake (Net Working

Capital) should be reckoned

with reference to the projected

turnover or with reference to

the working capital arrived at

based on production/

processing cycle.

In terms of extant guidelines the working capital

requirement is to be assessed at 25 per cent of

the projected turnover to be shared between the

borrower and bank viz. borrower contributing

5% of the turnover as NWC and bank providing

finance at a minimum of 20 per cent of the

turnover. The above guidelines were framed

assuming an average production/processing

cycle of 3 months (i.e. working capital would be

turned over four times in a year). It is possible

that certain industries may have a production

85

cycle shorter/longer 3 months. While in the case

of a shorter cycle, the same principle could be

applied as it is the intention to make available at

least 20 per cent of turnover by way of bank

finance. In case the cycle is longer, it is expected

that the borrower should bring in

proportionately higher stake in relation to his

requirement of bank finance. Going by the

above principle, at least 1/5th of working capital

requirement should be brought in by way of

NWC.

(iv) Whether 5 per cent NWC

should be reckoned with

reference to turnover or with

reference to available long term

sources; in other words is the

prescribed NWC the minimum

amount?

Since the bank finance is only intended to

support need-based requirement of a borrower if

the available NWC (net long term surplus funds)

is more than 5 per cent of the turnover the

former should be reckoned for assessing the

extent of the bank finance

(v) Whether drawing power should

continue to be regulated

through stocks and whether

unpaid stocks deducted for

arriving at drawing power ?

It is left to the discretion of banks. However, in

arriving at drawing power, unpaid stocks are not

financed as it would result in double financing.

The drawing power should conform to Reserve

Bank of India directives in the case of Selective

Credit Control commodities

(vi) Since the present instructions

cover traders as well, and most

trade is done at market credit,

In the case of traders, while bank finance could

be assessed at 20 per cent of the projected

turnover, the actual drawals should be allowed

86

whether the credit limits should

be assessed as 20 per cent of

the turnover per se and actual

drawing regulated through

stocks ?

on the basis of drawing powers to be determined

by banks after ensuring that unpaid stocks are

excluded. In the case of SCC commodities the

RBI directive should be scrupulously followed.

* Other modes of financing

After the development of financial markets in India, a significant rise has been

evident in the use of the rated and non-rated instruments for short term financing. Some

of the most popular instruments are –

1. Commercial Papers

2. FCNR(B) Loans

3. MIBOR based loans

4. Channel Financing

These instruments are discussed in detail below.

1. Commercial papers

This is an unsecured, short term debt instrument issued by a corporation, typically

for the financing of account receivables, inventories and meeting short term liabilities. It

is generally in the form of promissory note with fixed maturities and is negotiable by

endorsement and delivery. Under the current guide lines, the commercial papers can be

issued for a minimum tenor of 15 days and a maximum tenor of 365 days. Commercial

papers are generally issued by highly rated borrowers and since they are tradable, they

offer a liquid investment opportunity.

2. FCNR (B) Loans

FCNR (B) stands for Foreign Currency Non Resident Banking. Lending for

working capital and term loan requirements of resident customers for productive

87

activities by way of Foreign Currency Loans through deployment of FCNRB deposit

funds with commercial banks is known as FCNRB loan. RBI permitted this facility in

Oct.1996

This facility for working capital is given by way of FCNRB (Demand Loan).

Previously it was restricted to a period between 3 to 11 months and to 50% of the fund

based working capital facility. Now, the maturity of the demand loan will be the same as

that for working capital demand loan (WCDL) in rupees. The loan can also be availed for

broken periods. Also, the loan can be given for an amount in excess of 50% of fund based

working capital facility, provided it is given on fully hedged basis. These loans are

available through many leading private and PSU banks.

Generally, no part payment is allowed in FCNR (B) loans and it has to be

disbursed in one lump sum and repaid in one lump sum on the due date. The minimum

loan amount for both demand loan and term loan is $100,000 or its equivalent in other

currencies. Loan can be made available in US Dollars, GBP, EURO and YEN.

The major advantage of these loans is that the borrower gets the loan at a cheaper

cost as the interest is linked to LIBOR. / EURIBOR. The disadvantage is that he has to

bear the exchange fluctuation risk. This scheme will be attractive to those who have

regular forex earnings. Those who do not have any forex earnings should understand this

risk and arrange for covering the risk.

The number of FCNRB (DL) and WCDL put together should not exceed seven at

a time. The number of FCNRB (TL) should not exceed two. The outstanding under

FCNRB (DL) and FCNRB (TL) put together should not exceed 20 million dollar or its

equivalent in other currencies.

3. MIBOR Linked Loans

MIBOR is an abbreviation for Mumbai Interbank Offer Rate. It’s a bench mark

rate for the overnight call money market. NSE helps the call money market to identify 14

88

days, One month and 3 months offer rate through MIBOR for each specific period. The

loans which are based on this MIBOR are termed as ‘MIBOR Linked Loans’.

The loans offered under this facility are on floating rate basis. The rate is decided

on the basis of prevailing MIBOR and the bank margin. The duration of the loan ranges

from 30 days to 90 days. The amount taken in this scheme is also covered in the credit

limit decided by the banks for the borrower.

4. Channel Financing

Forward and backward linkages in a business organization play a significant role

in the success or failure of the business entity. For (say) a manufacturing or trading firm,

while the suppliers of raw material are important as they provide input for production,

equally important is the role of its distributors which sell products manufactured by the

firm through retailers to the ultimate consumer. Channel financing relates to ensuring that

integrated financial and commercial solution is available to the entire chain of supply and

distribution that could ensure the health of the firm, financed by the bank.

Channel financing is different from the conventional lending since, in

conventional lending, the financing banks are generally not concerned as to how the

suppliers of the firm and dealers of the products of firm, are financing their activity. The

weak financials of the supplier (leading to delay in supply and non-availability of market

credit) or the dealers of the products (delay in receipt in payment leading to higher book

debts) could adversely impact the top-line(sales) as well as bottom-line(profits) of the

financed firm. In the channel financing the financing bank may have to find ways and

means as to how the suppliers and buyers (dealers of the product) can be financed

through various instruments/facilities. Hence, the channel financing adds value to the

transaction for all the parties concerned, be it the manufacturer/trader, the supplier of the

inputs or the dealer/buyer or the financing bank.

Through channel financing, the business firms can out-source a major part of their

working capital needs thereby reducing their dependence on bank finance. For instance, it

89

need not avail of credit from its bank to pay off the supplier if the supplier gets the

finance in his own name from the bank for the raw materials supplied on credit in the

form of say, drawee bills financing. The bank can also allow loan to the dealer for the

credit term that has been fixed between the firm and the dealer in the form of receivable

finance or finance against book debts or factoring of the receivables. This enables the

manufacturing firm to get cash immediately for the finished goods supplied. This firm

functions as the principal customer which suggests the names of its suppliers and dealers

to the bank. Thereafter, the bank makes a due diligence assessment of the

suppliers’/dealers’ standing and credit worthiness and decides to provide finance on

merit.

The main benefit from the channel financing is that the pre and post sale working

capital requirement of the manufacturing concern would be scaled down. Such firms can

concentrate more on their core competence area of production and marketing their

products besides saving time and costs involved in arranging creditors and monitoring

recovery. As regards the suppliers and dealers, the major benefit is that they get payments

promptly, which improve their liquidity position and cost. This also helps them as well as

the bank to cut level of counter party risks.

The banks also gain substantially from the process of channel financing which

include increased customer base, effective due diligence and smoothness of lending

activity and loan origination process. Besides, the banks will be able to ensure better

credit discipline. Since the risk is diversified through finance to supplier, manufacturer

and the dealers, the credit exposure norms are better observed. Hence channel financing

is a very convenient tool in managing their assets portfolio.

Sources of Working Capital for Small Businesses –

90

Commercial banks are the largest financing source for external business debt,

including working capital loans, and they offer a large range of debt products. With

banking consolidation, commercial banks are multi-state institutions that increasingly

focus on lending to small business with large borrowing needs that pose limited risks.

Consequently, alternate sources of working capital debt become more important. Savings

banks and thrift lenders are increasingly providing small business loans, and, in some

regions, they are important small business and commercial real estate lenders. Although

savings banks offer fewer products and may be less familiar with unconventional

economic development loans, they are more likely to provide smaller loans and more

personalized service. Commercial finance companies are important working capital

lenders since, as non-regulated financial institutions, they can make higher risk loans.

Some finance companies specialize in serving specific industries, which allows

them to better assess risk and creditworthiness, and extend loans that more general

lenders would not make. Another approach used by finance companies is asset-based

lending in which a lender carefully evaluates and lends against asset collateral value,

placing less emphasis on the firm’s overall balance sheet and financial ratios. An asset-

based lending approach can improve loan availability and terms for small firms with

good quality assets but weaker overall credit. Commercial finance companies also are

more likely to offer factoring than banks. Trade credit extended by vendors is a fourth

alternative for small firms. While trade credit does not finance permanent or long-term

working capital, it helps address short-term borrowing needs. Extending payment periods

and increasing credit limits with major suppliers is a fast and cost-effective way to

finance some working capital needs that can be part of a firm’s overall plan to manage

seasonal borrowing needs.

Other working capital finance options exist beyond these three conventional credit

sources.

91

• First, loan guarantees can help early-stage small firms, and those with weaker credit

and collateral, secure loans. As per the Green Line Program, a specialized loan

guarantee for line-of-credit financing is offered.

• Business development corporations (BDCs) are a second alternative source for

working capital loans. BDCs are high-risk lending arms of the banking industry that

exist in almost every state. They borrow funds from a large base of member banks and

specialize in providing subordinate debt and lending to higher-risk businesses. While

BDCs rely heavily on bank loan officers for referrals, economic development

practitioners need to understand their debt products and build good working

relationships with their staffs.

• Venture capital firms also finance working capital, especially permanent working

capital to support rapid growth. While venture capitalists typically provide equity

financing, some also provide debt capital. A growing set of mezzanine funds, often

managed by venture capitalists, supply medium-term subordinate debt and take

warrants that increase their potential returns. This type of financing is appropriate to

finance long-term working capital needs and is a lower-cost alternative to raising

equity. However, the availability of venture capital and mezzanine debt is limited to

fast-growing firms, often in industries and markets viewed as offering the potential for

high returns.

• Government and non-profit revolving loan funds also supply working capital loans.

While small in total capital, these funds help firm’s access conventional bank debt by

providing subordinate loans, offering smaller loans, and serving firms that do not

qualify for conventional working capital credit. Many entrepreneurs and small firms

also rely on personal credit sources to finance working capital, especially credit cards

and second mortgage loans on the business owner’s home. These sources are easy to

come by and involve few transaction costs, but they have certain limits. First, they

provide only modest amounts of capital. Second, credit card debt is expensive with

interest rates of 18% or higher, which reduces cash flow for other business purposes.

Third, personal credit links the business owner’s personal assets to the firm’s success,

92

putting important household assets, such as the owner’s home, at risk. Finally, credit

cards and second mortgage loans are not viable for entrepreneurs who do not own a

home or lack a formal credit history. Immigrant or low-income business owners, in

particular, are least able to use personal credit to finance a business. Given these many

limitations, it is desirable to move entrepreneurs from informal and personal credit

sources into formal business working capital loans that are structured to address the

credit needs of their firms.

Underwriting Issues in Working Capital Financing –

Since repayment is closely linked to short-term cash flow, especially for cyclical

working capital loans, finance practitioners need to scrutinize these projections in detail.

Borrowers will need to provide monthly or quarterly cash flow projections for the next 1

to 2 years to facilitate this analysis. Moreover, this requirement helps assess how

carefully the firm plans and monitors cash flow and helps identify weaknesses in this key

management area. Detailed monthly projections can also uncover ways to improve cash

flow that may reduce borrowing needs and improve the firm’s capacity to repay and

qualify for a loan. For example, a firm may be able to reduce its inventory, offer

incentives for more rapid payment of invoices, or improve supplier credit terms.

For working capital loans, lenders will pay special attention to liquidity ratios and

the quality of current assets since these factors are most critical to loan repayment.

Finally, the underwriting analysis needs to evaluate the applicant’s need for permanent

versus cyclical working capital debt. Small businesses with limited long-term capital are

under heavy pressure to meet short-term cash flow needs. Adding short-term working

capital loans does not address this problem and may make matters worse. Thus, it is

important to analyze why the firm is seeking debt, what purpose the loan will serve, and

how these relate to short-term cyclical needs versus long-term permanent working capital

needs.

93

In some cases, practitioners need to revise the borrower’s loan request and

structure debt that better reflects the firm’s needs. This might entail proposing a term loan

in place of a line of credit when the business needs permanent working capital or

combining short-term and medium-term debt instruments to create a good balance

between cyclical and permanent working capital debt. These alternatives can improve a

firm’s cash flow and liquidity to partially offset the greater repayment risk that results

from extending loan repayment. Loan guarantees and subordinate debt can reduce this

additional risk and help convince conventional lenders to both supply credit and provide

it on terms that fit a borrower’s financial needs.

Computation of working capital requirement of Shree Cement

(FUND BASED)

The requirements of Current Assets for Shree Cement Ltd. may be calculated as

follows:

(All figures used for calculation of working capital gap are in Rs. lacs)

1. INVENTORY

a) Raw Material & other Materials

The yearly consumption of raw materials for the year 2009-10 was Rs. 100895 lacs and stock was Rs. 18238 lacs representing stock holding of 2.17months. For the year 2010-11, we have assumed consumption of Rs. 132834 lacs considering the production growth and stock level has been assumed at the level of 1.63 months

Material Consumption 2009-10 2010-11(E) 2011-12(E)

Raw Material 4610159548

65757

94

Coal (Indigenous) 19673 31289 34209

Coal (Imported) 24921 28247 30883

Packing Material 10200 13750 15000

Total 100895 132834 145849

Stock Level 2009-10

Raw Material 2496

Coal (Indigenous) 13773

Coal (Imported) 1454

Packing Material 515

Total 18238

Holding level for 2009-10= (18238 *12)/100895=2.169 say 2.17months

Stock Level 2010-11

Raw Material 4962

Coal(Indigenous) 5215

Coal(Imported) 7062

95

Packing Material 859

Total 18098

Assumed Holding level for 2010-11= (18098*12)/132834 = 1.63 months

Working capital required = (132834* 1.63)/12= 18043.285 lacs

b) Consumable Spares: The yearly consumption of consumable spares for the year 2009-10 was Rs. 8916

lacs and the holding level of spares inventory last year was 17 months.

Considering the last year’s consumption, it can be estimated as Rs.9900 lacs and

the holding level has been assumed to be same as 18 months. So, the working

capital required for the financing would be equal to :

Consumable Spares 2009-10 2010-11 (E) 2011-12 (E)

Imported - - -

Indigenous 8916 9900 10800

Total 8916 9900 10800

Consumable Spares 2009-10

Imported -

Indigenous 12358

Total 12358

Holding level for 2007-08 = (12358 * 12) / 8916 = 16.63 say 17 months

96

Consumable spares 2010-11

Imported -

Indigenous 14850

Total 14850

Assumed holding level for 2010-11 = (14850*12)/ 9900 = 18 months

Working capital required = (9900 * 18) / 12 = 14850 lacs

c) Stock-in-progress:

The cost of production for 2009-10 was Rs. 198685 lacs and holding level of SIP inventory last year was 0.13 months. This year for an expected the cost of production may be estimated at Rs. 234626 lacs. This time the holding level has been estimated at 0.25 months. Hence, the working capital required for its financing would be equal to

2009-10 2010-11 (E) 2011-12 (E)

Cost of Production 198685 234626 263766

Total 198685 234626 263766

Stock level 2009-10

Stock in progress 2215

Total 2215

Holding level for 2009-10 = (2215 * 12) / 198685 = 0.133 say 0.13 months

97

Assumed holding level for 2010-11 = (4888*12)/ 234626 = 0.249 or say 25 months

Working capital required= (224383 * 0. 25) / 12 = 4674.64 lacs

d) Finished goods:

The yearly cost of sales in 2009-10 was Rs. 235898 lacs (including excise duty)

for the overall sale quantity and the holding levels of finished goods inventory last

year was 0.15 months. For the year 2010-11, the cost of sales may be estimated as

Rs. 289042 lacs. The holding level has been estimated as 0.19 months as more

inventories of finished goods will be required to be kept at the dealer’s point to

support the rising market demand and increased competition. Hence the working

capital requirement for this item will be :

2009-10 2010-11 (E) 2011-12 (E)

Cost of Production 198685 234626 263766

Add Opening Stock 1628 3004 4662

Deduct Closing Stock 3004 4662 5237

Add Excise Duty 38589 46750 51000

98

Stock level 2010-11

Stock in progress 4888

Total 4888

Total 235898 289042 324665

Stock Level 2009-10

Finished Goods 3004

Total 3004

Holding level for 2009-10 = (3004 * 12) / 235898 = 0.152 say 0.15 months

Stock Level 2010-11

Finished Goods 4662

Total 4662

Assumed holding level for 2010-11 = (4662*12)/289042 = 0.193 months or say 0.19

months

Working capital required= (289042 * 0.19) / 12 = 54917.98 lacs

b)RECEIVABLES

99

The domestic sales for the year 2009-10 were Rs.401409 lacs and the average debt

collection period in 2009-10 was 0.25 months. Now with increased production in 2010-

11, sales have been estimated at Rs. 481623 lacs. In view of the requirement of extending

more credit to customer due to increased quantity of sales and opening of more sales

outlets, the debt collection period has been taken as 0.25 months. Working capital

requirement for this specific item will be:

Sales 2009-10 2010-11 (E) 2011-12 (E)

Domestic Sales 401409 481623 554316

Export Sales - - -

Total 401409 481623 554316

2009-10

Debtors 8242

Total 8242

Holding level for 2007-08 = (8242 * 12) / 401409 = 0.2475 months say 0.25 months

2010-11

Debtors 10034

100

Total 10034

Assumed holding level for 2010-11 = (10034*12)/481623 = 0.25 months

Working capital required = (481623* 0.25) / 12 = 10033.81 lacs

c) OTHER CURRENT ASSETS:

This category includes cash and bank balances, margin money with the bank, unpaid

dividend, sundry depositors, sales tax, deposits with the government, amount recoverable,

interest accrued but not due, advance payment of taxes etc. the value of other current

assets is decided on the basis of the requirement as well as taking last year’s level into

consideration.

Particulars 2009-102010-11

(E)

2011-12

(E)

Cash and bank balances 5178 7500 8500

Investments (other than long term investments) 5000 10000 85000

Advances to suppliers of raw materials &

stores/spares3947 5500

6000

Advance payment of taxes 50864 55590 62190

Other current assets 17714 20283 20580

Total 82703 98873 182270

101

Current Assets of Shree Cement Ltd for the year 2009-10 (Rs in lacs)

Sr.

No.

Particulars of Current

Assets2009-10 2010-11 (E)

1. I N V E N T O R Y

1.1 RAW MATERIAL 18238 18098

1.2OTHER CONSUMABLE &

SPARES12358 14850

1.3 STOCK IN PROGRESS 2215 4888

1.4 FINISHED GOODS 3004 4662

2. RECEIVABLES 8242 10034

3.OTHER CURRENT

ASSETS82703 98873

TOTAL 126760 151405

CURRENT LIABILITIES

The requirement for Current Liabilities (other than bank borrowings) may be calculated

as follows

1. Credit for purchase of raw materials:

102

The A/c payable to the creditors of the company for the year 2009-10 was Rs.2036 lacs

and the average payment deferral period was 0.24 months. The average consumption for

the year 2010-11 can be estimated as Rs.5424 lacs on estimated basis.

2009-10 2010-11 (E) 2011-12 (E)

Sundry Creditors 2036 3500 3900

Total 2036 3500 3900

Raw Material cost for 2009-10---100895((calculated and shown in I-(a) above)

Holding level for 2009-10 = (2036 X 12) / 100895 = 0.24 months

Raw material cost for 2010-11----Rs132834 (calculated and shown in I-(a) above)

Assumed Holding level for 2010-11= (3500*12)/132834 =

0.316 months or say 0.32 months

Sundry creditors (trade) for 2010-11 = (132834 * 0.31) / 12 = 3431.54 lacs

2. Statutory Liability:

This mainly contains the sales tax due. This has been estimated to be Rs 2100 lacs for

the year 2010-11 and in the year 2009-10 the same was Rs 1804 lacs.

3) Other Current Liabilities :

This Category includes provision for doubtful debts, dividend payable (including

corporate tax), unclaimed dividend, interest accrued but not due etc. the value other

current liabilities is generally decided on a judgemental basis.

Particulars 2009-10 2010-11 (E) 2011-12 (E)

103

Interest accrued but not

due2296 2144

1678

Proposed dividend 3250 6508 6508

Provision for taxation 45627 50353 56953

Other current liability 1180 1400 1600

Total 52353 60405 66739

Current Liabilities of Shree Cement Ltd for the year 2009-10 (Rs in lacs)

S.No. Particulars 2009-10 2010-11 (E)

1. CREDITORS 2036 3500

2. STATUTORY LIABILITIES 1804 2100

3. OTHER CURRENT LIABILITIES 52353 60405

Total 56193 66005

WORKING CAPITAL GAP = (CURRENT ASSETS) – (CURRENT LIABILITIES)

= 151360 – 66005 = 85355 (Adjusted for number after decimal)

104

i. COMPUTATION OF WORKING CAPITAL REQUIREMENTS (NON FUND BASED) :

Apart from the fund based borrowings from he banks, Non-fund requirement is

also raised. The main sources of non-fund based limits are Letter of Credit and

Bank Guarantee.

Letter of Credit (LC): This limit is commonly used to finance international trade. At

Shree Cement Ltd, LC is used for domestic purchase / import of consumable stores

and spares / packing materials / coal and certain capital items on an ongoing basis

for modification / replacement of parts of the machinery.

COMPUTATION OF THE BANK BORROWINGS: The amount of borrowings for Shree

Cement for the year 2009-10 is calculated as follows: (Rs in lacs)

S.No. Particulars2009-10

(Actual)

20010-11

(Estimated)

2011-12

(Estimated)

1. Total Current Assets 126758 156405 246089

2.Current Liabilities (other than bank

borrowings)

56192 66005 72889

3. Working Capital Gap (1 – 2) 70566 90400 173201

4.Min. stipulated net working capital

i.e. 25% of the total current assets31689 39101 61522

5.Actual / projected net working

capital (short term bank borrowings)53283 70400 148201

6. Item (3 – 4) 38876 51299 111678

7. Item (3 – 5) 17283 20000 25000

105

8. Maximum permissible bank finance 17283 20000 25000

Credit Rating Of the Company

Credit rating given to Shree Cement by various institutions is as follows:

Sr. No.

Institution Rating Description

1 CARE PR-1 PLUS Investment Grade

2 SBBJ SBBJ-1Highest Rating, Most Credit

worthy

106

Various Modes Available for company to fulfill Working Capital Finance :-

1. Cash Credit and Overdraft facility from banks

2. Long Term Loans from banks (For Permanent Working Capital part)

3. FCNR (B) Loans

4. MIBOR Linked Loans

5. Commercial Papers

The above mentioned options for working capital financing of Shree Cement are

discussed below.

1. Cash Credit and Overdraft facility

Shree Cement has high credit standing in the domestic market. It continues to

enjoy the highest credit rating from its bankers (eg. SBBJ-1) as well as from credit rating

agencies like CARE (PR-1 PLUS) for its working capital requirements. The company

continues to secure high investment grade rating from CARE (CARE AA) for its long

term funds. These high ratings indicate the strong financial status of the company in the

eyes of financial institutes.

The consortium of bankers of the company includes

State Bank of Bikaner and Jaipur

State Bank of India

ICICI Bank Ltd.

IDBI Bank Ltd.

UTI Bank Ltd.

BNP Paribas

Standard Chartered Bank

DBS Bank

107

ABN Amro Bank

It is understood from finance executives of Shree Cement that in the financial year 2007-

08, it was able to avail its entire working capital financing requirement through this mode

at 8.5% from its banks due to its high credit standing.

Generally, for the customers having highest credit rating and loan requirement of

more than Rs.25 Cr., the interest rate on these accounts ranges from 9% to 12%. As Shree

Cement has better credit rating, it is able to acquire cash credit loans at lower limit of

interest rate. To get it approved to the maximum limit can be understood from financial

safety point, but total reliance on a single mode is not advisable. It may be simple in

procedure and less rigorous, but in an economic situation in which higher inflation and

higher liquidity are causing problems to financial regulators, there are all the way chances

of tightening of liquidity and bank finances. It could result in an increase in interest rates.

In such situation, exploring other means of finances becomes even more necessary.

2. Long Term Loans from banks (For Permanent Working Capital part)

The permanent working capital of Shree Cement can be determined in a following

way.

Permanent Working Capital =

(A/c Receivables) + (Inventory) – (A/c Payable) – (Accruals)

The Permanent component of the working capital can be financed through long term

financing. This long term financing can be in the form of

Term Loans

Preferred Stocks

Right Issue

Term Loans –

108

The interest rates for the long term loans are generally higher than the short term

loans. But, they reduce the future uncertainty in arranging finances for the firm.

Financing all or most of the short term financial requirements through short term loans

reflects flexible approach of the firm.

Shree Cement is a growing company and is in the process of capacity expansion.

The cement industry in India as such is going to see lot of capacity addition in coming

few years. In such circumstances, the long term loans from banks and financial

institutions could be better utilised for the expansion plans. It will not be a good idea to

finance the current requirements through long term loans at this point of time. The

prevailing interest rates on long term loans are 12 to 15%.

Preferred Stock

One of the modes of long term finance is preferred stock. Preferred stock

represents equity of a corporation, but it is different from common stock because it has

preference over common stock in the payment of dividends and in the assets of the

corporation in the event of bankruptcy. Preference means only that the holders of the

preferred share must receive a dividend (in the case of an ongoing firm) before holders of

common shares are entitled to anything.

Following benefits can be availed by Preference Capital:

There is no legal obligation to pay preference dividend. A company does not face

bankruptcy or legal action if it skips preference dividend.

Preference capital is redeemable in nature. Financial distress on account of

redemption obligation is not high because periodic sinking fund payments are not

required and redemption can be delayed without significant penalties.

109

Preference capital is generally regarded as part of net worth. Hence, it enhances

the creditworthiness of the firm. This will help Shree Cement in maintaining its

creditworthiness with its banks by maintaining good financial indicators.

Preference shares do not, under normal circumstances, carry voting right. Hence,

there is no dilution of control. There will be no threat to the company of losing

control to financial institutions or other investors if this mode of capital raising is

adopted.

No assets are pledged in favour of preference shareholders. Hence, mortgageable

assets of the firm are conserved. More mortgageable assets will be available for

the company for financing its capacity expansion program and bank borrowings

can be used in a better way for it.

As promoters’ stake in the company is above the comfort level, the company can

also explore the option of ‘convertible preference shares’. The preference shares

offered under this scheme will be converted into equity stocks after specified

period. While offering these preference shares to prospective buyers, Shree

Cement will be in position to offer it at fairly low preferred dividend. Thus, the

availability of finance will be at lower interest rate.

If the firm is skeptical about the dilution of the control of the company to

aggressive investors, it can add a ‘poison pill’ to the preferred stock. The right to

buy the equity stocks of the company at bargain price will be at attractive offer for

the promoters of the company. By this way, they will be in a position to finance

the needs of the company and avoid dilution of control over it.

Rights Issue

A rights issue is an issue of capital to the existing share holders of the company

through a letter of offer made in the first instance to the existing shareholders on a pro

rata basis. The share holders may forfeit this right partially or fully.

110

The rights issue will help Shree Cement to raise finance for its long term capital

needs. The larger stake of promoters in the company will provide a cushion to raising

finance through this mode. But, as promoters’ stake is quite big in the company, the

implementation of it will entirely depend on them.

It has been observed in the market that a pure rights issue is much cheaper than an

equity issue with underwriting or a rights issue with standby underwriting. But, as cement

sector as such is experiencing a bearish phase on the stock markets, the offer in the rights

issue need to be very much attractive to the shareholder. After touching the highs of

Rs.1600, the price of the stock has corrected in a big way and is now trading in the range

of Rs.850. Hence, to appear attractive to its share holders, Shree Cements need to offer

the rights issue in the range of Rs.600. If Shree Cement offers one right share for every

two shares held by a shareholder, the amount it can raise can be calculated as follows eg:

No. of outstanding shares = 3,48,37,225

No. of right shares on offer = 1,74,18,613

Price of each right share = Rs.600/-

Share Capital raised = Rs.1045.12 Cr.

Considering forfeiting of right by some of the investors, the capital raised can be around

Rs.1000Cr. The cost of right flotation will be in the range of 4 to5 %. This fund will also

be available to support the long term capital financing required in capacity expansion.

However the decision of right issue is puirly a management isuue .

3. FCNR (B) Loans

FCNR (B) loans will be one of the better options available for the company.

FCNR (B) loans are available at the select branches of major private and PSU banks.

111

These loans are available in Dollar, Euro, Japanese Yen and GBP. As these rates

are offered in above mentioned foreign currencies, the fluctuations in the currency rates

are a major worry in these loans.

Banks generally charge a rate differential over the base rate as per the credit rating of the

borrower. As Shree Cement enjoys very good credit rating in the financial world, it will

be possible for it to get these loans at lower differential charges. The only concern for

Shree Cement will be that it doesn’t earn much of its income in foreign currencies.

Hence, it has to go for aggressive foreign currency hedging. A hypothetical calculation

for net interest rate on FCNR loans is shown below.

= Base Rate (1.5 to 2.5 %)

Differential charges (2 %)

Hedging charges (1.5 to 2%)

Processing & other charges ( 1 to 1.5%)

= Net Interest will range from 5.5% to 8%.

(The interest on FCNR deposits at various banks is shown in the appendix attached. )

The maximum limit of the interest rate is comparable to the interest rate on cash credit

facility. Hence, company can seriously look for the FCNR loans in these currencies

(preferably Euro or Yen) . If the company succeeds in getting the loans at interest rate 1%

lower than the CC facility, it will translate into savings of almost Rs.1.5Cr.

4. MIBOR Linked Loans

The loans offered by banks which uses MIBOR, i.e. Mumbai Interbank Offer

Rate, as a base rate are termed as MIBOR Linked Loans. MIBOR for various periods,

112

like daily, 14-day, one month and three month, is available. MIBOR loans are generally

based on 14-day or one month MIBOR.

5. Commercial Papers

The market of commercial papers in India is not developed as such. It is believed

in the industry that cement sector have almost completed its upward journey in recent

times and may follow the downward path of the business cycle. It is all the way possible

that market may not respond enthusiastically to the commercial papers and the bonds

may need to offer at larger discount. Hence, this is not a good option at this point of time.

RESULTS AND CONCLUSIONS :

The results obtained during the studies have brought me to several conclusions and enabled me to give my opinion on financial standing of the company:

Over the last few years the company has been in the expansion mode and constantly

increasing the installed capacity. The latest being the addition of 1 MTPA clinker

unit in RAS in the world record time of 367 days.

Though there is a slowdown going on in the country and it also includes the cement

industry. But the effect is least visible on the performance of this top organization. In

fact this organization is getting better every year. This is because of the huge cost

cutting measures going on in the company which also includes live projects like

“ Mission 11” (to reduce cost by 11% and increase profitability by 11%) and also

with the increase demand of its products in the country.

Shree Cement is a company where best practices of financial management are

applied every day. It is very well rated by financial institutions. This gives the

company possibility of cooperation with financial basis on every field and even

113

the most sophisticated products are dedicated to the company. The company

also has good relations with governmental institutions and wisely uses scheme

and facilities provided by state. In effect costs of debts are very low and cost of

borrowing capital for new projects is at lowest possible level.

Industry situation is highly competitive within the next few years due to major

capacity additions within the last period surplus of cement may take place on the

market. This situation may result in margin cuts and price war. For Shree Cement it

should still be very comfortable because its’ costs are well controlled and margin at

above-the-average level. India as a second largest cement producer in nominal terms

still can count on recovery in building industry.

Shree Cements’ financial standing makes it invulnerable to buyout or acquisition.

This is a great advantage because in the times of overcapacity, Greenfield

investments may not bring required rate of return. That is why larger companies

may try to utilize their profits on mergers and acquisitions to own a larger piece

of the market. Shree cement as an industry out performer. This gives the

company an opportunity to become a possible buyer of another company

because there are substantial amounts of profits to be utilised in the future.

SCL has healthy and sound financial status, with characteristics of a company that

evolves from middle sized to large sized one. Of course this growth with many

benefits like effect of scales. But sometimes it brings also internal pains, also on

financial side, when fixed costs rise out of control, workers demand higher

salaries, sometimes not parallel with efficiency growth, or invested capital does

not bring required rate of return. Also going global may reduce the cost of capital

but on the other side may expose the company on new kind of political risk which

may be often impossible to hedge. So far as the Shree is concerned , these factors

are well within the control.

114

Some Other Recommendation on Working Capital Management to enhance

NWC and Cash Cycle

The major part of the operating cycle of the company is occupied by the ‘days

in inventory’ (48.5 days) and a very small part is associated with ‘days in

receivables’ (7.5 days). The holding period for various sub-items in inventory

is as follows:

Raw Material and other material 48.9 days

Consumable spares 540 days

Stock-in progress 7.5 days

Finished goods 5.7 days

These figures of holding period seem a bit on higher side. Company should

employ better control in inventory management to bring down these figures.

The figures of holding period of consumable stores and raw material seem a bit

on higher side. Company should employ better control in inventory management

to bring down these figures.

Shree Cement has a big network of suppliers. These suppliers vary in size and

business. Shree Cement can take benefit of its creditworthiness with financial

institutions and can introduce many of its small vendors to channel financing.

Many private and PSU banks offer this facility. If Shree Cement introduces its

selected suppliers to the bank, the supplier’s creditworthiness will be identified

by the bank. The supplier will be able to get finance from the bank in his own

name under ‘drawee bills financing’ due to his business with Shree Cement.

This will solve his liquidity problem and it will be possible for Shree Cement to

get better credit period.

115

The company has recently implemented ERP system in the organization. This

has given further advantage to the company to complete all activities on line.

If suppliers and dealers are brought under the ERP network, it will help the

company in integrating its activities and avoid unnecessary delay.

Company has huge cash amount in its account. Company can use this amount

for further expansions

Bibliography:

116

INTERNET:www.shreecementltd.com , www.worldcement.com,

www.cmaindia.org.

Magazines – Cement Manufacturing Association (CMA) weekly and monthly

reports, Annual Reports of Shree Cement Limited (2007-08,2008-09),

Books –

Financial Management by Khan and Jain.

Financial Management by I.M.Pandey.

Financial Management by prasanna Chandra.

117