General Engineering Company (GEC)1

1. Early in January 1991, Mr. Pulok, credit officer of Rashtriya Bank, was studying the request of the General Engineering Company Ltd. (GEC) for increasing the company's cash credit limit, from the existing Rs.5 lakhs to Rs.8 lakhs. GEC manufactures two-stage D.A. (Dissolved Acetylene) regulators. The bulk of their sales were made to a public sector shipyard, a Naval dockyard and a large heavy vessels fabricating unit. The fabricating unit was expected to make substantial purchases in February and March, in view of a large contract received by it recently.

2. The provisional financial statements of GEC for the first nine months of 1990-91 were available (Exhibit 1). Additionally Mr. Pulok wanted the projected income statement for the quarter ended 31st March 1991, the monthly cash forecast for this quarter, and the projected balance sheet as of 31st March 1991.

3. In a cash credit account, a credit limit was sanctioned by the bank to a borrower, usually for a one-year period. As security for the advance, the borrower normally created a charge on current assets in favour of the bank. Both in order to ensure that the borrower had a reasonable stake in the business and to protect the bank's interests, in case of a fall in the value of the current assets, the bank stipulated a "margin". In the case of GEC, the assets charged were inventories and receivables and the margin stipulated against both was 30%. This meant that as on 31st December 1990 borrowings by GEC could not exceed Rs.4.87 lakhs (70 per cent of Rs.6.96 lakhs [inventories plus receivables]) although the sanctioned cash credit limit was Rs.5 lakhs. Borrowers were expected to route all their receipts (such as collections from sales) and payments (such as payment for purchase of raw materials) through the cash credit account. A number of organisations usually sought enhancement of their cash credit limits between January and March. Since interest was paid on utilised credit and not on the sanctioned cash credit ceiling, there was a tendency to overstate their credit requirements. Rashtriya Bank tried to curtail these exaggerated requests as otherwise its own funds management became problematic. Mr. Pulok, therefore, decided to prepare the financial forecasts himself. He held detailed discussions with the senior managers of GEC as well as with the representatives of their clients. Based on these, he collected the following information.

4. Generally, 10 per cent of the sales was collected within the same month, 50 per cent was collected in the month following sales, and 40 per cent was collected in the second month following sales. This trend was expected to continue over the next few months. GEC had sold 250 regulators and 300 regulators in November and December 1990, respectively. They expected to sell 300 regulators in January 1991, 500 in February 1991 and 700 in March 1991. The selling price was Rs.800 per regulator.

5. Production was linked to sales requirement and all items produced were sold in the same month. No inventories of finished goods, or of work-in-progress were maintained.

6. Raw materials were purchased in the beginning of each month, to meet that month’s production requirements; and purchases were paid for in the beginning of the following month. In the next three months, raw material consumption was expected to be 50 per cent of sales. This was the level that prevailed in the last quarter of 1990. Inventories of raw materials would be maintained throughout at December 1990 levels.

7. The labour strength would be adjusted to meet production requirements. In the next three months, wages were expected to be 25 per cent of sales. Wages would be paid on the last day of the month.

8. Operating expenses would be Rs.20,000 per month. These would be paid in cash.

1 Case prepared by R Srinivasan [Revision 10th August 2015]1

9. GEC was expected to add plant and equipment worth Rs.1 lakh in the quarter ending 31st March 1991, the payments for these would be made in February 1991. Depreciation (including on the new assets) would be Rs.32,000 in the next three months.

10. The term loan was repayable in annual instalments of Rs. 80,000. The next instalment was due on 31st March 1991. Quarterly interest on this term loan, at interest rate of 10% per annum, would also be paid on 31st March 1991.

11. Interest on public deposits at 16 per cent per annum was payable half yearly in June and December. Out of the public deposits, Rs.1 lakh was due in 1991-92 (in fact by December 1991). Rs 10,000 (10 per cent of this amount of Rs.1 lakh) had to be invested in marketable securities (with maturity of nine months) on 31st March 1991.

12. Interest was payable on the cash credit at 18 per cent per annum. The bank computed interest on the monthly closing cash credit balances and debited interest to the cash credit account in June, September, December and March. It was expected that interest on cash credit in the last quarter of 1990-91 would be around Rs. 24,000.2

13. Estimated income tax, for the fiscal year ending 31st March, had to be paid in advance in three instalments in September, December and March. GEC had already paid the first two instalments in time and intended to pay a final instalment on 15th March 1991. GEC would square the tax accounts (i.e. in the balance sheet as of 31st March, the Advance tax would equal the Provision for income- tax). The income tax rate was 50 per cent. Assume that income tax is calculated on the profit before tax computed by you (i.e. financial accounting Profit Before Tax is the same as taxable income).

14. For 1990-91, a dividend at 20 per cent (on the paid-up share capital) would be proposed by the management, on 31st March 1991. Dividends would usually be paid within 45 days of the Annual General Meeting (in which shareholders’ approval of the dividends would be sought). This meeting would be held in June, 1991.

15. GEC would maintain a cash balance of Rs. 60,000, throughout.

2 Accept this number. The companion Financial Planning note will tell you how this number was obtained.

2

Exhibit 1GEC Provisional Income Statement for the period 1st April 1990 to 31st December 1990 (Rs.000s)Sales 2000Cost of goods sold [1] 1590Gross profit 410Operating expenses 180Earnings before interest and tax 230Interest [2] 130Profit before tax 100Tax 50Profit after tax 50

[1] Consisting of raw material consumption 1000, wages 500, and depreciation 90.[2] Consisting of interest on term-loan 30, on public deposits 22, and on cash-credit 78.

GEC Provisional Balance Sheet as of 31st December 1990 (Rs. 000s)Net fixed assets 820

Cash 60Accounts receivable 296Inventories 400Advance tax 80Total current assets 836TOTAL ASSETS 1656

Accounts payable 120Provision for income-tax 50Cash credit 436Current portion: Public deposits 100Current portion: Term loan 80Total current liabilities 786

Public deposits 100Term loan 320

Paid-up Share capital 200Reserves as of 31.3.90 200Profit in the period 50 1.4.90 to 31.12.90Share Capital & Reserves 450TOTAL LIABILITIES AND EQUITY 1656

3