Description
Project Made On Five Star Pharma Co.
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Project Report On “WORKING CAPITAL AND PHARMACEUTICAL INDUSTRY” Submitted to Gujarat University for the degree of Master in Commerce Faculty: Commerce
Subject: ACCOUNTANCY AND FINANCE
By. MAHMMADRAMIZ A. SHAIKH Seth Damodardas School of Commerce Gujarat University Ahmedabad
College Seat No . 37 Exam Seat No . _____
Year : 2012 Year _____
Under the guidance of Dr. Harish S. oza (Director of School of Commerce) Seth Damodardas School of Commerce
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Seth Damodardas School of Commerce Gujarat University-Ahmedabad
CERTIFICATE
This is to certify that Mr. Mahmmadramiz A. Shaikh has worked and completed his Project Work for the degree of MASTER IN COMMERCE in the faculty of COMMERCE in the subject of ACCOUNTANCY on Title of project work to be written “Working capital and pharmaceutical industry.” under my supervision. It is her / his own work and facts reported by her/his personal findings and investigations.
Name & Signature of Guide
Date of submission:
Name & Signature of Professor in Charge/ Director/Principal of the Institute
Stamp of the Institute with date
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Declaration by Student
I the undersigned Mr. MahmmadRamiz A. Shaikh here by, declare that this project work entitled “Working capital and pharmaceutical industry” is a result of my own research work and has not been previously submitted to any other University for any other examination.
I hereby further declare that all information of this document has been obtained and presented in accordance with academic rules and ethical conduct.
College Seat No. __________
Year _______.
Exam Seat No. ___________
Year________.
Date
Name & Signature
Place:
Research Scholar
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ACKNOWLEDGEMENT
Behind every study there stands a myriad of people whose help and contribution make it successful. Since such a list will be a prohibitively long. I may be excused for important omission.
I am grateful to all who helped & guided me at every stage of my work. Their constant appraisal & encouragement helped me to accomplish my training smoothly.
I am thankful to “Dr.Harish.S.Oza” (Director of S.D.School Of Commerce) for the cooperation extended to me in compiling the project report. This acknowledgement would be incomplete without the mention of Him who sorted out my queries time to time. My parents were very supportive in any endeavor and offer valuable emotional support during times of stress. Finally, I thank to my friend who gave me time for finding data about my subject. I gained a lot of knowledge & experience by observing their way of working which is surely to be admired. I extend My gratitude to the entire staff that provided a very comfortable environment which helped me deliver this performance.
MAHMMADRAMIZ SHAIKH
M.COM 4th Sem.
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INDEX
Chapter No 1.
Title of Chapter Introduction
INTRODUCTION ON FINANCE
Page No.
8
INTRODUCTION OF WORKING CAPITAL
10
NEED FOR WORKING CAPITAL
15
REQUIREMENTS OF FUNDS
16
SOURCE OF WORKING CAPITAL
17
WORKING CAPITAL CYCLE
23 DEBTORS MANAGEMENT 37 CREDITORS MANAGEMENT 43 Pharmaceutical Industry In India 44 Company Profile 45
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RESEARCH METHODOLOGY
OBJECTIVES OF THE PROJECT 50
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Hypothesis 50 Ratio Analysis 51 Limitations of the study 51
LITERATURE REVIEW 3 DATA PRESENTATION AND DATA 4 ANALYSIS 53
57
DATA ANALYSIS AND INTERPRETATION 58 IMPORTANCE OF RATIO ANALYSIS 61 RECEIVABLES MANAGEMENT 68 INVENTORY MANAGEMENT 76
PROFIT & LOSS ACCOUNT FOR THE PERIOD 1ST April 2008 TO 31 ST MARCH 2011 BALANCE SHEET AS ON 1ST APRIL 2008 TO 31ST MARCH 2011
96
97
CONCLUSION 5 BIBLIOGRAPHY 6 100 98
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CHAPTER-1 INTRODUCTION
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INTRODUCTION ON FINANCE
Finance is one of the major elements that activate the overall growth of the economy. Finance is the life blood of economic activity. A well - knit financial system directly contributes to the growth of the economy. An efficient financial system calls for the efficient performance of institution, financial instruments and financial markets.
Finance which acts as the lifeblood in the modern business types is one of the most important consideration for an entrepreneur-company. While Implementing, expanding, diversifying, modernizing or rehabilitating any project the meaning of finance is better understood. In this section we have covered finance related information and the process of managing the same.
Finance is a science of managing money and other assets. It is the process of channelization of funds in the form of invested capital, credits, or loans to those economic agents who are in need of funds for productive investments or otherwise. E.g. On one hand, the consumers, business firms, and governments need funds for making their expenditures, pay their debts, or complete other transactions. On the other hand, savers accumulate funds in the form of savings deposits, pensions, insurance claims, and savings or loan shares, etc which becomes a source of investment funds. Here, finance comes to the fore by channeling these savings into proper channels of investment, In general, finance is that business activity which is concerned with acquisition and Conservation of capital funds in meeting financial needs and over all objectives of a business entrepreneur.
Finance is the common denominator for a vast range of corporate ., projects and the major part of any corporate plan must be expressed in financial terms”.
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The main reasons a business needs finance are to:
• Start a business
• Finance expansions to production capacity
• To develop and market new products
• To enter new markets
• Take-over or acquisition
• Moving to new premises
• To pay for the day to day running of business
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INTRODUCTION OF WORKING CAPITAL
Working capital management refers to all management decisions and actions that ordinarily influence the size and effectiveness of the working capital. It is concerned with the most effective choice of working capital sources and the determination of the appropriate levels of the current assets and their use. It focuses attention to the managing of the current assets, current liability and their relationships that exist between them. In other words, working capital management may be defined as the management of a firm’s liquid assets viz-cash, marketable securities, accounts receivable and inventories.
In the present day context of rising capital cost and scarce funds, the importance of working capital needs special emphasis. It has been widely accepted that the profitability of a business concern likely depends upon the manner in which its working capital is managed. The inefficient profitability but ultimately may also lead a concern to financial crisis. On the other hand, proper management of working capital leads to a material savings and ensures financial returns at the optimum level even on the minimum level of capital employed. We also know that both excessive and inadequate working capital is harmful for a firm. Excessive working capital leads to un-remunerative use of scarce funds. On the other hand inadequate working capital usually interrupts the normal operations of a business and impairs profitability. There are many instances of business failure for inadequate working capital. Further, working capital has to play a vital role to keep pace with the scientific and technological developments that are taking place in the concerned area of pharmaceutical industry. If new ideas, methods and techniques are not injected or brought into practice for want of working capital, the concern will certainly not be able toface competition and survive. In this context, working capital management has a special relevance and a through investigation regarding working capital practice in the pharmaceutical industry is of utmost importance. An attempt has, therefore, been
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11 made to undertake an in-depth study on, working capital practices by Indian firms in pharmaceutical industry enlisted in BSE. Working capital may be regarded as life blood of a business. Its effective provision can do much to ensure the success of a business while its in provision can do much to ensure the success of a business while its in efficient management can lead not only to loss of profits but also to the ultimate downfall of what otherwise might be considered as a promising concerns.
DEFINITIONS OF WORKING CAPITAL
The following are the most important definitions of Working capital: ? According to shoo-in, “Working Capital is the amount of funds necessary to cover the cost of operating the enterprise”. Working Capital is also known as Revolving or Circulating Capital. ? According to Genesterberg, “Circulating Capital means current assets of a company that are changed in the ordinary cause of business from one to another form. Example: From cash to inventory, inventories to bills receivable and bills receivable to cash.
? Working capital is the difference between the inflow and outflow of funds. In other words it is the net cash inflow . ? Working capital represents the total of all current assets. In otherwords it is the “Gross working capital”, it is also known as Circulating capital or Current capital for current assets are rotating in their nature.
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WORKING CAPITAL MANAGEMENT
Working Capital is the key difference between the long term financial management and short term financial management in terms of the timing of cash. Long term finance involves the cash flow over the extended period of time i.e 5 to 15 years, while short term financial decisions involve cash flow within a year or within operating cycle. Working capital management is a short term financial management.
Working capital management is concerned with the problems that arise in attempting to manage the current assets, the current liabilities & the inter relationship that exists between them. The current assets refer to those assets which can be easily converted into cash in ordinary course of business, without disrupting the operations of the firm.
Composition of working capital ? Major Current Assets
1) Cash 2) Accounts Receivables 3) Inventory 4) Marketable Securities
? Major Current Liabilities
1) Bank Overdraft 2) Outstanding Expenses 3) Accounts Payable 4) Bills Payable
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13 The Goal of Capital Management is to manage the firm s current assets & liabilities, so that the satisfactory level of working capital is maintained. If the firm can not maintain the satisfactory level of working capital, it is likely to become insolvent & may be forced into bankruptcy. To maintain the margin of safety current asset should be large enough to cover its current assets.
Main theme of the theory of working capital management is interaction between the current assets & current liabilities.
NET WORKING CAPITAL = CURRENT ASSETS- CURRENT LIABILITIES
Concept of working capital
There are five concepts of working capital :-
o Gross Working Capital
o Net Working Capital
o Negative working capital
o Permanent working capital
o Variable working capital
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14 On the basis of the components or items comprised in working capital, working capital can be classified into the following types:
Gross Working capital: Simply called as working capital, refers to the firms
investment in current assets. Current assets which can be converted in to cash with in the accounting year (or operating cycle) and includes cash, short term securities, debtors, Bills receivable and stock (inventory) .
Net Working Capital: Refers to the difference between current assets and current
liabilities. Current liabilities are those claims of outsiders, which are expected to mature for payment with in a year and include creditors, Bills payable and outsider’s expenses.
Negative working capital or working capital deficit: means the excess of
current liabilities over the current assets. It accurse when the current liabilities exceed the current assets,
Permanent working capital or fixed working capital : refer to the
minimum amount of investment in current assets required throughout the year for carrying out the business. In other words , it is the amount of working capital which remains in the business permanently in one form or other.
Variable working capital or fluctuating working capital: refer to the amount
of working capital which goes on fluctuating or changing from time to time with the change in the volume of business activities.
.
Ratios : The term ratio simply means one number expressed in terms of another. It
describes in mathematical terms the quantitative relationship that exists between two numbers.
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NEED FOR WORKING CAPITAL
Every business undertaking requires funds for two purposes, investments in fixed assets & investment in current assets. Funds required for investing in inventory, debtors & other current assets keep changing in shape & volume. Company has some cash in the beginning; this cash may be the source of raw material, keeping the labor cost & other overheads. These three combined would generate work in progress, which will be converted into finished goods on the completion of the production process into debtors & when the debtor pay, the firm may generate cash. Working capital is needed for sustaining (i.e., maintaining) the sales activities. If adequate working capital is not maintain for this period ,the firm will not be able to sustain or maintain the sales , since it may not be in a position to purchase raw material and pay wages and other expenses ands produce the goods required for the sales.
NATURE OF WORKING CAPITAL
In ordinary parlance, Working Capital is taken to be the fund available for meeting day-to-day requirements of enterprises. It cannot be denied that a part of the fixed or permanent capital is invested in assets, which are kept in the business or for a long period for the purpose of earning profit. These are usually known as fixed assets viz. Land & buildings, plant & machinery, furniture & fitting & intangibles like goodwill, patents, trademarks & long-term investment. Another part of permanent capital left in the business for supporting the day-to-day normal operation is known as the “Working Capital”. This Working
Capital generates the important element of cost viz. Material, wages & expenses. These cost usually lead to production & sales in case of manufacturing concerns & sales alone in others. These costs occur gradually in a flow & do not come into being abruptly at a given moment. Hence the initial investment of cash as working capital for this specific purpose has to be continued until the sales revenue commences flowing in substantially & in a regular way. From this stage the business is found to acquire a momentum of its own. The flow
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16 of revenue is expected to continue to replace the cost lost in its day-to-day out flow for the generation of the revenue mentioned above.
REQUIREMENTS OF FUNDS
Every company requires funds for investing in two types of capital i.e. fixed capital, which requires long-term funds, and working capital, which requires short-term funds.
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SOURCE OF WORKING CAPITAL
The financial manager is always interested in obtaining the working capital at the right time, at a reasonable cost and at the best possible favorable terms. A part of the working capital investment are permanent investments is fixed assets. The following is snapshot of various source of working capital.
Sources of working capital divided into two
• Long –term
• Short –term
Sources of additional working capital include the following: ? ? Existing cash reserves Profits (when you secure it as cash!) M.COM(SEM-IV) 2011-2012
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18 ? ? ? ? Payables (credit from suppliers) New equity or loans from shareholders Bank overdrafts or lines of credit Term loans
If you have insufficient working capital and try to increase sales, you can easily over-stretch the financial resources of the business. This is called overtrading. Early warning signs include: ? ? ? ? ? ? ? ?
Pressure on existing cash Exceptional cash generating activities e.g. offering high discounts for early cash payment Bank overdraft exceeds authorized limit Seeking greater overdrafts or lines of credit Part-paying suppliers or other creditors Paying bills in cash to secure additional supplies Management pre-occupation with surviving rather than managing Frequent short-term emergency requests to the bank (to help pay wages, pending receipt of a cheque).
LONG TERM SOURCES ISSUE OF SHARES
Ordinary shares are also known as equity shares and they are the most common form of share in the UK. An ordinary share gives the right to its owner to share in the profits of the company (dividends) and to vote at general meetings of the company. Since the profits of companies can vary wildly from year to year, so can the dividends paid to ordinary shareholders. In bad years, dividends may be nothing whereas in good years they may be substantial.
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19 The nominal value of a share is the issue value of the share - it is the value written on the share certificate that all shareholders will be given by the company in which they own shares. The market value of a share is the amount at which a share is being sold on the stock exchange and may be radically different from the nominal value. When they are issued, shares are usually sold for cash, at par and/or at a premium. Shares sold at par are sold for their nominal value only - so if Rs.10 share is sold at par, the company selling the share will receive Rs. 10 for every share it issues. If a share is sold at a premium, as many shares are these days, then the issue price will be the par value plus an additional premium.
DEBENTURES
Debentures are loans that are usually secured and are said to have either fixed or floating charges with them. A secured debenture is one that is specifically tied to the financing of a particular asset such as a building or a machine. Then, just like a mortgage for a private house, the debenture holder has a legal interest in that asset and the company cannot dispose of it unless the debenture holder agrees. If the debenture is for land and/or buildings it can be called a mortgage debenture. Debenture holders have the right to receive their interest payments before any dividend is payable to shareholders and, most importantly, even if a company makes a loss, it still has to pay its interest charges. If the business fails, the debenture holders will be preferential creditors and will be entitled to the repayment of some or all of their money before the shareholders receive anything.
LOANS FROM OTHER FINANCIAL INSTITUTIONS
The term debenture is a strictly legal term but there are other forms of loan or loan stock. A loan is for a fixed amount with a fixed repayment schedule and may appear on a S.D.SCHOOL OF COMMERCE AHMEDABAD M.COM(SEM-IV) 2011-2012
20 balance sheet with a specific name telling the reader exactly what the loan is and its main details.
SHORT TERM SOURCES FACTORING
Factoring allows you to raise finance based on the value of your outstanding invoices. Factoring also gives you the opportunity to outsource your sales ledger operations and to use more sophisticated credit rating systems. Once you have set up a factoring arrangement with a Factor, it works this way: Once you make a sale, you invoice your customer and send a copy of the invoice to the factor and most factoring arrangements require you to factor all your sales. The factor pays you a set proportion of the invoice value within a pre-arranged time - typically, most factors offer you 80-85% of an invoice's value within 24 hours. The major advantage of factoring is that you receive the majority of the cash from debtors within 24 hours rather than a week, three weeks or even longer.
INVOICE DISCOUNTING
Invoice discounting enables you to retain the control and confidentiality of your own sales ledger operations. The client company collects its own debts. 'Confidential invoice discounting' ensures that customers do not know you are using invoice discounting as the client company sends out invoices and statements as usual. The invoice discounter makes a proportion of the invoice available to you once it receives a copy of an invoice sent. Once the client receives payment, it must deposit the funds in a bank account controlled by the invoice discounter. The invoice discounter will then pay the remainder of the invoice, less any charges. The requirements are more stringent than for factoring. Different invoice discounters will impose different requirements.
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OVERDRAFT FACILITIES
Many companies have the need for external finance but not necessarily on a longterm basis. A company might have small cash flow problems from time to time but such problems don't call for the need for a formal long-term loan. Under these circumstances, a company will often go to its bank and arrange an overdraft. Bank overdrafts are given on current accounts and the good point is that the interest payable on them is calculated on a daily basis. So if the company borrows only a small amount, it only pays a little bit of interest. Contrast the effects of an overdraft with the effects of a loan.
TRADE CREDIT
This source of finance really belongs under the heading of working capital management since it refers to short-term credit. By a 'line of credit' they mean that a creditor, such as a supplier of raw materials, will allow us to buy goods now and pay for them later. Why do they include lines of credit as a source of finance? They ll, if they manage their creditors carefully they can use the line of credit they provide for us to finance other parts of their business. Take a look at any company's balance sheet and see how much they have under the heading of Creditors falling due within one year' - let's imagine it is Rs. 25,000 for a company. If that company is allowed an average of 30 days to pay its creditors then they can see that effectively it has a short term loan of Rs. 25,000 for 30 days and it can do whatever it likes with that money as long as it pays the creditor on time.
PLANNING OF WORKING CAPITAL
Working capital is required to run day to day business operations. Firms differ in their requirement of working capital (WC). Firm s aim is to maximize the wealth of share holders and to earn sufficient return from its operations. WCM is a significant facet of financial management. Its importance stems from two reasons:
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22 ? ? Investment in current asset represents a substantial portion of total investment. Investment in current assets and level of current liability has to be geared quickly to change in sales. Business undertaking required funds for two purposes: ? ? To create productive capacity through purchase of fixed assets. To finance current assets required for running of the business.
The importance of WCM is reflected in the fact that financial managers spend a great deal of time in managing current assets and current liabilities. The extent to which profit can be earned is dependent upon the magnitude of sales. Sales are necessary for earning profits. However, sales do not convert into cash instantly; there is invariably a time lag between sale of goods and the receipt of cash. WC management affect the profitability and liquidity of the firm which are inversely proportional to each other, hence proper balance should be maintained between two. To convert the sale of goods into cash, there is need for WC in the form of current asset to deal with the problem arising out of immediate realization of cash against good sold. Sufficient WC is necessary to sustain sales activity. This is referred to as the operating or cash cycle.
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WORKING CAPITAL CYCLE
The working capital of a concern goes on changing in shape and volume. For Instance, a concern may have some cash in the beginning. The cash may be used by the concern for the purpose of purchase of raw material, payment of wages and other expenses’. These elements of cost or items of expenses, raw material , wages and overheads , will result in work- in-progress during the process of manufacture. On the in compilation of the production process, the work- in –progress becomes finished goods.
Meaning The length of time involved in this cycle of conversion of cash into raw material, raw material into work-in progress, work-in-progress into finished goods, finished goods into debtors and debtors into cash again is called the operating cycle or working capital cycle of the firm, in other words, it is period between the date raw material are purchased and the date the sale proceeds of finished goods are realized by concern. S.D.SCHOOL OF COMMERCE AHMEDABAD M.COM(SEM-IV) 2011-2012
24 A firm requires many years to recover initial investment in fixed assets. On contrary the investment in current asset is turned over many times a year. Investment in such current assets is realized during the operating cycle of the firm. Each component of working capital (namely inventory, receivables and payables) has two dimensions ... TIME ......... and MONEY. When it comes to managing working capital - TIME IS MONEY. If you can get money to move faster around the cycle (e.g. collect dues 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 longer credit or an increased credit limit; you effectively create free finance to help fund future sales. It can be tempting to pay cash, if available, for fixed assets e.g. computers, plant, vehicles etc. If you do pay cash, remember that this is now longer available for working capital. Therefore, if cash is tight, consider other ways of financing capital investment - loans, equity, leasing etc. Similarly, if you pay dividends or increase drawings, these are cash outflows and, like water flowing down a plughole, they remove liquidity from the business
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INTER-DEPENDENCE AMOUNG COMPONENTS OF WORKING CAPITAL OPERATING CYCLE
A company starting with cash purchase raw materials, components etc., on a cash or credit basis. These materials will be converted into finished goods after undergoing various stages of work-in-process. For this purpose the company has to make payments towards wages, salaries and manufacturing costs. Payments to suppliers have to be made on purchases in the case of cash purchases and on the expiry of the credit purchases. Further, the company has to meet other operating costs such as selling and distribution costs, general administration costs and non-operating costs described as financial costs (interest on borrowed capital). In case the company sells its finished goods on cash basis, it will pass through one more stage, viz, accounts receivable and gets back cash along with profit on expiry of credit period. Once again the cash will be used for the purchase of materials and / or payments to suppliers and the whole cycle is termed as working capital or operating cycle repeats itself. This process indicates the dependents of each stage or components of working capital on its previous stage or component.
Advantages of working capital
• It helps the business concern in maintaining the goodwill. • It can arrange loans from banks and others on easy and favorable terms. • It enables a concern to face business crisis in emergencies such as depression. • It creates an environment of security, confidence, and over all efficiency in a business. • It helps in maintaining solvency of the business.
Disadvantages of working capital
• Rate of return on investments also fall with the shortage of working capital. • Excess working capital may result into over all inefficiency in organization. • Excess working capital means idle funds which earn no profits. • Inadequate working capital can not pay its short term liabilities in time.
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Operating cycle
The working capital cycle refers to the length of time between the firms paying the cash for materials, etc., entering into production process/stock & the inflow of cash from debtors (sales), suppose a company has certain amount of cash it will need raw materials. Some raw materials will be available on credit but, cash will be paid out for the other part immediately. Then it has to pay labour costs & incurs factory overheads. These three combined together will constitute work in progress. After the production cycle is complete, work in progress will get converted into sundry debtors.Sundry debtors will be realized in cash after the expiry of the credit period. This cash can be again used for financing raw material, work in progress etc. thus there is complete cycle from cash to cash wherein cash gets converted into raw material, work in progress, finished goods and finally into cash again. Short term funds are required to meet the requirements of funds during this time period. This time period is dependent upon the length of time within which the original cash gets converted into cash again. The cycle is also known as operating cycle or cash cycle.
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28 Working capital cycle can be determined by adding the number of days required for each stage in the cycle. For example, company holds raw material on average for 60 days, it gets credit from the supplier for 15 days, finished goods are held for 30 days & 30 days credit is extended to debtors. The total days are 120, i.e., 60 15 + 15 + 15 + 30 + 30 days is the total of working capital. Thus the working capital cycle helps in the forecast, control & management of working capital. It indicates the total time lag & the relative significance of its constituent parts. The duration may vary depending upon the business policies. In light of the facts discusses above we can broadly classify the operating cycle of a firm into three phases viz. 1 Acquisition of resources. 2 Manufacture of the product and 3 Sales of the product (cash / credit).
First and second phase of the operating cycle result in cash outflows, and be predicted with reliability once the production targets and cost of inputs are known. However, the third phase results in cash inflows which are not certain because sales and collection which give rise to cash inflows are difficult to forecast accurately.
Operating cycle consists of the following: ? ? ? ? ? Conversion of cash into raw-materials; Conversion of raw-material into work-in-progress; Conversion of work-in-progress into finished stock; Conversion of finished stock into accounts receivable through sales; and Conversion of accounts receivable into cash.
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29 In the form of an equation, the operating cycle process can be expressed as follows:
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30 The firm is therefore, required to invest in current assets for smooth and uninterrupted functioning.
Here, the length of GOC is the sum of ICP and RCP. ICP is the total time needed for producing and selling the products. Hence it is the sum total of RMCP, WIPCP and FGCP. On the other hand, RCP is the total time required to collect the outstanding amount from customers. Usually, firm acquires resources on credit basis. PDP is the result of such an incidence and it represent the length of time the firm is able to defer payments on various resources purchased. The difference between GOC and PDP is know as Net Operating Cycle and if Depreciation is excluded from the expenses in computation of operating cycle, the NOC also represents the cash collection from sale and cash payments for resources acquired by the firm and during such time interval between cash collection from sale and cash payments for resources acquired by the firm and during such time interval over which additional funds called working capital should be obtained in order to carry out the firms operations. In short, the working capital position is directly proportional to the Net Operating Cycle.
Types of working capital
1) PERMANENT AND 2) VARIABLE WORKING CAPITAL
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31 The need for current assets arises because of the operating cycle. The operating cycle is a continuous process and, therefore, the need for current assets is felt constantly. But the magnitude of current assets needed is not always a minimum level of current assets which is continuously required by the firm to carry on its business operations. This minimum level of current assets is referred to as permanent, or fixed, working capital. It is permanent in the same way as the firms fixed assets are. Depending upon the changes in production and sales, the need for working capital, over and above permanent working capital, will fluctuate. For example, extra inventory of finished goods will have to be maintained to support the peak periods of sales, and investment in receivable may also increase during such periods. On the other hand, investment in raw material, work-inprocess and finished goods will fall if the market is slack. The extra working capital, needed to support the changing production and sales activities is called FLUCTUATING, or VARIABLE, or TEMPORARY working capital. Both kinds of working capital - PERMANENT and TEMPORARY - are necessary to facilitate production and sale through the operating cycle, but temporary-working capital is created by the firm to meet liquidity requirements that will last only temporary working capital. It is shown that permanent working capital is stable over time. While temporary working capital is fluctuating- sometimes increasing and sometimes decreasing. However, the permanent capital is difference between permanent and temporary working capital can be depicted through figure.
BALANCED WORKING CAPITAL POSITION
The firm should maintain a sound working capital position. It should have adequate working capital to run its business operations. Both excessive as well as inadequate working capital positions are dangerous from the firm’s point of view. Excessive working capital not only impairs the firm’s profitability but also result in production interruptions and inefficiencies. The dangers of excessive working capital are as follows: ? It results in unnecessary accumulation of inventories. Thus, chances of inventory mishandling, waste, theft and losses increase.
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32 ? It is an indication of defective credit policy slack collections period. Consequently, higher incidence of bad debts results, which adversely affects profits. ? Excessive working capital makes management complacent which degenerates into managerial inefficiency. ? Tendencies of accumulating inventories tend to make speculative profits grow. This may tend to make dividend policy liberal and difficult to cope with in future when the firm is unable to make speculative profits.
Inadequate working capital is also bad and has the following dangers: ? It stagnates growth. It becomes difficult for the firm to undertake profitable projects for non- availability of working capital funds. ? It becomes difficult to implement operating plans and achieve the firm s profit target. ? Operating inefficiencies creep in when it becomes difficult even to meet day commitments. ? Fixed assets are not efficiently utilized for the lack of working capital funds. Thus, the firm s profitability would deteriorate. ? Paucity of working capital funds render the firm unable to avail attractive credit opportunities etc. ? The firm loses its reputation when it is not in a position to honour its short-term obligations. As a result, the firm faces tight credit terms. An enlightened management should, therefore, maintain the right amount of working capital on a continuous basis. Only then a proper functioning of business operations will be ensured. Sound financial and statistical techniques, supported by judgment, should be used to predict the quantum of working capital needed at different time periods. A firm s net working capital position is not only important as an index of liquidity but it is also used as a measure of the firm s risk.
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33 Risk in this regard means chances of the firm being unable to meet its obligations on due date. The lender considers a positive net working as a measure of safety. All other things being equal, the more the net working capital a firm has, the less likely that it will default in meeting its current financial obligations. Lenders such as commercial banks insist that the firm should maintain a minimum net working capital position.
DETERMINANTS OF WORKING CAPITAL
There are no set rules or formula to determine the working capital requirements of firms. A large number of factors, each having a different importance, influence working capital needs of firms. Also, the importance of factors changes for a firm over time. Therefore, an analysis of relevant factors should be made in order to determine total investment in working capital. The following is the description of factors which generally influence the working capital requirements of firms. ? Nature of Business ? Sales and Demand Conditions ? Technology and Manufacturing Policy ? Credit Policy ? Availability of Credit Operating Efficiency ? Price Level Changes
Nature of Business
Working capital requirements of a firm are basically influenced by the nature of its business. Trading and financial firms have a very small investment in fixed assets, but require a large sum of money to be invested in working capital. Retail stores, for example, must carry large stocks of a variety of goods to satisfy varied and continuous demand of their customers. Some manufacturing business, such as tobacco manufacturers and construction firm, also have to invest substantially in working capital and a nominal amount in fixed assets. In contrast, public utilities have a very limited need for working capital and have to invest abundantly in fixed assets. Their working capital requirements are nominal because they may have only cash and supply services, not products. Thus, no funds will be tied up in debtors and stock (inventories). Working capital requires most of S.D.SCHOOL OF COMMERCE AHMEDABAD M.COM(SEM-IV) 2011-2012
34 the manufacturing concerns to fall between the two extreme requirements of trading firms and public utilities. Such concerns have to make adequate investment in current assets depending upon the total assets structure and other variables.
Sales and Demand Conditions
The working capital needs of a firm are related to its sales. It is difficult to precisely determine the relationship between volume of sales and working capital needs. In practice, current assets will have to be employed before growth takes place. It is , therefore, necessary to make advance planning of working capital for a growing firm on a continuous basis. A growing firm may need to invest funds in fixed assets in order to sustain its growing production and sales. This will, in turn, increase investment in current assets to support enlarged scale of operations. It should be realized that a growing firm needs funds continuously. It uses external sources as well as internal sources to meet increasing needs of funds. Such a firm faces further financial problems when it retains substantial portion of its profits. It would not be able to pay dividends to shareholders. It is, therefore, Imperative that proper planning be done by such companies to finance their increasing needs for working capital. Sales depend on demand conditions. Most firms experience seasonal and cyclical fluctuations in the demand for their products and services. These business variations affect the working capital requirements, specially the temporary working capital requirement of the firm. When there is an upward swing in the economy, sales will increase; correspondingly, the firm’s investment in inventories and debtors will also increase. Under boom, additional investment in fixed assets may be made by some firms to increase their productive capacity. This act of firm will require further additions of working capital. To meet their requirements of funds for fixed assets and current assets under boom further additions of working capital. To meet their requirements of funds for fixed assets and current assets under boom period, firms generally resort to substantial borrowing. On the other hand, when there is a decline in the economy, sales will fall and consequently, levels of inventories and debtors will also fall. Under recessionary conditions, firms try to reduce their short term borrowings.
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35 Seasonal fluctuations not only affect working capital requirements but also create production problems for the firm. During periods of peak demand, increasing production may be expensive for the firm. Similarly, it will be more expensive during slack periods when the firm has to sustain its working force and physical facilities without adequate production and sales. A firm may, thus, follow a policy of steady production, irrespective of seasonal changes in order to utilize its resources to the fullest extent. Such a policy will mean accumulation of inventories during off season and their quick disposal during the peak season. The increasing level of inventories during the slack season will require increasing funds to be tied up in the working capital for some months. Unlike cyclical fluctuations, seasonal fluctuations generally conform to a steady pattern. Therefore, financial arrangements for seasonal working capital requirements can be made in advance. However, the financial plan or arrangement should be flexible enough to take care of some abrupt seasonal fluctuations.
Technology and Manufacturing Policy
The manufacturing cycle (or the inventory conversion cycle) comprises of the purchase and use of raw material the production of finished goods. Longer the manufacturing cycle, larger will be the firm working capital requirements. For example, the manufacturing cycle in the case of a boiler, depending on its size, may range between six to twenty- four months. On the other hand, the manufacturing cycle of products such as detergent powder, soaps, chocolate etc. may be a few hours. An extended manufacturing time span means a larger tie- up of funds in inventories. Thus, if there are alternative technologies of manufacturing a product, the technological process with the shortest manufacturing cycle may be chosen. Once a manufacturing technology has been selected, it should be ensured that manufacturing cycle is completed within the specified period. This needs proper planning and coordination at all levels of activity. Any delay in manufacturing process will results in accumulation of work- inprocess and waste of time. In order to minimize their investment in working capital, some firms, especially firm Manufacturing industrial products have a policy of asking for advance payment from
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36 their customers. Non-manufacturing firms, service and financial enterprises do not have a manufacturing cycle. A strategy of constant production may be maintained in order to resolve the working capital problems arising due to seasonal changes in the demand for the firm product. A steady production policy will cause inventories to accumulate during the offreason periods and the firm will be exposed to greater inventory costs and risks. Thus, if costs and risks of maintaining a constant production policy, varying its production utilized for manufacturing varied products, can have the advantage of diversified Activities and solve their working capital problems. They will manufacture the original product line during its increasing demand and when it has an off- season, other products may be manufactured to utilize physical resources and working force. Thus, production policies will differ from firm to firm, depending on the circumstances of individual firm.
Credit Policy
The credit policy of the firm affects the working capital by influencing the level of debtors. The credit terms to be granted to customers may depend upon the norms of the industry to which the firm belongs. But a firm has the flexibility of shaping its credit policy within the constraint of industry norms and practices. The firm should be discretion in granting credit terms to its customers. Depending upon the individual case, different terms may be given to different customers. A liberal credit policy, without rating the creditworthiness of customers, will be detrimental to the firm and will create a problem of collections. A high collection period will mean tie- up of large funds in book debts. Slack collection procedures can increase the chance Of bad debts. In order to ensure that unnecessary funds are not tied up in debtors, the firm should follow a rationalized credit policy based on the credit standing of customers and periodically review the creditworthiness of the exiting customers. The case of delayed payments should be thoroughly investigated.
Availability of Credit
The working capital requirements of a firm are also affected by credit terms granted by its creditors. A firm will need less working capital if liberal credit terms are available to it. Similarly, the availability of credit from banks also influences the working capital S.D.SCHOOL OF COMMERCE AHMEDABAD M.COM(SEM-IV) 2011-2012
37 needs of the firm. A firm which can get bank credit easily on favorable condition will operate with less working capital than a firm without such a facility.
Operating Efficiency
The operating efficiency of the firm relates to the optimum utilization of resources at minimum costs. The firm will be effectively contributing in keeping the working capital investment at a lower level if it is efficient in controlling operating costs and utilizing current assets. The use of working capital is improved and pace of cash conversion cycle is accelerated with operating efficiency. Better utilization of resources improves profitability and, thus, helps in releasing the pressure on working capital. Although it may not be possible for a firm to control prices of materials or wages of labour, it can certainly ensure efficiency and effective use of its materials, labour and other resources.
Price Level Changes
The increasing shifts in price level make functions of financial manager difficult. He should anticipate the effect of price level changes on working capital requirement of the firm. Generally, rising price levels will require a firm to maintain higher amount of working capital. Same levels of current assets will need increased investment when price are increasing. However, companies which can immediately revise their product price levels will not face a server working capital problem. Further, effects of increasing general price level will be felt differently by firm as individual price may move differently. It is possible that some companies may not be affected by rising price will be different for companies. Some will face no working capital problem, while working capital problems of other may be aggravated.
DEBTORS MANAGEMENT
Assessing the credit worthiness of customers
Before extending credit to a customer, a supplier should analyze the five Cs of credit worthiness, which will provoke a series of questions. These are:
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38 ? Capacity: will the customer be able to pay the amount agreed within the allowable credit period? What is their past payment record? How large is the customer's business capital. what is the financial health of the customer? Is it a liquid and profitable concern, able to make payments on time? ? ? ? Character: do the customers management appear to be committed to prompt payment? Are they of high integrity? What are their personalities like? Collateral: what is the scope for including appropriate security in return for extending credit to the customer? Conditions: what are the prevailing economic conditions? How are these likely to impact on the customers ability to pay promptly? Whilst the materiality of the amount will dictate the degree of analysis involved, the major sources of information available to companies in assessing customers credit worthiness are: ? Bank references. These may be provided by the customers bank to indicate their financial standing. However, the law and practice of banking secrecy determines the way in which banks respond to credit enquiries, which can render such references uninformative, particularly when the customer is encountering financial difficulties. ? Trade references. Companies already trading with the customer may be willing to provide a reference for the customer. This can be extremely useful, providing that the companies approached are a representative sample of all the clients suppliers. Such references can be misleading, as they are usually based on direct credit experience and contain no knowledge of the underlying financial strength of the customer. ? Financial accounts. The most recent accounts of the customer can be obtained either direct from the business, or for limited companies, from Companies House. While subject to certain limitations past accounts can be useful in vetting customers. Where the credit risk appears high or where substantial levels of credit are required, the supplier may ask to see evidence of the ability to pay on time. This demands access to internal future budget data.
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39 ? Personal contact. Through visiting the premises and interviewing senior management, staff should gain an impression of the efficiency and financial resources of customers and the integrity of its management. ? Credit agencies. Obtaining information from a range of sources such as financial accounts, bank and newspaper reports, court judgments, payment records with other suppliers, in return for a fee, credit agencies can prove a mine of information. They will provide a credit rating for different companies. The use of such agencies has grown dramatically in recent years. ? Past experience. For existing customers, the supplier will have access to their past payment record. However, credit managers should be aware that many failing companies preserve solid payment records with key suppliers in order to maintain supplies, but they only do so at the expense of other creditors. Indeed, many companies go into liquidation with flawless payment records with key suppliers. ? General sources of information. Credit managers should scout trade journals, business magazines and the columns of the business press to keep abreast of the key factors influencing customers' businesses and their sector generally. Sales staffs who have their ears to the ground can also prove an invaluable source ofinformation. ? Credit terms granted to customers Although sales representatives work under the premise that all sales are good (particularly, one may add, where commission is involved!), the credit manager must take a more dispassionate view. They
must balance the sales representative's desire to extend generous credit terms, please customers and boost sales, with a cost/benefit analysis of the impact of such sales, incorporating the likelihood of payment on time and the possibility of bad debts. Where a customer does survive the credit checking process, the specific credit terms offered to them will depend upon a range of factors. These include: o Order size and frequency: companies placing large and/or frequent orders will be in a better position to negotiate terms than firms ordering on a one-off basis.
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40 o Market position: the relative market strengths of the customer and supplier can be influential. For example, a supplier with a strong market share may be able to impose strict credit terms on a weak, fragmented customer base. o Profitability: the size of the profit margin on the goods sold will influence the generosity of credit facilities offered by the supplier. If margins are tight, credit advanced will be on a much stricter basis than where margins are wider. o Financial resources of the respective businesses: from the supplier's perspective, it must have sufficient resources to be able to offer credit and ensure that the level of credit granted represents an efficient use of funds. For the customer, trade credit may represent an important source of finance, particularly where finance is constrained. If credit is not made available, the customer may switch to an alternative, more understanding supplier. o Industry norms: unless a company can differentiate itself in some manner (e.g., unrivalled after sales service), its credit policy will generally be guided by the terms offered by its competitors. Suppliers will have to get a feel for the sensitivity of demand to changes in the credit terms offered to customers. o Business objectives: where growth in market share is an objective, trade credit may be used as a marketing device (i.e., liberalized to boost sales volumes).
The main elements of a trade policy are: o Terms of trade: the supplier must address the following questions: which customers should receive credit? How much credit should be advanced to particular customers and what length of credit period should be allowed? o Cash discounts: suppliers must ponder on whether to provide incentives to encourage customers to pay promptly. A number of companies have abandoned the expensive practice of offering discounts as customers frequently accepted discounts without paying in the stipulated period. o Collection policy: an efficient system of debt collection is essential. A good accounting system should invoice customers promptly, follow up disputed invoices speedily, issue statements and reminders at appropriate intervals, and
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41 generate management reports such as an aged analysis of debtors. A clear policy must be devised for overdue accounts, and followed up consistently, with appropriate procedures (such as withdrawing future credit and charging interest on overdue amounts). Materiality is important. Whilst it may appear nonsensical to spend time chasing a small debt, by doing so, a company may send a powerful signal to its customers that it is serious about the application of its credit and collection policies. Ultimately, a balance must be struck between the cost of implementing a strict collection policy (i.e., the risk of alienating otherwise good customers) and the tangible benefits resulting from good credit management
Problems in collecting debts
Despite the best efforts of companies to research the companies to whom they extend credit, problems can, and frequently do, arise. These include disputes over invoices, late payment, deduction of discounts where payment is late, and the troublesome issue of bad debts. Space precludes a detailed examination of debtor finance, so this next section concentrates solely on the frequently examined method of factoring.
Factoring an evaluation Key elements:
Factoring involves raising funds against the security of a company's trade debts, so that cash is received earlier than if the company waited for its credit customers to pay. Three basic services are offered, frequently through subsidiaries of major clearing banks: ? ? ? Sales ledger accounting, involving invoicing and the collecting of debts; Credit insurance, which guarantees against bad debts; Provision of finance, whereby the factor immediately advances about 80% of the value of debts being collected. There are two types of factoring service:
Non-recourse factoring is where the factoring company purchases the debts without recourse to the client. This means that if the clients debtors do not pay what they owe, the factor will not ask for his money back from the client. S.D.SCHOOL OF COMMERCE AHMEDABAD M.COM(SEM-IV) 2011-2012
42 Recourse factoring, on the other hand, is where the business takes the bad debt risk. With 80% of the value of debtors paid up front (usually electronically into the clients bank account, by the next working day), the remaining 20% is paid over when either the debtors pay the factor (in the case of recourse factoring), or, when the debt becomes due (non-recourse factoring). Factors usually charge for their services in two ways: administration fees and finance charges. Service fees typically range from 0.5 - 3% of annual turnover. For the finance made available, factors levy a separate charge, similar to that of a bank overdraft.
Advantages
? ? ? ? provides faster and more predictable cash flows; finance provided is linked to sales, in contrast to overdraft limits, which tend to be determined by historical balance sheets; growth can be financed through sales, rather than having to resort to external funds; the business can pay its suppliers promptly (perhaps benefiting from discounts) and because they have sufficient cash to pay for stocks, the firm can maintain optimal stock levels; ? ? management can concentrate on managing, rather than chasing debts; the cost of running a sales ledger department is saved and the company benefits from the expertise (and economies of scale) of the factor in credit control
Disadvantages
? ? ? The interest charge usually costs more than other forms of short-term debt; The administration fee can be quite high depending on the number of debtors, the volume of business and the complexity of the accounts; By paying the factor directly, customers will lose some contact with the supplier. Moreover, where disputes over an invoice arise, having the factor in the middle can lead to a confused three-way communication system, which hinders the debt collection process;
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43 ? Traditionally the involvement of a factor was perceived in a negative light (indicating that a company was in financial difficulties), though attitudes are rapidly changing. ?
Conclusion
Working capital management is of critical importance to all companies. Ensuring that sufficient liquid resources are available to the company is a pre-requisite for corporate survival. Companies must strike a balance between minimizing the risk of insolvency (by having sufficient working capital) with the need to maximize the return on assets, which demands a far less conservative outlook.
CREDITORS MANAGEMENT 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 your 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? 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? S.D.SCHOOL OF COMMERCE AHMEDABAD M.COM(SEM-IV) 2011-2012
44 ? ? 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? There is an old adage in business that if you can buy well then you can sell well. Management of your creditors and suppliers is just as important as the management of your debtors. It is important to look after your creditors - slow payment by you may create ill feeling and can signal that your company is inefficient (or in trouble!).
Pharmaceutical Industry In India Introduction
The pharmaceutical industry in India is going through a major shift in its business model in the last few years in order to get ready for a product patent regime from 2005 onwards. This shift in the model has become necessary due to the earlier process patent regime put in place since 1972 by the Government of India. This was done deliberately to promote and encourage the domestic health care industry in producing cheap and affordable drugs. As prior to this the Indian pharmaceutical sector was completely dominated by multinational companies (MNCs). These firms imported most of the bulk drugs (the active pharmaceutical ingredients) from their parent companies abroad and sold the formulations (the end products in the form of tablets and capsules, syrups etc.) at prices unaffordable for a majority of the Indian population. This led to a revision of Government of India’s (GOI) policy towards this industry in 1972 allowing Indian firms to reverse engineer the patented drugs and produce them using a different process that was not under patent. The entry of MNC’s was also discouraged by restricting foreign equity to 40%. The licensing policy was also biased towards indigenous firms and firms with lesser foreign equity1. All these measures by GOI laid foundations to a strong manufacturing base for bulk drugs and formulations and accelerated the growth in the Indian Pharmaceutical Industry (IPI), which today consists of more than 20,000 players1. As a result the Indian pharmaceutical industry today not only meets the domestic
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45 requirement but has started exporting bulk drugs as well as formulations to the international market. Currently the main activities of Indian pharmaceutical industry are broadly restricted to producing (i) bulk drugs and (ii) formulations with very few companies risking investing in primary research aimed at developing and patenting new drugs. The bulk drug business is essentially a commodity business, where as the formulation business is primarily a market driven and brand oriented business. Multinational companies which have entered the Indian market have mostly restricted themselves to formulation segment till date. The domestic pharmaceutical industry (MNC’s and Domestic) meets about 90% of the country’s bulk drug requirement and almost the entire demand for formulations2. The economics of bulk drug business and that of formulation business are quite different. Since a majority of the Indian companies are producing both bulk as well as formulations, these are considered together for the purpose of the present study.
Company Profile
Profile says
Established in the year 1995, our organization, ‘Saket Projects Limited' is a reckoned name operating as a service provider. We are serving a large clientèle with our Event Management, Energy Management, Industrial Publication & Pharmaceutical (Formulations). Annual turnover of around INR 60 Million is a self-proof of our wide acceptance in the industry. With our reliable services and prompt solutions, we are able to serve clients in both corporate as well as commercial sectors We have also started an Industrial Publication Division, which is aimed at disseminating fair and objective business information to ‘loi polloi’. Our IPD professionals report on preventing economic scenario and the emerging business opportunities in India and abroad. With our professionals, who have an extensive experience, we communicate directly with our clients and offer most customized solutions to them. It is ensured that the projects are timely completed. S.D.SCHOOL OF COMMERCE AHMEDABAD M.COM(SEM-IV) 2011-2012
46 Under the able guidance of our Founder Chiarman, ‘Mr. Jay Narayan Vyas’, we have achieved phenomenal growth over the past decades. He has always motivated us to perform up to our true potential.
Pharmaceutical Manufacturing (Formulations)
FIVE STAR PHARMACEUTICALS, A division of Saket Projects Ltd., has full – fledged pharmaceuticals formulation unit on the out skirts of Ahmedabad to manufacture entire range of formulation was acquired by Saket Projects Limited as an ongoing concern in June’1996.
Pharmaceutical Formulations
The company is holding Good Manufacturing Practices (cGMP) and revised Schedule-M certificate by FOOD & DRUGS CONTROL ADMINISTRATION, GOVERNMENT OF GUJARAT, GANDHINAGAR..
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47 The Formulation Activity is spread in 2555 sq. mt. having sections such as Liquid Vials Injectable, Ampoules Injectable and Oral liquids.
The Unit is also having state of an Art Microbiological & Chemical Laboratory (Q.C.) with well equip high tech laboratory testing equipments. Five Star Pharma. are currently focusing on Third Party & job work as for as marketing is concern Five Star Pharma. have been successfully exported their products to Ukrain, Venzuella, Brazil, Sri Lanka, Russia and other European Countries. Five Star Pharma. also working for big companies such as Cadila Healthcare Ltd., Zydus Animal Healthcare Ltd., J.B. Chemicals & Pharmaceuticals, Themis Pharmaceuticals etc. for Third Party & Job Work. So, Company gives its humble share to increasing nation’s economy under leadership of managing director Mr. Saket Vyas with his hardworking team. The Tremendous efforts were put in by the management; in developing the infrastructure which has helped the company in a greater way to fulfill the requirements and expectations of the customer.
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48 With the commitment to Quality and customer services have helped the company to reach an impressive position. This attracted big Pharma units To start their production on Loan License, third party basis at Five Star and are still continuing Their production for long time with Five Star.
Company Profile
Nature of Business Ownership & Capital Year of Establishment Ownership Type Trade & Market Annual Turnover Team & Staff Total Number of Employees Company USP Primary Competitive Advantage Packaging/Payment and Shipment Details Payment Mode
? ?
Service Provider
1995
Limited Liability/Corporation (Listed Company) US$ 1-10 Million (or Rs. 4-40 Crore Approx.) 101 to 500 People
Provide Customized Solutions
Cheque DD
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CHAPTER-2
RESEARCH METHODOLOGY
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OBJECTIVES OF THE PROJECT The objectives of study
1) To identify the financial strengths & weakness of the company. 2) Through the net profit ratio & other profitability ratio, understand the profitability of the company. 3) Evaluating company’s performance relating to financial statement analysis. 4) To know the liquidity position of the company with the help of current ratio. 5) To find out the utility of financial ratio in credit analysis & determinig the financial capacity of the firm. 6) To analyse and evaluate the techniques and strategies of cash management. 7) To analyse and evaluate the techniques and strategies of Debtors management. 8) To suggest, on the basis of conclusion, innovations in the management of working capital in Pharmaceutical companies in India.( Five Star Pharma.)
Hypothesis
1. Current Ratio of Pharmaceutical companies does not differ significantly among the years. 2. Gross Working Capital Turnover Ratio of Pharmaceutical companies does not differ significantly among the years. 3. Gross Working Capital Turnover Ratio does not differ significantly among the various Pharmaceutical companies over the years. 4. Net Working Capital Turnover Ratio of Pharmaceutical companies does not differ significantly among the years. 5. Net Working Capital Turnover Ratio does not differ significantly among the various Pharmaceutical companies over the years. 6. Inventory Turnover Ratio of Pharmaceutical companies does not differ significantly among the years. 7. Inventory Turnover Ratio does not differ significantly among the various Pharmaceutical companies over the years. 8. Debtors Turnover Ratio of Pharmaceutical companies does not differ significantly among the years. S.D.SCHOOL OF COMMERCE AHMEDABAD M.COM(SEM-IV) 2011-2012
51 9. Debtors Turnover Ratio does not differ significantly among the various Pharmaceutical companies over the years. 10. Cash Turnover Ratio of Pharmaceutical companies does not differ significantly among the years. 11 Cash Turnover Ratio does not differ significantly among the various Pharmaceutical companies over the years.
Ratio Analysis
Ratio analysis is regarded as one of the best tools in analyzing and comparing the time series account data of different firms. It has been extensively used in the present study. The purpose of ratio analysis was three-fold: size analysis, composition analysis and circulation/efficiency analysis. Various ratios computed in order to analyse the size, composition and circulation of working capital and its various components (inventory, receivables, cash and current liabilities) have been explained at the relevant places in different chapters. However, in this study the use of ratios has not been made in the course of analysis directly. To make the analysis and interpretation more precise and accurate the values of mean, and C.V. have been computed from the ratios.
Limitations of the study:
In a research design selected in the study, there is a great chance of personal bias in the selection of sample companies. However, it is attempted to be as objective and impartial to obtain reliable and meaningful results from final analysis. This study is based on secondary data taken from FIVE STAR PHARMA database as well
published annual reports of the said companies and as such its finding depends entirely on the accuracy of such data. Moreover, the data were processed to 12 months on an average basis wherever required. The study is largely based on the financial tool of ratio analysis, which has its own limitations that also applies to this study. Executives, who were interviewed, sometime became very reluctant to share the information on their privacy policy ground. As an alternative, it was possible to
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52 collect some relevant information through general discussion with top management finance executives. Hence, the conclusions drawn in the present study should be taken in the light of these deficiencies of data.
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CHAPTER-3
LITERATURE REVIEW
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54 Working capital management is a very important component of corporate finance because it directly affects the liquidity and profitability of the company. It deals with current assets and current liabilities. Working capital management is important due to many reasons. For one thing, the current assets of a typical manufacturing firm accounts for over half of its total assets. For a distribution company, they account for even more. Excessive levels of current assets can easily result in a firm’s realizing a substandard return on investment. However firms with too few current assets may incur shortages and difficulties in maintaining smooth operations (Horne and Wachowicz, 2000). Efficient working capital management involves planning and controlling current assets and current liabilities in a manner that eliminates the risk of inability to meet due short term obligations on the one hand and avoid excessive investment in these assets on the other hand (Eljelly, 2004). Many surveys have indicated that managers spend considerable time on day-to-day problems that involve working capital decisions. One reason for this is that current assets are short-lived investments that are continually being converted into other asset types (Rao 1989). With regard to current liabilities, the firm is responsible for paying these obligations on a timely basis. Liquidity for the on going firm is not reliant on the liquidation value of its assets, but rather on the operating cash flows generated by those assets (Soenen, 1993). Taken together, decisions on the level of different working capital components become frequent, repetitive, and time consuming. Working Capital Management is a very sensitive area in the field of financial management (Joshi, 1994). It involves the decision of the amount and composition of current assets and the financing of these assets. Current assets include all those assets that in the normal course of business return to the form of cash within a short period of time, ordinarily within a year and such temporary investment as may be readily converted into cash upon need. The Working Capital Management of a firm in part affects its profitability. While designing the Project the following articles published in international Journals, were reviewed. This paper is presented on the basis of four major dimensions of Working Capital. Many researchers have studied working capital from different views and in different environments. The following ones were very interesting and useful for our research: A survey conducted by Gitman, Moses, and White reveals that Lockboxes were widely used to accelerate the collection process. Virtually alllarge firms use lockbox S.D.SCHOOL OF COMMERCE AHMEDABAD M.COM(SEM-IV) 2011-2012
55 systems as do a large percentage of smaller firms. This somewhat lower use by smaller firms is a reflection of the costs versus the gains from lockbox systems. The survey farther reveals that to bring collected funds together for use, over one-half of all large firms use concentration banking, with wire transfers and depository transfer checks being the primary means of moving funds from one bank to another. The survey was also extended to management of disbursement. The survey says the primary tools for the management of cash outflows are zero-balance accounts and centrally controlled disbursing. Central control of disbursements is the major tool for about 70 percent of large firms. The vast majority of larger firms use zero-balance accounts, although smaller firms use them less frequently. [see Gitman, Managerial Financial Management, 8th Edition, Thomson, 1998, pp. 350-390] A questionnaire survey by Smith and Sell [see “Working Capital Management in Practices” published in 1978] indicate that 68% of the respondent firm used either cost balancing models or computerized inventory control. The survey evidence reports that the basic models of inventory management are widely used. A survey by Besley and Osteryoung revels that the vast majority of the firm sell output via trade credit, 87% of the manufacturing firms reported that 91 to 100 percentages of their sales are made on a credit basis. [see Besley and Osteryoung, “Account Receivable Management,” pp. 79-95] The Survey by Hill, Wood & Sorenson indicates that a firm once set, rarely consider changes in its terms of sale. They also found that when competitors change terms, other sellers typically will “follow the leader”. [see N. Hill, “A Generalized Cash Flow Approach to Short-term Financial Decision,” Journal of Finance,Vol.38, No. 2 (May 1983), pp. 349-60] Another survey by Farragher on 33 firms reveled that most of the firm uses the traditional form of financing. The researchers had also found that thereis a growing interest among the firm in using Factoring as an alternative means of financing. [See E. Farragher, “Factoring Account Receivable,” Journal of Cash Management (March/April 1986), Page 39] Afza and Nazir (2009) made an attempt in order to investigate the traditional relations between working capital management policies and a firm’s profitability for a sample of 204 non-financial firms listed on Karachi Stock Exchange (KSE) for the period 1998-2005.The study found significant different among their working capital S.D.SCHOOL OF COMMERCE AHMEDABAD M.COM(SEM-IV) 2011-2012
56 requirements and financing policies across different industries. Moreover, regression result found a negative relationship between the profitability of firms and degree of aggressiveness of working capital investment and financing Annales Universitatis Apulensis Series Oeconomica, 12(1), 2010 policies. They suggested that managers could crease value if they adopt a conservative approach towards working capital investment and working capital financing policies. Lazaridis and Tryfonidis (2006) have investigated the relation between working capital management and corporate profitability of listed company in the Athens Stock Exchange. A sample of 131 listed companies for period of 2001-2004 was used to examine this relationship. The result from regression analysis indicated that there was a statistical significance between profitability, measured through gross operating profit, and the cash conversion cycle. From those results, they claimed that the managers could create value for shareholders by handling correctly the cash conversion cycle and keeping each different component to an optimum level.
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CHAPTER-4
DATA PRESENTATION AND DATA ANALYSIS
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Data source
Data collection was through literature survey and expert opinion. Literature survey includes the collection of data from various sources like bank agreement and statement, handbooks as well as study material. A part of data` s was collected from primary data and other was collected from the secondary data.
Primary sources
Information gathered by interview and discussions with the head and employees of various departments and my project guide.
Secondary sources
? ? ? ? Company annual report. Published information on finance. Internal circulation booklets. Company Websites
DATA ANALYSIS AND INTERPRETATION
Ratio Analysis is a powerful tool o financial analysis. Alexander Hall first presented it in 1991 in Federal Reserve Bulletin. Ratio Analysis is a process of comparison of one figure against other, which makes a ratio and the appraisal of the ratios of the ratios to make proper analysis about the strengths and weakness of the firm’s operations. The term ratio refers to the numerical or quantitative relationship between two accounting figures. Ratio analysis of financial statements stands for the process of determining and presenting the relationship of items and group of items in the statements. Ratio analysis can be used both in trend analysis and static analysis. A creditor would like to know the ability of the company, to meet its current obligation and therefore would think of current and liquidity ratio and trend of receivable. Major tool of financial are thus ratio analysis and Funds Flow analysis. Financial analysis is the process of identifying the financial strength and weakness of the firm by properly establishing relationship between the items of the balance sheet and the profit account
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59 The financial analyst may use ratio in two ways. First he may compare a present ratio with the ratio of the past few years and project ratio of the next year or so. This will indicate the trend in relation that particular financial aspect of the enterprise. Another method of using ratios for financial analysis is to compare a financial ratio for the company with for industry as a whole, or for other, the firm’s ability to meet its current obligation. It measures the firm’s liquidity. The greater the ratio, the greater the firms liquidity and vice-versa. A ratio can be defined as a numerical relationship between two numbers expressed in terms of (a) proportion (b) rate (c) percentage. It is also define as a financial tool to determine an interpret numerical relationship based on financial statement yardstick that provides a measure of relationship between two variable or figures.
Meaning and Importance: Ratio analysis is concerned to be one of the important financial tools for appraisal of financial condition, efficiency and profitability of business. Here ratio analysis id useful from following objects.
1. Short term and long term planning
2. Measurement and evaluation of financial performance
3. Stud of financial trends
4. Decision making for investment and operations
5. Diagnosis of financial ills
6. Providing valuable insight into firms financial position or picture
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ADVANTAGES & DISADVANTAGES OF RATIO ANALYSIS :
Advantages: The following are the main advantages derived of ratio analysis, which are obtained from the financial statement via Profit & Loss Account and Balance Sheet.
a) The analysis helps to grasp the relationship between various items in the financial statements. b) They are useful in pointing out the trends in important items and thus help the management to forecast c) With the help of ratios, inter firm comparison made to evolve future market strategies. d) Out of ratio analysis standard ratios are computed and comparison of actual with standards reveals the variances. This helps the management to take corrective action. e) The communication of that has happened between two accounting the dates are revealed effective Action. f) Simple assessments of liquidity, solvency profitability efficiency of the firm are indicted by ratio analysis. Ratios meet comparisons much more valid.
Disadvantages: Ratio analysis is to calculate and easy to understand and such statistical calculation stimulation thinking and develop understanding. But there are certain drawbacks and dangers they are.
i)There is a trendy to use to ratio analysis profusely. ii)Accumulation of mass data obscured rather than clarifies relationship. iii) Wrong relationship and calculation can lead to wrong conclusion.
1. In case of inter firm comparison no two firm are similar in size, age and product unit.(for example) one firm may purchase the asset at lower price with a higher return
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61 and another firm witch purchase the asset at asset at higher price will have a lower return) 2. Both the inter period and inter firm comparison are affected by price level changes. A change in price level can affect the validity of ratios calculated for different time period. 3. Unless varies terms like group profit, operating profit, net profit, current asset, current liability etc., are properly define, comparison between two variables become meaningless. 4. Ratios are simple to understand and easy to calculate. The analyst should not take decision should not take decision on a single ratio. He has to take several ratios into consideration.
STANDARDS OF COMPARISION: 1. Ratios calculated from the past financial statements of the same firm. 2. Ratio developed using the projected or perform financial statement of the same firm 3. Ratios of some selected firm especially the most progressive and successful, at the same point of time. 4. Ratios of the industry to which the firm belongs.
IMPORTANCE OF RATIO ANALYSIS In the preceding discussion in the form, we have illustrated the compulsion and implication of important ratios that can be calculated from the Balance Sheet and Profit & Loss account of a firm. As a tool of financial management, they are of crucial significance. The importance of ratio analysis lies in the fact and enables the drawing of inferences regarding the performance of a firm. Ration analysis is a relevant in assessing the performance of a firm in respect of the following aspect.
CAUTION IN USING RATIOS 1. It is difficult to decide on the proper bases of comparison. 2. The comparison rendered difficult because of difference in situation of two companies or of one-company for different years. 3. The price level change make the interpretation of ratios invalid S.D.SCHOOL OF COMMERCE AHMEDABAD M.COM(SEM-IV) 2011-2012
62 4. The difference in the definition of items in the balance sheet and Profit & Loss statement make the interpretation of ratios difficult. 5. The ratios calculated at a point of time are less informative and defective as they suffer from sort term changes. 6. The ratios are generally calculated from the past financial statement and thus are no indicators of Future.
CURRENT RATIO : The relationship of current assets to current liabilities is
known as current ratio. It is also known as banker’s ratio or working capital ratio.
1. CURRENT RATIO It is relationship between firm’s current assets and current liability.
Current assets Current ratio = _______________________________ Current liability
TABLE – 1 STATEMENT SHOWING CURRENT RATIO Rs.
YEAR
CURRENT ASSETS CURRENT LIABILITIES CURRENT RATIO 12012339.59 9875695.78 3478204.91 3076638.35 16015687.23 15409430.47 10151656.05 15887448.20
2007-2008
2008-2009
2009-2010
2010-11
1.33
1.56
2.91
5.16
SOURCE: SECONDARY DATA FROM FIVE STAR ANNUAL REPORTS
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INTERPRETATION
The current ratio is a test of the short term solvency of the business enterprise since this ratio assumes current assets could be converted into cash to meet current liabilities.
Current ratio during the year 2007-2008 was 1.33 and it increased constantly up to 201011 by 1.56 , 2.91 , 5.16 here Five star has 5th times assets then liabilities in the year of 2010-11
CHART – 1 CURRENT RATIO
current ratio
6 5 PERCENTAGE 4 3 2 1 0 2007-08 2008-09 2009-10 2010-11 YEARS
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CASH MANAGEMENT
Introduction Cash management is one of the key areas of working capital management. Cash is the liquid current asset. The main duty of the finance manager is to provide adequate cash to all segments of the organization. The important reason for maintaining cash balances is the transaction motive. A firm enters into variety of transactions to accomplish its objectives which have to be paid for in the form of cash. Meaning of cash The term “cash” with reference to cash management used in two senses. In a narrower sense it includes coins, currency notes, cheques, bank drafts held by a firm. n a broader sense it also includes “near-cash assets” such as marketable securities and time deposits with banks.
Objectives of cash management:
There are two basic objectives of cash management. They are? To meet the cash disbursement needs as per the payment schedule. ? To minimize the amount locked up as cash balances.
Basic problems in Cash Management:
Cash management involves the following four basic problems. ? Controlling level of cash ? Controlling inflows of cash ? Controlling outflows of cash and ? Optimum investment of surplus cash. ? Determining safety level for cash:
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65 The finance manager has to take into account the minimum cash balance that the firm must keep to avoid risk or cost of running out of funds. Such minimum level may be termed as “safety level of cash”. The finance manager determines the safety level of cash separately both for normal periods and peak periods. Under both cases he decides about two basic factors. They are-
Desired days of cash: It means the number of days for which cash balance should be sufficient to cover payments.
Average daily cash flows: This means average amount of disbursements which will have to be made daily.
Criteria for investment of surplus cash: In most of the companies there are usually no formal written instructions for investing the surplus cash. It is left to the discretion and judgment of the finance manager. While exercising such judgment, he usually takes into consideration the following factors-
Security: This can be ensured by investing money in securities whose price remains more or less stable.
Liquidity: This can be ensured by investing money in short term securities including short term fixed deposits with banks.
Yield: Most corporate managers give less emphasis to yield as compared to security and liquidity of investment. So they prefer short term government securities for investing surplus cash.
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66 Maturity: It will be advisable to select securities according to their maturities so the finance manager can maximize the yield as well as maintain the liquidity of investments.
CASH RATIO It is relationship between cash and current liabilities.
Cash Cash ratio = _______________________ Current liabilities
TABLE – 2 STATEMENT SHOWING CASH RATIO Rs.
YEAR CASH
813541.98 3003725.65 1693041.14 9170192.80
2007-2008
2008-2009
2009-2010
2010-2011
CURRENT LIABILITIES
12012339.59 9875695.78 3478204.91 3076638.35
CASH RATIO
0.067
0.30
0.48
2.98
SOURCE: SECONDARY DATA FROM BHEL ANNUAL REPORTS
INTERPRETATION
The Cash ratio of FIVE STAR in the 2007-2011 was fluctuation in 2010-2011 it was 2.98 times and in 2006-2007 it was 0.30 times and 2008-2009 it was reduced to 0.48.
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67 The standard norms of absolute quick ratio are 0.5:1. From the above table the firms not maintain the sufficient level of quick assets because of the day-to-day expenses. It is fluctuating between the standard norms for this ratio is 1:2 means for every 2 rupees of current Liabilities, Company must have 1 rupee of cash and bank balance and marketablesecurities.
CASH RATIO
CASH
3
PERCENTAGE
2 1 0 2007- 2008- 2009- 201008 09 10 11
YEARS
\
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RECEIVABLES MANAGEMENT
Introduction: Receivables constitute a significant portion of the total assets of the business. When a firm seller goods or services on credit, the payments are postponed to future dates and receivables are created. If they sell for cash no receivables created.
Meaning: Receivable are asset accounts representing amounts owed to the firm as a result of sale of goods or services in the ordinary course of business.
Purpose of receivables: Accounts receivables are created because of credit sales. The purpose of receivables is directly connected with the objectives of making credit sales. The objectives of credit sales are as follows? ? ? Achieving growth in sales. Increasing profits. Meeting competition.
Factors affecting the size of Receivables: The main factors that affect the size of the receivables are? ? ? Level of sales. Credit period. Cash discount.
Costs of maintaining receivables: The costs with respect to maintenance of receivables are as follows-
Capital costs: This is because there is a time lag between the sale of goods to customers
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69 and the payment by them. The firm has, therefore to arrange for additional funds to meet its obligations.
Administrative costs: Firm incur this cost for manufacturing accounts receivables in the form of salaries to the staff kept for maintaining accounting records relating to customers.
Collection costs: The firm has to incur costs for collecting the payments from its credit customers.
Defaulting costs: The firm may not able to recover the over dues because of the inability of customers. Such debts treated as bad debts.
Receivables management: Receivables are direct result of credit sale. The main objective of receivables management is to promote sales and profits until that point is reached where the ROI in further funding of receivables is less than the cost of funds raised to finance that additional credit (i.e.; cost of capital). Increase in receivables also increases chances of bad debts. Thus, creation of receivables is beneficial as well as dangerous. Finally management of accounts receivable means as the process of making decisions relating to investment of funds in this asset which result in maximizing the overall return on the investment of the firm.
Receivables management and Ratio Analysis: Ratio Analysis is one of the important techniques that can be used to check the efficiency with which receivables management is being managed by a firm. The most important ratios for receivables management are as follows-
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70 DEBTORS TURNOVER RATIO: Debtors constitute an important constituent of current assets and therefore the quality of the debtors to a great extent determines a firm’s liquidity. It shows how quickly receivables or debtors are converted into cash. In other words, the DTR is a test of the liquidity of the debtors of a firm. The liquidity of firm’s receivables can be examined in two ways they are DTR and Average Collection Period. It indicates the number time debtors turned over each year. Generally the higher value of debtor’s turnover shows high efficiency to manage the credit management.
Total sales Debtors turnover ratio = ______________________________ Debtors
TABLE –3 STATEMENT SHOWING DEBTORS TURNOVER RATIO Rs.
YEAR TOTAL SALES DEBTORS DEBTOR TURNOVER RATIO 3.11 3.68 0.69 0.49
38029989.34 12212965.73 31004127.36 8426880.24 2862505.99 4101413.16 2350703.00 4702051.34
2007-2008
2008-2009
2009-2010
2010-2011
SOURCE: SECONDARY DATA FROM FIVE STAR ANNUAL REPORTS INTERPRETATION Debtors constitute an important constituent of current assets and therefore the quality of the debtors to a great extent determines a firm’s liquidity. It shows how quickly receivables or debtors are converted into cash. In other words, the DTR is a test of the liquidity of the debtors of a firm. The liquidity of firm’s receivables can be examined in
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71 two ways they are DTR and Average Collection Period. .The higher the ratio, the better it is, since it would indicate that debts are being collected promptly.
In the year 2010 - 2011 the debt is 0.49 comparing to the previous year came downwards.
CHART- 3 DEBTOR TURNOVER RATIO
4
PERCENT AGE
2 0 2007- 2008- 2009- 201008 09 10 11
YEARS
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72
DEBT COLLECTION PERIOD
Debtor’s collection period is nothing but the period required to collect the money from the customers after the credit sales. A speed collection reduces the length of operating cycle and vice versa. The more quickly the customers pay, the less risk from bad debts, the lower the expenses of collection and more liquid the nature of of this asset.
It indicates the speed with which debts are collected. Days/months in a year Debt collection period = _______________________________ Debtor’s turnover ratio
TABLE – 4 Rs.
YEAR DAYS DEBT TURNOVER RATIO DEBT COLLECTION PERIOD 118 99 529 745 2007-2008 365 3.11 2008-2009 365 3.68 2009-2010 365 0.69 2010-2011 365 0.49
SOURCE: SECONDARY DATA FROM FIVE STAR ANNUAL REPORTS
INTERPRETATION The debt collection period of BHEL in the 2007-2008 was 118 days and in goes to 2010 - 2011 it was increased in (5.31%) 745 days. Standard Debt Collection Period of a firm is less than 90 days. But, above tables consists of increased of DCP in rapidly.
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CHART – 4 DEBT COLLECTION PERIOD
DTCP
1000 500
No. of Days
0 2007- 2008- 2009- 201008 09 10 11
YEARS
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TABLE –5 CASH TO CURRENT ASSETS RATIO Rs.
YEAR CASH CURRENT ASSETS CAS CURRENT ASSETS RATIO TO 0.050 0.19 0.16 0.57
16015687.23 15409430.47 10151656.05 15887448.20
2007-2008
813541.98
2008-2009
3003725.65
2009-2010
1693041.14
2010-2011
9170192.80
SOURCE: SECONDARY DATA FROM BHEL ANNUAL REPORTS
INTERPRETATION The Cash to current assets turnover ratio of FIVE STAR was fluctuating during the year 2007 – 2011. It was upward in (2007– 2009) was 0.05 times to 0.19 times and it was goes up in 2010 – 2011 is 0.57 times.
CHART -5 CASH TO CURRENT ASSETS RATIO
CASH TO CURRENT ASSETS RATIO
0.6 0.5 0.4 PERCENTAG 0.3 E 0.2 0.1 0 200708 2008- 200909 10 YEARS 201011
C.C.A.R
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TABLE –6 CASH TURNOVER RATIO Rs.
YEAR SALES CASH
813541.98 3003725.65 1693041.14 9170192.80
2007-2008
38029989.34
2008-2009
31004127.36
2009-2010
2862505.99
2010-2011
2350703.00
CASH TURNOVER RATIO 46.74 10.32 1.69 0.25
SOURCE: SECONDARY DATA FROM FIVE STAR ANNUAL REPORTS
INTERPRETATION The cash turnover ratio in the years 2007-2011 it was on fluctuating ratios, in the year 2010-2011 it was decrease 0.25
CASH TURNOVER RATIO
60
PERCENTAGE
40 20
C.T.R
0 2007- 2008- 2009- 201008 09 10 11 YEARS
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INVENTORY MANAGEMENT
Introduction: Inventories are stock of the product a company is manufacturing for sale and components. That makeup the products. The various forms in which inventories exist in a manufacturing company are: Raw-materials, work-in-process, finished goods. ?
Raw-Materials: - Are those basic inputs that are converted into finished products through the manufacturing process. Raw-materials inventories are those units, which have been purchased and stored for future production.
? ?
Work-In-Process inventories are semi-manufactured products. The represent products that need more work before they become finished products for sale. Finished Goods inventories are those completely manufactured products, which are ready for sale. Stocks of raw-materials and work-in-process facilitate production which stock of finished goods is required for smooth marketing operations. These inventories serve as a link between production and consumption of goods.
?
Stores and spares are also maintained by some firms. This includes office and plant cleaning materials like soaps, brooms, oil, fuel, light, bulbs etc. These materials do not directly enter in production. But are necessary for production process.
Need to holding inventory The question of managing inventories arises only when the company holds inventories. Maintaining inventories involves tying up of the company's funds and incurrence of storage and handling cost. It is expensive to maintain inventories, why does company hold inventories? There are three general motives for holding inventories.
1. Transaction Motive: - Emphasizes the need to maintain inventories to facilitate smooth production and sales operations.
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2. Precautionary motive: - Necessitates holding of inventories to guard against the risk of unpredictable changes in demand and supply forces and other factors. 3. Speculative motive: - Influences the decision to increase or reduce inventory levels to take advantages of price influences. A company should maintain adequate stock of materials for a continuous supply to the factory for the uninterrupted production. It is not possible for a company to procure raw materials whenever it is needed. A time lag exists between demand for materials and its supply. Also there exists uncertainty in procuring raw materials in time on many occasions. The procurement of materials may be delayed because of such factors as strike, transport disruption or short supply. Therefore, the firm should maintain sufficient stock of raw materials at a given time to stream line production.
Objective of Inventory Management In the context of inventory management the firm is faced with the problem of meeting two conflicting needs ; ? To maintain a large size of inventory for sufficient and smooth production and sales operations. ? To maintain a minimum investment in inventories to maximize profitability.
Both excessive and inadequate inventories are not desirable. These are two dangerous points within which the firm should operate. The objective of inventory management should be to determine and maintain optimum level of inventory investment. The optimum level of inventory will lie between the two danger points of excessive and inadequate inventories. The firm should always avoid a situation of over investment or under investment in inventories. The major dangerous of over investment are, ? ? ?
Unnecessary tie-up of the firms funds losses of profit Excessive carrying cost Risk of quality
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78 The aim of inventory management thus should be to avoid excessive and inadequate levels of inventories and to maintain sufficient inventory for smooth production and sales operations. Efforts should be made to place an order at the right time with the right source to acquire the right quantity at the right price and quality. An effective inventory management should ?
Ensure a continuous supply of raw materials to facilitate uninterrupted production.
? Maintain sufficient stock of raw materials in periods of short supply and anticipate price changes. ? Maintain sufficient finished goods inventory for smooth sales operations and efficient customer service. ? Minimize the carrying cost and time. ? Control investment in inventories and keep it at an optimum level.
Inventory management techniques : In managing inventories the firm objective should be in consonance with the shareholders' wealth maximization principle. To achieve this firm should determine the optimum level of inventory. Efficiently controlled inventories make the firm flexible. Inefficient inventory control results in unbalanced inventory and inflexibility-the firm ma sometimes run out of stock and sometimes may pileup unnecessary stocks. This increases level of investment and makes the firm unprofitable.
To manage inventories efficiency, answers should be sought to the following two questions. 1) How much should be ordered?
2) When should it be ordered? S.D.SCHOOL OF COMMERCE AHMEDABAD M.COM(SEM-IV) 2011-2012
79 The first question how much to order, relates to the problem of determining economic order quantity (EOQ), and is answered with an analysis of costs of manufacturing certain level of inventories. The second question when to order arise because of determining the reorder point.
Inventory turnover Ratio:Inventory turnover ratio indicates the efficiency of the firm in producing and selling its products. It is calculated by dividing the cost of goods sold by the average inventory. The average inventory is the average of open and closing balance of inventory.
It indicates the inventories turning into receivables through sales. Sales Inventory turnover ratio =__________________________ Inventory
TABLE –7 INVENTORY TURNOVER RATIO Rs.
YEAR SALES INVENTORY
2082529.04 2565319.68 12.08 724831.25 3.94 201443.55 11.66
2007-2008
38029989.34
2008-2009
31004127.36
2009-2010
2862505.99
2010-2011
2350703.00
INVENTORY TURNOVER RATIO
18.26
SOURCE: SECONDARY DATA FROM FIVE STAR ANNUAL REPORT
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80 INTERPRETATION This ratio indicates the liquidity of the inventory, that is, how quickly, on the average, the inventory was sold during the year and consequently the significance of the inventory for the debt paying purposes.
A high stock turnover ratio is generally considered desirable because it is indicative of efficient performance since an improvement in the ratio shows hat volume of sales has been either maintained or increased without additional investment in stock.
Inventory turnover of
FIVE STAR for 2008 – 2009 was 12.08 In 2009-2010 the
inventory turnover ratio was down up to 3.37 and it was high in 2010-2011 at 11.66.
CHART –7 INVENTORY TURNOVER RATIO
20 15 10 5 0 ITR 2010-11 2009-10 2008-09 2007-08
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TABLE –8 INVENTORY HOLDING PERIOD
YEAR DAYS MONTH YEAR INVENTORY TURNOVER RATIO INVENTORY HOLDING PERIOD / IN
2007-2008
2008-2009
2009-2010
2010-2011
365
365
365
365
18.26
12.08
3.94
11.66
20
30
93
31
SOURCE: SECONDARY DATA FROM FIVE STAR ANNUAL REPORTS
INTERPRETATION Inventory holding period of FIVE STAR is varying on every year. In the year of 200708 to 2009-10 it’s increased in 4.65% (20 to 93) and 2010-11 it’s decreased by 31
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CHART –8 INVENTORY HOLDING PERIOD
200 180 160 140 120 100 80 60 40 20 0 IHP
2010-11 2009-10 2008-09 2007-08
TABLE-9 WORKING CAPITAL TURNOVER RATIO Rs.
YEAR SALES NET WORKING CAPITAL WORKING CAPITAL TURNOVER RATIO 9.49 5.60 0.43 0.18
4003347.64 5533734.69 6673451.14 12810809.85
2007-2008
38029989.34
2008-2009
31004127.36
2009-2010
2862505.99
2010-2011
2350703.00
SOURCE: SECONDARY DATA FROM BHEL ANNUAL REPORTS
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83 INTERPRETATION Working capital turnover ratio for the year 2010 - 2011 was 0.18 times. It is lower when comparing the past three years. The working capital management has to improve by more concentration on collection strategies.
CHART-9 WORKING CAPITAL TURNOVER RATIO
10 8 PERCENTAGE 6 4
WCTR
2 0 2007- 2008- 2009- 201008 09 10 11 YEARS
TABLE –10 WORKING CAPITAL FOR TREND ANALYSIS Rs.
YEAR CURRENT ASSETS CURRENT LIABILITIES WORKING CAPITAL
4003347.64 5533734.69 6673451.14 12810809.85 12012339.59 9875695.78 3478204.91 3076638.35 16015687.23 15409430.47 10151656.05 15887448.20
2007-2008
2008-2009
2009-2010
2010-2011
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INTERPRETATION
In this current asset is fluctuating 2007-2011 Whereas Current Liabilities of Five Star Pharma is down constantly. Working capital is Increasing.
CHART – 10 WORKING CAPITAL FOR TREND ANALYSIS
VALUES
18000000 16000000 14000000 12000000 10000000 8000000 6000000 4000000 2000000 0 2007- 2008- 2009- 201008 09 10 11
YEARS
CA WC
CL
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TABLE –11 ANALYSIS OF VARIOUS COMPONENTS IN WORKING CAPITAL CURRENT ASSETS Rs in lakhs Particulars inventories Sundry debtors C& B balance Other assets Loans and advances
20072008 20082009 20092010 20102011
20.82
25.65
7.25 41.01 16.00 -36.32
21.24 47.02 57.00 -18.13
122.13 84.26 5.00 -9.06 19.00 -14.13
CHART – 11 ANALYSIS OF VARIOUS COMPONENTS IN WORKING CAPITAL
GRAPH 11.1 INVENTORY
30 25 20 PERCENTA 15 GE 10 5 0 2007- 2008- 2009- 201008 09 10 11 YEARS
INVENTORIES
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GRAPH 11.2 SUNDRY DEBTORS
140 120 100 PERCENTAGE 80 60 40 20 0 2007-08 2008-09 2009-10 YEARS 2010-11
GRAPH 11.3 CASH AND BANK BALANCES
60 50 40 PERCENTAGE 30 20 10 0 200708 200809 200910 YEARS 201011
INVENTORIES
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GRAPH 11.4 LOANS AND ADVANCES
40 PERCENTAGE 20 0 2007-08 2008-09 2009-10 YEARS 2010-11 LOAN & ADV.
GROSS PROFIT RATIO :
Gross profit margin shows the company can return income at the gross level. This ratio helps to control inventory usage and production performance and fixing unit price of goods.
TABLE – 12 ANALYSIS OF GROSS PROFIT RATIO Rs. Particulars Gross Profit /
2007-2008
48294492.18
2008 - 2009
41773757.53
2009-2010
31022789.84
2010-2011
30043433.68
Profit before tax Total Sales Gross Profit ratio
38029989.34 31004127.36 2862505.99 2350703.00
1.27
1.35
10.84
12.78
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GRAPH 12 GROSS PROFIT RATIOS
14 2010-11, 1278% 12 2009-10, 1084% 10
8
6
4 2007-08, 127% 2 2008-09, 135%
0 2007-08 2008-09 2009-10 2010-11
INTERPRETATION
In the analysis of Gross profit ratio Five star must control production expenses in future. Comparison of 2007-08 to 2010-11 margin profit ratio will goes up 1.27 to 12.78.
NET PROFIT RATIO:
As every business is to earn profit, this ratio is very important because it measures the profitability of sales. A business may yield high gross income but low net income because of increasing operating and non-operating expenses. This situation can easily be detected by calculating this ratio.
The profits used for this purpose may be profits after/before tax. To obtain this ratio, the figure of net profits after tax is divided by the figure of net profits after tax is divided by
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TABLE – 13
ANALYSIS OF NET PROFIT RATIO Rs. Particulars Net Profit Profit after tax Net Sales Net Profit ratio /
5834169.72 38029989.34 1812400.71 31004127.36 5887693.70 2862505.99 7233550.81 2350703.00
2007-2008
2008 - 2009
2009-2010
2010-2011
0.153
0.058
2.05
3.077
GRAPH 13 NET PROFIT RATIOS
3.5 3 2.5 % 2 1.5 1 0.5 0 2007-08 2008-09 2009-10
YEARS
2010-11
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90 SOURCE: SECONDARY DATA FROM BHEL ANNUAL REPORTS
INTERPRETATION
In this period of research of study Net profit of the Five star company goes upwards from 2009 to 2011 comparing previous year achievements.
Gross Profit to Net Profit Ratio
Analysis of ratio’s G.P. to N.P is very important in every firm. It helps to find out the cost of expense increased in production or administrative level and other hand it helps to control in overall financial expenses.
TABLE – 14
ANALYSIS OF G.P. TO N.P RATIO Rs in lakhs Particulars Gross Profit Net Profit G.P. - N.P. RATIO
2007-2008
482.94 58.34 8.27
2008 - 2009
417.73
2009-2010
310.22
2010-2011
300.43
18.12 23.04
58.87 5.27
72.33 4.15
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GRAPH 14 G.P. TO N.P. RATIO
500 400 300 200 100
N.P. G.P.
0 2007-08 2008-09 2009-10 2010-11 G.P. N.P. %
%
YEARS
INTERPRETATION
In this period of research of study Gross Profit and Net Profit are equal. Five star could not control his marginal and administrative cost. There is High variation and it does not stable.
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Projection of changes in working capital (2007-2008).
Particulars A) Current Assets a) Inventories b) Sundry debtors c) Cash and bank d) Loans & advances Total Current Assets B)Current Liabilities & Provisions (1) CREDITORS FOR GOODS AS PER LIST (2) CREDITOR FOR EXPENSES AS PER LIST (3)Debtors having Credit Balance Total Current Liabilities Net Current Assets
2006-07
1636475.17 7336194.74 582184.25 2500481.23 12055335.39
2007-08 2082529.04 12212965.73 813541.98 906650.48 16015687.23
Increase 446053.87 4876770.99 231357.73
Decrease
1593830.75
7083596.24 4081840.54 33364.03
8006834.87 3975510.82 29993.90
923238.63 106329.72 3370.13
11198800.81 856534.58
12012339.59
4003347.64 5663882.44 2517069.38 3146813.06
Increase in working capital
3146813.06
Interpretation:
This statement shows the increase in Working Capital in the year 2007-08 by increase in cash & bank balance, inventories & debtors.
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Projection of changes in working capital (2008-2009). Particulars
A) Current Assets a) Inventories b) Sundry debtors c) Cash and bank d) Loans & advances Total Current Assets
B)Current Liabilities & Provisions (1) CREDITORS FOR GOODS AS PER LIST (2) CREDITOR FOR EXPENSES AS PER LIST (3)Debtors having Credit Balance 8006834.87 3975510.82 29993.90 5444602.36 3850906.44 580186.98
2007-08
2082529.04 12212965.73 813541.98 906650.48
2008-09
2565319.68 8426880.24 3003725.65 1413504.90
Increase
482790.64
Decrease
3786085.49
2190183.67 506854.42
16015687.23
15409430.47
2562232.51 124604.38 550193.08
Total Current Liabilities
Net Current Assets
12012339.59 4003347.64
9875695.78 5533734.69
5866665.62 4336278.57
Increase in working capital
1530387.05
1530387.05
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Projection of changes in working capital (2009-2010). Particulars
A) Current Assets a) Inventories b) Sundry debtors c) Cash and bank d) Loans & advances Total Current Assets
B)Current Liabilities & Provisions (1) CREDITORS FOR GOODS AS PER LIST (2) CREDITOR FOR EXPENSES AS PER LIST (3)Debtors having Credit Balance
2008-09
2565319.68 8426880.24 3003725.65 1413504.90
15409430.47
2009-10
724831.25 4101413.16
Increase
Decrease
1840488.43 4325467.08 1310684.51
1693041.14 3632370.50
2218865.6
10151656.05
5444602.36 3850906.44 580186.98 9875695.78 5533734.69
504638.88 2868751.00 104815.03 3478204.91 6673451.14
4939963.48 982155.44 475371.95
Total Current Liabilities
Net Current Assets
8616356.47
7476640.02 1139716.45
Increase in working capital
1139716.45
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Projection of changes in working capital (2010-2011). Particulars
A) Current Assets a) Inventories b) Sundry debtors c) Cash and bank d) Loans & advances Total Current Assets
B)Current Liabilities & Provisions (1) CREDITORS FOR GOODS AS PER LIST (2) CREDITOR FOR EXPENSES AS PER LIST (3)Debtors having Credit Balance 504638.88 2868751.00 104815.03 729095.00 2347543.35 0.00 724831.25 4101413.16 1693041.14 3632370.50 10151656.05 201443.55 4702051.34 9170192.80 1813760.51 15887448.20
2009-2010
2010-2011
Increase
Decrease
523387.7 600638.18 7477151.66 1818609.99
224456.12 521207.65
104815.03
Total Current Liabilities
Net Current Assets
3478204.91 6673451.14
3076638.35 12810809.85
8703812.52
2566453.81 6137358.71
Increase in working capital
6137358.71
Interpretation: This statement shows the increase in Working Capital in the year 2005-06 by increase in cash & bank balance, & debtors.
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FIVESTAR PHARMACEUTICALS (A DIV. OF SAKET PROJECTS LTD.) PROFIT & LOSS ACCOUNT FOR THE PERIOD 1ST April 2008 TO 31 ST MARCH 2011
PARTICULARS INCOME Income from operations Sales Pharma net of returns Job Work
RUPEES AS ON 31/03/08
RUPEES AS ON 31/03/09
RUPEES AS ON 31/03/10
RUPEES AS ON 31/03/11
38029989.34 9229473.16
31004127.36 10542249.77
2862505.99 26199767.66 1037433.48 923082.71 -359685.82 30663104.02
2350703.00 27380076.76 0.00 312653.92 0.00 30043433.68
Finish Goods Sales
Other Income Increase in Stock of Work in Process & Finished Goods TOTAL [A]
0
1035029.68 53568.64 48348060.82
0
227380.40 -352834.28 41420923.25
EXPENSES Manufacturing Exp. Administrative & Other Expenses Selling & Distribution Expenses Interest Finish Goods Purchase 36714304.73 2158005.21 866828.78 215605.73 329408.18 752221.45 26317.00 TOTAL 40284152.63 34587885.67 2126026.67 878682.76 35526.64 0.00 0.00 24621.00 37628121.74 18736358.28 2076488.54 120642.00 0.00 919143.00 0.00 642730.00 37102.50 22532464.32 17854927.24 2158623.63 139952.00 0.00 0.00 0.00 263451.00 26309.00 20443262.87
Fringe Benefit Tax
Loss on Sale of Asset Fringe Benefit Tax
Profit /(LOSS) before Depreciation [A - B] Add/Less :- Depreciation ADD :- Previous Year Income Net Profit /(LOSS) trasnsfer to Balance Sheet
8063908.19 2229738.47 0.00 5834169.72
3792801.51 2209305.00 228904.20 1812400.71
8130639.70 2242946.00 0.00 5887693.70
9600170.81 2366620.00 0.00 7233550.81
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FIVESTAR PHARMACEUTICALS (A DIV. OF SAKET PROJECTS LTD.) BALANCE SHEET AS ON 1ST APRIL 2008 TO 31ST MARCH 2011
Particulars
RUPEES AS ON 31/03/08
RUPEES AS ON 31/03/09
RUPEES AS ON 31/03/10
RUPEES AS ON 31/03/11
SOURCES OF FUNDS 1. Loan Funds Unsecured Loans Total 3 81740026.70 81740026.70 80020593.79 80020593.79 76183625.79 76183625.79 75894507.79 75894507.79
1. Fixed Assets a. Gross Block b. Less : Depreciation c. Net Block Investment 2. Current Assets, Loans and Advances a. Investories b. Sundry Debtors c. Cash and Bank Balances d. Loans and Advances 6 7 8 9 2082529.04 12212965.73 813541.98 906650.48 16015687.23 Less : Current Liabilities & Provisions Net Current Assets 4. Miscellaneous Expenses (to the extent not written off or adjested) 10 12012339.59 4003347.64 2565319.68 8426880.24 3003725.65 1413504.90 15409430.47 9875695.78 5533734.69 724831.25 4101413.16 1693041.14 3632370.50 10151656.05 3478204.91 6673451.14 201443.55 4702051.34 9170192.80 1813760.51 15887448.20 3076638.35 12810809.85 4 33582916.01 2229738.47 31353177.54 54500.00 32100442.29 2209305.00 29891137.29 54500.00 33045092.54 2242946.00 30802146.54 54500.00 33975839.64 2366620.00 31609219.64 54500.00
11
46329001.52 81740026.70
44541221.81 80020593.79
38653528.11 76183625.79
31419978.30 75894507.79
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Conclusion
FINDING
1) Standard current ratio is 2:1 and for industry it is 5.16:1. Five star ratio is satisfactory.
2) Debtors of the company were high; they were increasing year by year, so more funds were blocked in debtors. But now recovery is becoming faster.
3) Debtors turnover ratio is fluctuating from 2005-06 to 2009-10, which means inventory is not utilized in better way so it is not a good sign for the company.
5) Inventory turnover ratio is improving from 2009-10 to 2010-11.increase in ratio is beneficial for the company because as ratio increases the number of days of collection for debtors decreases.
6) Working capital turnover ratio is continuously decreasing that shows decreasing needs of working capital. The study is basically done to have a deep knowledge about WORKING CAPITAL of the Five Star Pharma is having an appropriate working capital management of the organizations. NET PROFIT growth rate is 30% in 2010-11, it is showing a nominal increase in net profit as compared to last year. The GROSS PROFIT of Five star is more Fluctuating 2007 – 2009 The firm DCP is decreasing every year which is major concern for firm as lower the DCP lower the chances of bad debts. DTR is also decreasing in 2007-08 it was 3.11 times now it has drop down to 0.49 times.
Current ratio is Acceptable thet is 5.16 in 2010-2011 it is very high. Company must have 1 rupee of cash and bank balance and marketable securities. Five Star improve their long term debt
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SUGGESTIONS
1)It can be said that overall financial position of the company is Good but it is required to be improved from the point of view of profitability.
2) Net operating cycle is increasing that means there is a need to make Improvements in receivables/debtors management.
3) Company should stretch the credit period given by the suppliers.
4) Company should try to increase Volume based sales so as to stand in the competition.
Since the Five Star is a profit making company and the interests of the investors are also safe so for making more profit and for increasing the net profit as well as gross profit the organization should curtail its operating, administrative & non productive expense. Company is having good marketability, profitability and liquidity so the company can raise its fund. Company should not forget its ‘Quality Policy’ i.e. we at Five Star, should aim to achieve and sustain excellence in all our activities. We are committed to total customer satisfaction by providing producers and services which meet or exceed the customer expectation.
Modernization of the manufacturing facilities, stress on technological innovation and training of employees at all levels shall be continuous process in Five Star.
LIMITATIONS
? ? The study does not consider the market fluctuations in all its calculations. Analysis is very much dependent on the companies internal bulletin.
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BIBLIOGRAPHY
Reports
? Annual Report (2007-2011)
Websites
? ? www.saketprojects.com as on 30th April 2012
Internet
Books
? ? ? Financial Management “Prassanna Chandra” Afza, T., Nazir, M., 2009. Impact of aggressive working capital management policy on firms’ profitability, The IUP Journal of Applied Finance, 15(8), 20-30 Lazaridis, I., Tryfonidis, D., 2006. Relationship between working capital management and profitability of companies listed in the Athens Stock Exchange, Journal of Financial Management and Analysis, 19(1), 26-35
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doc_200212437.pdf
Project Made On Five Star Pharma Co.
1
Project Report On “WORKING CAPITAL AND PHARMACEUTICAL INDUSTRY” Submitted to Gujarat University for the degree of Master in Commerce Faculty: Commerce
Subject: ACCOUNTANCY AND FINANCE
By. MAHMMADRAMIZ A. SHAIKH Seth Damodardas School of Commerce Gujarat University Ahmedabad
College Seat No . 37 Exam Seat No . _____
Year : 2012 Year _____
Under the guidance of Dr. Harish S. oza (Director of School of Commerce) Seth Damodardas School of Commerce
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Seth Damodardas School of Commerce Gujarat University-Ahmedabad
CERTIFICATE
This is to certify that Mr. Mahmmadramiz A. Shaikh has worked and completed his Project Work for the degree of MASTER IN COMMERCE in the faculty of COMMERCE in the subject of ACCOUNTANCY on Title of project work to be written “Working capital and pharmaceutical industry.” under my supervision. It is her / his own work and facts reported by her/his personal findings and investigations.
Name & Signature of Guide
Date of submission:
Name & Signature of Professor in Charge/ Director/Principal of the Institute
Stamp of the Institute with date
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Declaration by Student
I the undersigned Mr. MahmmadRamiz A. Shaikh here by, declare that this project work entitled “Working capital and pharmaceutical industry” is a result of my own research work and has not been previously submitted to any other University for any other examination.
I hereby further declare that all information of this document has been obtained and presented in accordance with academic rules and ethical conduct.
College Seat No. __________
Year _______.
Exam Seat No. ___________
Year________.
Date
Name & Signature
Place:
Research Scholar
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ACKNOWLEDGEMENT
Behind every study there stands a myriad of people whose help and contribution make it successful. Since such a list will be a prohibitively long. I may be excused for important omission.
I am grateful to all who helped & guided me at every stage of my work. Their constant appraisal & encouragement helped me to accomplish my training smoothly.
I am thankful to “Dr.Harish.S.Oza” (Director of S.D.School Of Commerce) for the cooperation extended to me in compiling the project report. This acknowledgement would be incomplete without the mention of Him who sorted out my queries time to time. My parents were very supportive in any endeavor and offer valuable emotional support during times of stress. Finally, I thank to my friend who gave me time for finding data about my subject. I gained a lot of knowledge & experience by observing their way of working which is surely to be admired. I extend My gratitude to the entire staff that provided a very comfortable environment which helped me deliver this performance.
MAHMMADRAMIZ SHAIKH
M.COM 4th Sem.
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INDEX
Chapter No 1.
Title of Chapter Introduction
INTRODUCTION ON FINANCE
Page No.
8
INTRODUCTION OF WORKING CAPITAL
10
NEED FOR WORKING CAPITAL
15
REQUIREMENTS OF FUNDS
16
SOURCE OF WORKING CAPITAL
17
WORKING CAPITAL CYCLE
23 DEBTORS MANAGEMENT 37 CREDITORS MANAGEMENT 43 Pharmaceutical Industry In India 44 Company Profile 45
2
RESEARCH METHODOLOGY
OBJECTIVES OF THE PROJECT 50
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Hypothesis 50 Ratio Analysis 51 Limitations of the study 51
LITERATURE REVIEW 3 DATA PRESENTATION AND DATA 4 ANALYSIS 53
57
DATA ANALYSIS AND INTERPRETATION 58 IMPORTANCE OF RATIO ANALYSIS 61 RECEIVABLES MANAGEMENT 68 INVENTORY MANAGEMENT 76
PROFIT & LOSS ACCOUNT FOR THE PERIOD 1ST April 2008 TO 31 ST MARCH 2011 BALANCE SHEET AS ON 1ST APRIL 2008 TO 31ST MARCH 2011
96
97
CONCLUSION 5 BIBLIOGRAPHY 6 100 98
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CHAPTER-1 INTRODUCTION
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INTRODUCTION ON FINANCE
Finance is one of the major elements that activate the overall growth of the economy. Finance is the life blood of economic activity. A well - knit financial system directly contributes to the growth of the economy. An efficient financial system calls for the efficient performance of institution, financial instruments and financial markets.
Finance which acts as the lifeblood in the modern business types is one of the most important consideration for an entrepreneur-company. While Implementing, expanding, diversifying, modernizing or rehabilitating any project the meaning of finance is better understood. In this section we have covered finance related information and the process of managing the same.
Finance is a science of managing money and other assets. It is the process of channelization of funds in the form of invested capital, credits, or loans to those economic agents who are in need of funds for productive investments or otherwise. E.g. On one hand, the consumers, business firms, and governments need funds for making their expenditures, pay their debts, or complete other transactions. On the other hand, savers accumulate funds in the form of savings deposits, pensions, insurance claims, and savings or loan shares, etc which becomes a source of investment funds. Here, finance comes to the fore by channeling these savings into proper channels of investment, In general, finance is that business activity which is concerned with acquisition and Conservation of capital funds in meeting financial needs and over all objectives of a business entrepreneur.
Finance is the common denominator for a vast range of corporate ., projects and the major part of any corporate plan must be expressed in financial terms”.
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The main reasons a business needs finance are to:
• Start a business
• Finance expansions to production capacity
• To develop and market new products
• To enter new markets
• Take-over or acquisition
• Moving to new premises
• To pay for the day to day running of business
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INTRODUCTION OF WORKING CAPITAL
Working capital management refers to all management decisions and actions that ordinarily influence the size and effectiveness of the working capital. It is concerned with the most effective choice of working capital sources and the determination of the appropriate levels of the current assets and their use. It focuses attention to the managing of the current assets, current liability and their relationships that exist between them. In other words, working capital management may be defined as the management of a firm’s liquid assets viz-cash, marketable securities, accounts receivable and inventories.
In the present day context of rising capital cost and scarce funds, the importance of working capital needs special emphasis. It has been widely accepted that the profitability of a business concern likely depends upon the manner in which its working capital is managed. The inefficient profitability but ultimately may also lead a concern to financial crisis. On the other hand, proper management of working capital leads to a material savings and ensures financial returns at the optimum level even on the minimum level of capital employed. We also know that both excessive and inadequate working capital is harmful for a firm. Excessive working capital leads to un-remunerative use of scarce funds. On the other hand inadequate working capital usually interrupts the normal operations of a business and impairs profitability. There are many instances of business failure for inadequate working capital. Further, working capital has to play a vital role to keep pace with the scientific and technological developments that are taking place in the concerned area of pharmaceutical industry. If new ideas, methods and techniques are not injected or brought into practice for want of working capital, the concern will certainly not be able toface competition and survive. In this context, working capital management has a special relevance and a through investigation regarding working capital practice in the pharmaceutical industry is of utmost importance. An attempt has, therefore, been
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11 made to undertake an in-depth study on, working capital practices by Indian firms in pharmaceutical industry enlisted in BSE. Working capital may be regarded as life blood of a business. Its effective provision can do much to ensure the success of a business while its in provision can do much to ensure the success of a business while its in efficient management can lead not only to loss of profits but also to the ultimate downfall of what otherwise might be considered as a promising concerns.
DEFINITIONS OF WORKING CAPITAL
The following are the most important definitions of Working capital: ? According to shoo-in, “Working Capital is the amount of funds necessary to cover the cost of operating the enterprise”. Working Capital is also known as Revolving or Circulating Capital. ? According to Genesterberg, “Circulating Capital means current assets of a company that are changed in the ordinary cause of business from one to another form. Example: From cash to inventory, inventories to bills receivable and bills receivable to cash.
? Working capital is the difference between the inflow and outflow of funds. In other words it is the net cash inflow . ? Working capital represents the total of all current assets. In otherwords it is the “Gross working capital”, it is also known as Circulating capital or Current capital for current assets are rotating in their nature.
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WORKING CAPITAL MANAGEMENT
Working Capital is the key difference between the long term financial management and short term financial management in terms of the timing of cash. Long term finance involves the cash flow over the extended period of time i.e 5 to 15 years, while short term financial decisions involve cash flow within a year or within operating cycle. Working capital management is a short term financial management.
Working capital management is concerned with the problems that arise in attempting to manage the current assets, the current liabilities & the inter relationship that exists between them. The current assets refer to those assets which can be easily converted into cash in ordinary course of business, without disrupting the operations of the firm.
Composition of working capital ? Major Current Assets
1) Cash 2) Accounts Receivables 3) Inventory 4) Marketable Securities
? Major Current Liabilities
1) Bank Overdraft 2) Outstanding Expenses 3) Accounts Payable 4) Bills Payable
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13 The Goal of Capital Management is to manage the firm s current assets & liabilities, so that the satisfactory level of working capital is maintained. If the firm can not maintain the satisfactory level of working capital, it is likely to become insolvent & may be forced into bankruptcy. To maintain the margin of safety current asset should be large enough to cover its current assets.
Main theme of the theory of working capital management is interaction between the current assets & current liabilities.
NET WORKING CAPITAL = CURRENT ASSETS- CURRENT LIABILITIES
Concept of working capital
There are five concepts of working capital :-
o Gross Working Capital
o Net Working Capital
o Negative working capital
o Permanent working capital
o Variable working capital
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14 On the basis of the components or items comprised in working capital, working capital can be classified into the following types:
Gross Working capital: Simply called as working capital, refers to the firms
investment in current assets. Current assets which can be converted in to cash with in the accounting year (or operating cycle) and includes cash, short term securities, debtors, Bills receivable and stock (inventory) .
Net Working Capital: Refers to the difference between current assets and current
liabilities. Current liabilities are those claims of outsiders, which are expected to mature for payment with in a year and include creditors, Bills payable and outsider’s expenses.
Negative working capital or working capital deficit: means the excess of
current liabilities over the current assets. It accurse when the current liabilities exceed the current assets,
Permanent working capital or fixed working capital : refer to the
minimum amount of investment in current assets required throughout the year for carrying out the business. In other words , it is the amount of working capital which remains in the business permanently in one form or other.
Variable working capital or fluctuating working capital: refer to the amount
of working capital which goes on fluctuating or changing from time to time with the change in the volume of business activities.
.
Ratios : The term ratio simply means one number expressed in terms of another. It
describes in mathematical terms the quantitative relationship that exists between two numbers.
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NEED FOR WORKING CAPITAL
Every business undertaking requires funds for two purposes, investments in fixed assets & investment in current assets. Funds required for investing in inventory, debtors & other current assets keep changing in shape & volume. Company has some cash in the beginning; this cash may be the source of raw material, keeping the labor cost & other overheads. These three combined would generate work in progress, which will be converted into finished goods on the completion of the production process into debtors & when the debtor pay, the firm may generate cash. Working capital is needed for sustaining (i.e., maintaining) the sales activities. If adequate working capital is not maintain for this period ,the firm will not be able to sustain or maintain the sales , since it may not be in a position to purchase raw material and pay wages and other expenses ands produce the goods required for the sales.
NATURE OF WORKING CAPITAL
In ordinary parlance, Working Capital is taken to be the fund available for meeting day-to-day requirements of enterprises. It cannot be denied that a part of the fixed or permanent capital is invested in assets, which are kept in the business or for a long period for the purpose of earning profit. These are usually known as fixed assets viz. Land & buildings, plant & machinery, furniture & fitting & intangibles like goodwill, patents, trademarks & long-term investment. Another part of permanent capital left in the business for supporting the day-to-day normal operation is known as the “Working Capital”. This Working
Capital generates the important element of cost viz. Material, wages & expenses. These cost usually lead to production & sales in case of manufacturing concerns & sales alone in others. These costs occur gradually in a flow & do not come into being abruptly at a given moment. Hence the initial investment of cash as working capital for this specific purpose has to be continued until the sales revenue commences flowing in substantially & in a regular way. From this stage the business is found to acquire a momentum of its own. The flow
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16 of revenue is expected to continue to replace the cost lost in its day-to-day out flow for the generation of the revenue mentioned above.
REQUIREMENTS OF FUNDS
Every company requires funds for investing in two types of capital i.e. fixed capital, which requires long-term funds, and working capital, which requires short-term funds.
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17
SOURCE OF WORKING CAPITAL
The financial manager is always interested in obtaining the working capital at the right time, at a reasonable cost and at the best possible favorable terms. A part of the working capital investment are permanent investments is fixed assets. The following is snapshot of various source of working capital.
Sources of working capital divided into two
• Long –term
• Short –term
Sources of additional working capital include the following: ? ? Existing cash reserves Profits (when you secure it as cash!) M.COM(SEM-IV) 2011-2012
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18 ? ? ? ? Payables (credit from suppliers) New equity or loans from shareholders Bank overdrafts or lines of credit Term loans
If you have insufficient working capital and try to increase sales, you can easily over-stretch the financial resources of the business. This is called overtrading. Early warning signs include: ? ? ? ? ? ? ? ?
Pressure on existing cash Exceptional cash generating activities e.g. offering high discounts for early cash payment Bank overdraft exceeds authorized limit Seeking greater overdrafts or lines of credit Part-paying suppliers or other creditors Paying bills in cash to secure additional supplies Management pre-occupation with surviving rather than managing Frequent short-term emergency requests to the bank (to help pay wages, pending receipt of a cheque).
LONG TERM SOURCES ISSUE OF SHARES
Ordinary shares are also known as equity shares and they are the most common form of share in the UK. An ordinary share gives the right to its owner to share in the profits of the company (dividends) and to vote at general meetings of the company. Since the profits of companies can vary wildly from year to year, so can the dividends paid to ordinary shareholders. In bad years, dividends may be nothing whereas in good years they may be substantial.
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19 The nominal value of a share is the issue value of the share - it is the value written on the share certificate that all shareholders will be given by the company in which they own shares. The market value of a share is the amount at which a share is being sold on the stock exchange and may be radically different from the nominal value. When they are issued, shares are usually sold for cash, at par and/or at a premium. Shares sold at par are sold for their nominal value only - so if Rs.10 share is sold at par, the company selling the share will receive Rs. 10 for every share it issues. If a share is sold at a premium, as many shares are these days, then the issue price will be the par value plus an additional premium.
DEBENTURES
Debentures are loans that are usually secured and are said to have either fixed or floating charges with them. A secured debenture is one that is specifically tied to the financing of a particular asset such as a building or a machine. Then, just like a mortgage for a private house, the debenture holder has a legal interest in that asset and the company cannot dispose of it unless the debenture holder agrees. If the debenture is for land and/or buildings it can be called a mortgage debenture. Debenture holders have the right to receive their interest payments before any dividend is payable to shareholders and, most importantly, even if a company makes a loss, it still has to pay its interest charges. If the business fails, the debenture holders will be preferential creditors and will be entitled to the repayment of some or all of their money before the shareholders receive anything.
LOANS FROM OTHER FINANCIAL INSTITUTIONS
The term debenture is a strictly legal term but there are other forms of loan or loan stock. A loan is for a fixed amount with a fixed repayment schedule and may appear on a S.D.SCHOOL OF COMMERCE AHMEDABAD M.COM(SEM-IV) 2011-2012
20 balance sheet with a specific name telling the reader exactly what the loan is and its main details.
SHORT TERM SOURCES FACTORING
Factoring allows you to raise finance based on the value of your outstanding invoices. Factoring also gives you the opportunity to outsource your sales ledger operations and to use more sophisticated credit rating systems. Once you have set up a factoring arrangement with a Factor, it works this way: Once you make a sale, you invoice your customer and send a copy of the invoice to the factor and most factoring arrangements require you to factor all your sales. The factor pays you a set proportion of the invoice value within a pre-arranged time - typically, most factors offer you 80-85% of an invoice's value within 24 hours. The major advantage of factoring is that you receive the majority of the cash from debtors within 24 hours rather than a week, three weeks or even longer.
INVOICE DISCOUNTING
Invoice discounting enables you to retain the control and confidentiality of your own sales ledger operations. The client company collects its own debts. 'Confidential invoice discounting' ensures that customers do not know you are using invoice discounting as the client company sends out invoices and statements as usual. The invoice discounter makes a proportion of the invoice available to you once it receives a copy of an invoice sent. Once the client receives payment, it must deposit the funds in a bank account controlled by the invoice discounter. The invoice discounter will then pay the remainder of the invoice, less any charges. The requirements are more stringent than for factoring. Different invoice discounters will impose different requirements.
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21
OVERDRAFT FACILITIES
Many companies have the need for external finance but not necessarily on a longterm basis. A company might have small cash flow problems from time to time but such problems don't call for the need for a formal long-term loan. Under these circumstances, a company will often go to its bank and arrange an overdraft. Bank overdrafts are given on current accounts and the good point is that the interest payable on them is calculated on a daily basis. So if the company borrows only a small amount, it only pays a little bit of interest. Contrast the effects of an overdraft with the effects of a loan.
TRADE CREDIT
This source of finance really belongs under the heading of working capital management since it refers to short-term credit. By a 'line of credit' they mean that a creditor, such as a supplier of raw materials, will allow us to buy goods now and pay for them later. Why do they include lines of credit as a source of finance? They ll, if they manage their creditors carefully they can use the line of credit they provide for us to finance other parts of their business. Take a look at any company's balance sheet and see how much they have under the heading of Creditors falling due within one year' - let's imagine it is Rs. 25,000 for a company. If that company is allowed an average of 30 days to pay its creditors then they can see that effectively it has a short term loan of Rs. 25,000 for 30 days and it can do whatever it likes with that money as long as it pays the creditor on time.
PLANNING OF WORKING CAPITAL
Working capital is required to run day to day business operations. Firms differ in their requirement of working capital (WC). Firm s aim is to maximize the wealth of share holders and to earn sufficient return from its operations. WCM is a significant facet of financial management. Its importance stems from two reasons:
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22 ? ? Investment in current asset represents a substantial portion of total investment. Investment in current assets and level of current liability has to be geared quickly to change in sales. Business undertaking required funds for two purposes: ? ? To create productive capacity through purchase of fixed assets. To finance current assets required for running of the business.
The importance of WCM is reflected in the fact that financial managers spend a great deal of time in managing current assets and current liabilities. The extent to which profit can be earned is dependent upon the magnitude of sales. Sales are necessary for earning profits. However, sales do not convert into cash instantly; there is invariably a time lag between sale of goods and the receipt of cash. WC management affect the profitability and liquidity of the firm which are inversely proportional to each other, hence proper balance should be maintained between two. To convert the sale of goods into cash, there is need for WC in the form of current asset to deal with the problem arising out of immediate realization of cash against good sold. Sufficient WC is necessary to sustain sales activity. This is referred to as the operating or cash cycle.
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23
WORKING CAPITAL CYCLE
The working capital of a concern goes on changing in shape and volume. For Instance, a concern may have some cash in the beginning. The cash may be used by the concern for the purpose of purchase of raw material, payment of wages and other expenses’. These elements of cost or items of expenses, raw material , wages and overheads , will result in work- in-progress during the process of manufacture. On the in compilation of the production process, the work- in –progress becomes finished goods.
Meaning The length of time involved in this cycle of conversion of cash into raw material, raw material into work-in progress, work-in-progress into finished goods, finished goods into debtors and debtors into cash again is called the operating cycle or working capital cycle of the firm, in other words, it is period between the date raw material are purchased and the date the sale proceeds of finished goods are realized by concern. S.D.SCHOOL OF COMMERCE AHMEDABAD M.COM(SEM-IV) 2011-2012
24 A firm requires many years to recover initial investment in fixed assets. On contrary the investment in current asset is turned over many times a year. Investment in such current assets is realized during the operating cycle of the firm. Each component of working capital (namely inventory, receivables and payables) has two dimensions ... TIME ......... and MONEY. When it comes to managing working capital - TIME IS MONEY. If you can get money to move faster around the cycle (e.g. collect dues 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 longer credit or an increased credit limit; you effectively create free finance to help fund future sales. It can be tempting to pay cash, if available, for fixed assets e.g. computers, plant, vehicles etc. If you do pay cash, remember that this is now longer available for working capital. Therefore, if cash is tight, consider other ways of financing capital investment - loans, equity, leasing etc. Similarly, if you pay dividends or increase drawings, these are cash outflows and, like water flowing down a plughole, they remove liquidity from the business
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INTER-DEPENDENCE AMOUNG COMPONENTS OF WORKING CAPITAL OPERATING CYCLE
A company starting with cash purchase raw materials, components etc., on a cash or credit basis. These materials will be converted into finished goods after undergoing various stages of work-in-process. For this purpose the company has to make payments towards wages, salaries and manufacturing costs. Payments to suppliers have to be made on purchases in the case of cash purchases and on the expiry of the credit purchases. Further, the company has to meet other operating costs such as selling and distribution costs, general administration costs and non-operating costs described as financial costs (interest on borrowed capital). In case the company sells its finished goods on cash basis, it will pass through one more stage, viz, accounts receivable and gets back cash along with profit on expiry of credit period. Once again the cash will be used for the purchase of materials and / or payments to suppliers and the whole cycle is termed as working capital or operating cycle repeats itself. This process indicates the dependents of each stage or components of working capital on its previous stage or component.
Advantages of working capital
• It helps the business concern in maintaining the goodwill. • It can arrange loans from banks and others on easy and favorable terms. • It enables a concern to face business crisis in emergencies such as depression. • It creates an environment of security, confidence, and over all efficiency in a business. • It helps in maintaining solvency of the business.
Disadvantages of working capital
• Rate of return on investments also fall with the shortage of working capital. • Excess working capital may result into over all inefficiency in organization. • Excess working capital means idle funds which earn no profits. • Inadequate working capital can not pay its short term liabilities in time.
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27
Operating cycle
The working capital cycle refers to the length of time between the firms paying the cash for materials, etc., entering into production process/stock & the inflow of cash from debtors (sales), suppose a company has certain amount of cash it will need raw materials. Some raw materials will be available on credit but, cash will be paid out for the other part immediately. Then it has to pay labour costs & incurs factory overheads. These three combined together will constitute work in progress. After the production cycle is complete, work in progress will get converted into sundry debtors.Sundry debtors will be realized in cash after the expiry of the credit period. This cash can be again used for financing raw material, work in progress etc. thus there is complete cycle from cash to cash wherein cash gets converted into raw material, work in progress, finished goods and finally into cash again. Short term funds are required to meet the requirements of funds during this time period. This time period is dependent upon the length of time within which the original cash gets converted into cash again. The cycle is also known as operating cycle or cash cycle.
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28 Working capital cycle can be determined by adding the number of days required for each stage in the cycle. For example, company holds raw material on average for 60 days, it gets credit from the supplier for 15 days, finished goods are held for 30 days & 30 days credit is extended to debtors. The total days are 120, i.e., 60 15 + 15 + 15 + 30 + 30 days is the total of working capital. Thus the working capital cycle helps in the forecast, control & management of working capital. It indicates the total time lag & the relative significance of its constituent parts. The duration may vary depending upon the business policies. In light of the facts discusses above we can broadly classify the operating cycle of a firm into three phases viz. 1 Acquisition of resources. 2 Manufacture of the product and 3 Sales of the product (cash / credit).
First and second phase of the operating cycle result in cash outflows, and be predicted with reliability once the production targets and cost of inputs are known. However, the third phase results in cash inflows which are not certain because sales and collection which give rise to cash inflows are difficult to forecast accurately.
Operating cycle consists of the following: ? ? ? ? ? Conversion of cash into raw-materials; Conversion of raw-material into work-in-progress; Conversion of work-in-progress into finished stock; Conversion of finished stock into accounts receivable through sales; and Conversion of accounts receivable into cash.
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29 In the form of an equation, the operating cycle process can be expressed as follows:
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30 The firm is therefore, required to invest in current assets for smooth and uninterrupted functioning.
Here, the length of GOC is the sum of ICP and RCP. ICP is the total time needed for producing and selling the products. Hence it is the sum total of RMCP, WIPCP and FGCP. On the other hand, RCP is the total time required to collect the outstanding amount from customers. Usually, firm acquires resources on credit basis. PDP is the result of such an incidence and it represent the length of time the firm is able to defer payments on various resources purchased. The difference between GOC and PDP is know as Net Operating Cycle and if Depreciation is excluded from the expenses in computation of operating cycle, the NOC also represents the cash collection from sale and cash payments for resources acquired by the firm and during such time interval between cash collection from sale and cash payments for resources acquired by the firm and during such time interval over which additional funds called working capital should be obtained in order to carry out the firms operations. In short, the working capital position is directly proportional to the Net Operating Cycle.
Types of working capital
1) PERMANENT AND 2) VARIABLE WORKING CAPITAL
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31 The need for current assets arises because of the operating cycle. The operating cycle is a continuous process and, therefore, the need for current assets is felt constantly. But the magnitude of current assets needed is not always a minimum level of current assets which is continuously required by the firm to carry on its business operations. This minimum level of current assets is referred to as permanent, or fixed, working capital. It is permanent in the same way as the firms fixed assets are. Depending upon the changes in production and sales, the need for working capital, over and above permanent working capital, will fluctuate. For example, extra inventory of finished goods will have to be maintained to support the peak periods of sales, and investment in receivable may also increase during such periods. On the other hand, investment in raw material, work-inprocess and finished goods will fall if the market is slack. The extra working capital, needed to support the changing production and sales activities is called FLUCTUATING, or VARIABLE, or TEMPORARY working capital. Both kinds of working capital - PERMANENT and TEMPORARY - are necessary to facilitate production and sale through the operating cycle, but temporary-working capital is created by the firm to meet liquidity requirements that will last only temporary working capital. It is shown that permanent working capital is stable over time. While temporary working capital is fluctuating- sometimes increasing and sometimes decreasing. However, the permanent capital is difference between permanent and temporary working capital can be depicted through figure.
BALANCED WORKING CAPITAL POSITION
The firm should maintain a sound working capital position. It should have adequate working capital to run its business operations. Both excessive as well as inadequate working capital positions are dangerous from the firm’s point of view. Excessive working capital not only impairs the firm’s profitability but also result in production interruptions and inefficiencies. The dangers of excessive working capital are as follows: ? It results in unnecessary accumulation of inventories. Thus, chances of inventory mishandling, waste, theft and losses increase.
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32 ? It is an indication of defective credit policy slack collections period. Consequently, higher incidence of bad debts results, which adversely affects profits. ? Excessive working capital makes management complacent which degenerates into managerial inefficiency. ? Tendencies of accumulating inventories tend to make speculative profits grow. This may tend to make dividend policy liberal and difficult to cope with in future when the firm is unable to make speculative profits.
Inadequate working capital is also bad and has the following dangers: ? It stagnates growth. It becomes difficult for the firm to undertake profitable projects for non- availability of working capital funds. ? It becomes difficult to implement operating plans and achieve the firm s profit target. ? Operating inefficiencies creep in when it becomes difficult even to meet day commitments. ? Fixed assets are not efficiently utilized for the lack of working capital funds. Thus, the firm s profitability would deteriorate. ? Paucity of working capital funds render the firm unable to avail attractive credit opportunities etc. ? The firm loses its reputation when it is not in a position to honour its short-term obligations. As a result, the firm faces tight credit terms. An enlightened management should, therefore, maintain the right amount of working capital on a continuous basis. Only then a proper functioning of business operations will be ensured. Sound financial and statistical techniques, supported by judgment, should be used to predict the quantum of working capital needed at different time periods. A firm s net working capital position is not only important as an index of liquidity but it is also used as a measure of the firm s risk.
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33 Risk in this regard means chances of the firm being unable to meet its obligations on due date. The lender considers a positive net working as a measure of safety. All other things being equal, the more the net working capital a firm has, the less likely that it will default in meeting its current financial obligations. Lenders such as commercial banks insist that the firm should maintain a minimum net working capital position.
DETERMINANTS OF WORKING CAPITAL
There are no set rules or formula to determine the working capital requirements of firms. A large number of factors, each having a different importance, influence working capital needs of firms. Also, the importance of factors changes for a firm over time. Therefore, an analysis of relevant factors should be made in order to determine total investment in working capital. The following is the description of factors which generally influence the working capital requirements of firms. ? Nature of Business ? Sales and Demand Conditions ? Technology and Manufacturing Policy ? Credit Policy ? Availability of Credit Operating Efficiency ? Price Level Changes
Nature of Business
Working capital requirements of a firm are basically influenced by the nature of its business. Trading and financial firms have a very small investment in fixed assets, but require a large sum of money to be invested in working capital. Retail stores, for example, must carry large stocks of a variety of goods to satisfy varied and continuous demand of their customers. Some manufacturing business, such as tobacco manufacturers and construction firm, also have to invest substantially in working capital and a nominal amount in fixed assets. In contrast, public utilities have a very limited need for working capital and have to invest abundantly in fixed assets. Their working capital requirements are nominal because they may have only cash and supply services, not products. Thus, no funds will be tied up in debtors and stock (inventories). Working capital requires most of S.D.SCHOOL OF COMMERCE AHMEDABAD M.COM(SEM-IV) 2011-2012
34 the manufacturing concerns to fall between the two extreme requirements of trading firms and public utilities. Such concerns have to make adequate investment in current assets depending upon the total assets structure and other variables.
Sales and Demand Conditions
The working capital needs of a firm are related to its sales. It is difficult to precisely determine the relationship between volume of sales and working capital needs. In practice, current assets will have to be employed before growth takes place. It is , therefore, necessary to make advance planning of working capital for a growing firm on a continuous basis. A growing firm may need to invest funds in fixed assets in order to sustain its growing production and sales. This will, in turn, increase investment in current assets to support enlarged scale of operations. It should be realized that a growing firm needs funds continuously. It uses external sources as well as internal sources to meet increasing needs of funds. Such a firm faces further financial problems when it retains substantial portion of its profits. It would not be able to pay dividends to shareholders. It is, therefore, Imperative that proper planning be done by such companies to finance their increasing needs for working capital. Sales depend on demand conditions. Most firms experience seasonal and cyclical fluctuations in the demand for their products and services. These business variations affect the working capital requirements, specially the temporary working capital requirement of the firm. When there is an upward swing in the economy, sales will increase; correspondingly, the firm’s investment in inventories and debtors will also increase. Under boom, additional investment in fixed assets may be made by some firms to increase their productive capacity. This act of firm will require further additions of working capital. To meet their requirements of funds for fixed assets and current assets under boom further additions of working capital. To meet their requirements of funds for fixed assets and current assets under boom period, firms generally resort to substantial borrowing. On the other hand, when there is a decline in the economy, sales will fall and consequently, levels of inventories and debtors will also fall. Under recessionary conditions, firms try to reduce their short term borrowings.
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35 Seasonal fluctuations not only affect working capital requirements but also create production problems for the firm. During periods of peak demand, increasing production may be expensive for the firm. Similarly, it will be more expensive during slack periods when the firm has to sustain its working force and physical facilities without adequate production and sales. A firm may, thus, follow a policy of steady production, irrespective of seasonal changes in order to utilize its resources to the fullest extent. Such a policy will mean accumulation of inventories during off season and their quick disposal during the peak season. The increasing level of inventories during the slack season will require increasing funds to be tied up in the working capital for some months. Unlike cyclical fluctuations, seasonal fluctuations generally conform to a steady pattern. Therefore, financial arrangements for seasonal working capital requirements can be made in advance. However, the financial plan or arrangement should be flexible enough to take care of some abrupt seasonal fluctuations.
Technology and Manufacturing Policy
The manufacturing cycle (or the inventory conversion cycle) comprises of the purchase and use of raw material the production of finished goods. Longer the manufacturing cycle, larger will be the firm working capital requirements. For example, the manufacturing cycle in the case of a boiler, depending on its size, may range between six to twenty- four months. On the other hand, the manufacturing cycle of products such as detergent powder, soaps, chocolate etc. may be a few hours. An extended manufacturing time span means a larger tie- up of funds in inventories. Thus, if there are alternative technologies of manufacturing a product, the technological process with the shortest manufacturing cycle may be chosen. Once a manufacturing technology has been selected, it should be ensured that manufacturing cycle is completed within the specified period. This needs proper planning and coordination at all levels of activity. Any delay in manufacturing process will results in accumulation of work- inprocess and waste of time. In order to minimize their investment in working capital, some firms, especially firm Manufacturing industrial products have a policy of asking for advance payment from
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36 their customers. Non-manufacturing firms, service and financial enterprises do not have a manufacturing cycle. A strategy of constant production may be maintained in order to resolve the working capital problems arising due to seasonal changes in the demand for the firm product. A steady production policy will cause inventories to accumulate during the offreason periods and the firm will be exposed to greater inventory costs and risks. Thus, if costs and risks of maintaining a constant production policy, varying its production utilized for manufacturing varied products, can have the advantage of diversified Activities and solve their working capital problems. They will manufacture the original product line during its increasing demand and when it has an off- season, other products may be manufactured to utilize physical resources and working force. Thus, production policies will differ from firm to firm, depending on the circumstances of individual firm.
Credit Policy
The credit policy of the firm affects the working capital by influencing the level of debtors. The credit terms to be granted to customers may depend upon the norms of the industry to which the firm belongs. But a firm has the flexibility of shaping its credit policy within the constraint of industry norms and practices. The firm should be discretion in granting credit terms to its customers. Depending upon the individual case, different terms may be given to different customers. A liberal credit policy, without rating the creditworthiness of customers, will be detrimental to the firm and will create a problem of collections. A high collection period will mean tie- up of large funds in book debts. Slack collection procedures can increase the chance Of bad debts. In order to ensure that unnecessary funds are not tied up in debtors, the firm should follow a rationalized credit policy based on the credit standing of customers and periodically review the creditworthiness of the exiting customers. The case of delayed payments should be thoroughly investigated.
Availability of Credit
The working capital requirements of a firm are also affected by credit terms granted by its creditors. A firm will need less working capital if liberal credit terms are available to it. Similarly, the availability of credit from banks also influences the working capital S.D.SCHOOL OF COMMERCE AHMEDABAD M.COM(SEM-IV) 2011-2012
37 needs of the firm. A firm which can get bank credit easily on favorable condition will operate with less working capital than a firm without such a facility.
Operating Efficiency
The operating efficiency of the firm relates to the optimum utilization of resources at minimum costs. The firm will be effectively contributing in keeping the working capital investment at a lower level if it is efficient in controlling operating costs and utilizing current assets. The use of working capital is improved and pace of cash conversion cycle is accelerated with operating efficiency. Better utilization of resources improves profitability and, thus, helps in releasing the pressure on working capital. Although it may not be possible for a firm to control prices of materials or wages of labour, it can certainly ensure efficiency and effective use of its materials, labour and other resources.
Price Level Changes
The increasing shifts in price level make functions of financial manager difficult. He should anticipate the effect of price level changes on working capital requirement of the firm. Generally, rising price levels will require a firm to maintain higher amount of working capital. Same levels of current assets will need increased investment when price are increasing. However, companies which can immediately revise their product price levels will not face a server working capital problem. Further, effects of increasing general price level will be felt differently by firm as individual price may move differently. It is possible that some companies may not be affected by rising price will be different for companies. Some will face no working capital problem, while working capital problems of other may be aggravated.
DEBTORS MANAGEMENT
Assessing the credit worthiness of customers
Before extending credit to a customer, a supplier should analyze the five Cs of credit worthiness, which will provoke a series of questions. These are:
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38 ? Capacity: will the customer be able to pay the amount agreed within the allowable credit period? What is their past payment record? How large is the customer's business capital. what is the financial health of the customer? Is it a liquid and profitable concern, able to make payments on time? ? ? ? Character: do the customers management appear to be committed to prompt payment? Are they of high integrity? What are their personalities like? Collateral: what is the scope for including appropriate security in return for extending credit to the customer? Conditions: what are the prevailing economic conditions? How are these likely to impact on the customers ability to pay promptly? Whilst the materiality of the amount will dictate the degree of analysis involved, the major sources of information available to companies in assessing customers credit worthiness are: ? Bank references. These may be provided by the customers bank to indicate their financial standing. However, the law and practice of banking secrecy determines the way in which banks respond to credit enquiries, which can render such references uninformative, particularly when the customer is encountering financial difficulties. ? Trade references. Companies already trading with the customer may be willing to provide a reference for the customer. This can be extremely useful, providing that the companies approached are a representative sample of all the clients suppliers. Such references can be misleading, as they are usually based on direct credit experience and contain no knowledge of the underlying financial strength of the customer. ? Financial accounts. The most recent accounts of the customer can be obtained either direct from the business, or for limited companies, from Companies House. While subject to certain limitations past accounts can be useful in vetting customers. Where the credit risk appears high or where substantial levels of credit are required, the supplier may ask to see evidence of the ability to pay on time. This demands access to internal future budget data.
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39 ? Personal contact. Through visiting the premises and interviewing senior management, staff should gain an impression of the efficiency and financial resources of customers and the integrity of its management. ? Credit agencies. Obtaining information from a range of sources such as financial accounts, bank and newspaper reports, court judgments, payment records with other suppliers, in return for a fee, credit agencies can prove a mine of information. They will provide a credit rating for different companies. The use of such agencies has grown dramatically in recent years. ? Past experience. For existing customers, the supplier will have access to their past payment record. However, credit managers should be aware that many failing companies preserve solid payment records with key suppliers in order to maintain supplies, but they only do so at the expense of other creditors. Indeed, many companies go into liquidation with flawless payment records with key suppliers. ? General sources of information. Credit managers should scout trade journals, business magazines and the columns of the business press to keep abreast of the key factors influencing customers' businesses and their sector generally. Sales staffs who have their ears to the ground can also prove an invaluable source ofinformation. ? Credit terms granted to customers Although sales representatives work under the premise that all sales are good (particularly, one may add, where commission is involved!), the credit manager must take a more dispassionate view. They
must balance the sales representative's desire to extend generous credit terms, please customers and boost sales, with a cost/benefit analysis of the impact of such sales, incorporating the likelihood of payment on time and the possibility of bad debts. Where a customer does survive the credit checking process, the specific credit terms offered to them will depend upon a range of factors. These include: o Order size and frequency: companies placing large and/or frequent orders will be in a better position to negotiate terms than firms ordering on a one-off basis.
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40 o Market position: the relative market strengths of the customer and supplier can be influential. For example, a supplier with a strong market share may be able to impose strict credit terms on a weak, fragmented customer base. o Profitability: the size of the profit margin on the goods sold will influence the generosity of credit facilities offered by the supplier. If margins are tight, credit advanced will be on a much stricter basis than where margins are wider. o Financial resources of the respective businesses: from the supplier's perspective, it must have sufficient resources to be able to offer credit and ensure that the level of credit granted represents an efficient use of funds. For the customer, trade credit may represent an important source of finance, particularly where finance is constrained. If credit is not made available, the customer may switch to an alternative, more understanding supplier. o Industry norms: unless a company can differentiate itself in some manner (e.g., unrivalled after sales service), its credit policy will generally be guided by the terms offered by its competitors. Suppliers will have to get a feel for the sensitivity of demand to changes in the credit terms offered to customers. o Business objectives: where growth in market share is an objective, trade credit may be used as a marketing device (i.e., liberalized to boost sales volumes).
The main elements of a trade policy are: o Terms of trade: the supplier must address the following questions: which customers should receive credit? How much credit should be advanced to particular customers and what length of credit period should be allowed? o Cash discounts: suppliers must ponder on whether to provide incentives to encourage customers to pay promptly. A number of companies have abandoned the expensive practice of offering discounts as customers frequently accepted discounts without paying in the stipulated period. o Collection policy: an efficient system of debt collection is essential. A good accounting system should invoice customers promptly, follow up disputed invoices speedily, issue statements and reminders at appropriate intervals, and
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41 generate management reports such as an aged analysis of debtors. A clear policy must be devised for overdue accounts, and followed up consistently, with appropriate procedures (such as withdrawing future credit and charging interest on overdue amounts). Materiality is important. Whilst it may appear nonsensical to spend time chasing a small debt, by doing so, a company may send a powerful signal to its customers that it is serious about the application of its credit and collection policies. Ultimately, a balance must be struck between the cost of implementing a strict collection policy (i.e., the risk of alienating otherwise good customers) and the tangible benefits resulting from good credit management
Problems in collecting debts
Despite the best efforts of companies to research the companies to whom they extend credit, problems can, and frequently do, arise. These include disputes over invoices, late payment, deduction of discounts where payment is late, and the troublesome issue of bad debts. Space precludes a detailed examination of debtor finance, so this next section concentrates solely on the frequently examined method of factoring.
Factoring an evaluation Key elements:
Factoring involves raising funds against the security of a company's trade debts, so that cash is received earlier than if the company waited for its credit customers to pay. Three basic services are offered, frequently through subsidiaries of major clearing banks: ? ? ? Sales ledger accounting, involving invoicing and the collecting of debts; Credit insurance, which guarantees against bad debts; Provision of finance, whereby the factor immediately advances about 80% of the value of debts being collected. There are two types of factoring service:
Non-recourse factoring is where the factoring company purchases the debts without recourse to the client. This means that if the clients debtors do not pay what they owe, the factor will not ask for his money back from the client. S.D.SCHOOL OF COMMERCE AHMEDABAD M.COM(SEM-IV) 2011-2012
42 Recourse factoring, on the other hand, is where the business takes the bad debt risk. With 80% of the value of debtors paid up front (usually electronically into the clients bank account, by the next working day), the remaining 20% is paid over when either the debtors pay the factor (in the case of recourse factoring), or, when the debt becomes due (non-recourse factoring). Factors usually charge for their services in two ways: administration fees and finance charges. Service fees typically range from 0.5 - 3% of annual turnover. For the finance made available, factors levy a separate charge, similar to that of a bank overdraft.
Advantages
? ? ? ? provides faster and more predictable cash flows; finance provided is linked to sales, in contrast to overdraft limits, which tend to be determined by historical balance sheets; growth can be financed through sales, rather than having to resort to external funds; the business can pay its suppliers promptly (perhaps benefiting from discounts) and because they have sufficient cash to pay for stocks, the firm can maintain optimal stock levels; ? ? management can concentrate on managing, rather than chasing debts; the cost of running a sales ledger department is saved and the company benefits from the expertise (and economies of scale) of the factor in credit control
Disadvantages
? ? ? The interest charge usually costs more than other forms of short-term debt; The administration fee can be quite high depending on the number of debtors, the volume of business and the complexity of the accounts; By paying the factor directly, customers will lose some contact with the supplier. Moreover, where disputes over an invoice arise, having the factor in the middle can lead to a confused three-way communication system, which hinders the debt collection process;
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43 ? Traditionally the involvement of a factor was perceived in a negative light (indicating that a company was in financial difficulties), though attitudes are rapidly changing. ?
Conclusion
Working capital management is of critical importance to all companies. Ensuring that sufficient liquid resources are available to the company is a pre-requisite for corporate survival. Companies must strike a balance between minimizing the risk of insolvency (by having sufficient working capital) with the need to maximize the return on assets, which demands a far less conservative outlook.
CREDITORS MANAGEMENT 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 your 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? 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? S.D.SCHOOL OF COMMERCE AHMEDABAD M.COM(SEM-IV) 2011-2012
44 ? ? 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? There is an old adage in business that if you can buy well then you can sell well. Management of your creditors and suppliers is just as important as the management of your debtors. It is important to look after your creditors - slow payment by you may create ill feeling and can signal that your company is inefficient (or in trouble!).
Pharmaceutical Industry In India Introduction
The pharmaceutical industry in India is going through a major shift in its business model in the last few years in order to get ready for a product patent regime from 2005 onwards. This shift in the model has become necessary due to the earlier process patent regime put in place since 1972 by the Government of India. This was done deliberately to promote and encourage the domestic health care industry in producing cheap and affordable drugs. As prior to this the Indian pharmaceutical sector was completely dominated by multinational companies (MNCs). These firms imported most of the bulk drugs (the active pharmaceutical ingredients) from their parent companies abroad and sold the formulations (the end products in the form of tablets and capsules, syrups etc.) at prices unaffordable for a majority of the Indian population. This led to a revision of Government of India’s (GOI) policy towards this industry in 1972 allowing Indian firms to reverse engineer the patented drugs and produce them using a different process that was not under patent. The entry of MNC’s was also discouraged by restricting foreign equity to 40%. The licensing policy was also biased towards indigenous firms and firms with lesser foreign equity1. All these measures by GOI laid foundations to a strong manufacturing base for bulk drugs and formulations and accelerated the growth in the Indian Pharmaceutical Industry (IPI), which today consists of more than 20,000 players1. As a result the Indian pharmaceutical industry today not only meets the domestic
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45 requirement but has started exporting bulk drugs as well as formulations to the international market. Currently the main activities of Indian pharmaceutical industry are broadly restricted to producing (i) bulk drugs and (ii) formulations with very few companies risking investing in primary research aimed at developing and patenting new drugs. The bulk drug business is essentially a commodity business, where as the formulation business is primarily a market driven and brand oriented business. Multinational companies which have entered the Indian market have mostly restricted themselves to formulation segment till date. The domestic pharmaceutical industry (MNC’s and Domestic) meets about 90% of the country’s bulk drug requirement and almost the entire demand for formulations2. The economics of bulk drug business and that of formulation business are quite different. Since a majority of the Indian companies are producing both bulk as well as formulations, these are considered together for the purpose of the present study.
Company Profile
Profile says
Established in the year 1995, our organization, ‘Saket Projects Limited' is a reckoned name operating as a service provider. We are serving a large clientèle with our Event Management, Energy Management, Industrial Publication & Pharmaceutical (Formulations). Annual turnover of around INR 60 Million is a self-proof of our wide acceptance in the industry. With our reliable services and prompt solutions, we are able to serve clients in both corporate as well as commercial sectors We have also started an Industrial Publication Division, which is aimed at disseminating fair and objective business information to ‘loi polloi’. Our IPD professionals report on preventing economic scenario and the emerging business opportunities in India and abroad. With our professionals, who have an extensive experience, we communicate directly with our clients and offer most customized solutions to them. It is ensured that the projects are timely completed. S.D.SCHOOL OF COMMERCE AHMEDABAD M.COM(SEM-IV) 2011-2012
46 Under the able guidance of our Founder Chiarman, ‘Mr. Jay Narayan Vyas’, we have achieved phenomenal growth over the past decades. He has always motivated us to perform up to our true potential.
Pharmaceutical Manufacturing (Formulations)
FIVE STAR PHARMACEUTICALS, A division of Saket Projects Ltd., has full – fledged pharmaceuticals formulation unit on the out skirts of Ahmedabad to manufacture entire range of formulation was acquired by Saket Projects Limited as an ongoing concern in June’1996.
Pharmaceutical Formulations
The company is holding Good Manufacturing Practices (cGMP) and revised Schedule-M certificate by FOOD & DRUGS CONTROL ADMINISTRATION, GOVERNMENT OF GUJARAT, GANDHINAGAR..
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47 The Formulation Activity is spread in 2555 sq. mt. having sections such as Liquid Vials Injectable, Ampoules Injectable and Oral liquids.
The Unit is also having state of an Art Microbiological & Chemical Laboratory (Q.C.) with well equip high tech laboratory testing equipments. Five Star Pharma. are currently focusing on Third Party & job work as for as marketing is concern Five Star Pharma. have been successfully exported their products to Ukrain, Venzuella, Brazil, Sri Lanka, Russia and other European Countries. Five Star Pharma. also working for big companies such as Cadila Healthcare Ltd., Zydus Animal Healthcare Ltd., J.B. Chemicals & Pharmaceuticals, Themis Pharmaceuticals etc. for Third Party & Job Work. So, Company gives its humble share to increasing nation’s economy under leadership of managing director Mr. Saket Vyas with his hardworking team. The Tremendous efforts were put in by the management; in developing the infrastructure which has helped the company in a greater way to fulfill the requirements and expectations of the customer.
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48 With the commitment to Quality and customer services have helped the company to reach an impressive position. This attracted big Pharma units To start their production on Loan License, third party basis at Five Star and are still continuing Their production for long time with Five Star.
Company Profile
Nature of Business Ownership & Capital Year of Establishment Ownership Type Trade & Market Annual Turnover Team & Staff Total Number of Employees Company USP Primary Competitive Advantage Packaging/Payment and Shipment Details Payment Mode
? ?
Service Provider
1995
Limited Liability/Corporation (Listed Company) US$ 1-10 Million (or Rs. 4-40 Crore Approx.) 101 to 500 People
Provide Customized Solutions
Cheque DD
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CHAPTER-2
RESEARCH METHODOLOGY
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OBJECTIVES OF THE PROJECT The objectives of study
1) To identify the financial strengths & weakness of the company. 2) Through the net profit ratio & other profitability ratio, understand the profitability of the company. 3) Evaluating company’s performance relating to financial statement analysis. 4) To know the liquidity position of the company with the help of current ratio. 5) To find out the utility of financial ratio in credit analysis & determinig the financial capacity of the firm. 6) To analyse and evaluate the techniques and strategies of cash management. 7) To analyse and evaluate the techniques and strategies of Debtors management. 8) To suggest, on the basis of conclusion, innovations in the management of working capital in Pharmaceutical companies in India.( Five Star Pharma.)
Hypothesis
1. Current Ratio of Pharmaceutical companies does not differ significantly among the years. 2. Gross Working Capital Turnover Ratio of Pharmaceutical companies does not differ significantly among the years. 3. Gross Working Capital Turnover Ratio does not differ significantly among the various Pharmaceutical companies over the years. 4. Net Working Capital Turnover Ratio of Pharmaceutical companies does not differ significantly among the years. 5. Net Working Capital Turnover Ratio does not differ significantly among the various Pharmaceutical companies over the years. 6. Inventory Turnover Ratio of Pharmaceutical companies does not differ significantly among the years. 7. Inventory Turnover Ratio does not differ significantly among the various Pharmaceutical companies over the years. 8. Debtors Turnover Ratio of Pharmaceutical companies does not differ significantly among the years. S.D.SCHOOL OF COMMERCE AHMEDABAD M.COM(SEM-IV) 2011-2012
51 9. Debtors Turnover Ratio does not differ significantly among the various Pharmaceutical companies over the years. 10. Cash Turnover Ratio of Pharmaceutical companies does not differ significantly among the years. 11 Cash Turnover Ratio does not differ significantly among the various Pharmaceutical companies over the years.
Ratio Analysis
Ratio analysis is regarded as one of the best tools in analyzing and comparing the time series account data of different firms. It has been extensively used in the present study. The purpose of ratio analysis was three-fold: size analysis, composition analysis and circulation/efficiency analysis. Various ratios computed in order to analyse the size, composition and circulation of working capital and its various components (inventory, receivables, cash and current liabilities) have been explained at the relevant places in different chapters. However, in this study the use of ratios has not been made in the course of analysis directly. To make the analysis and interpretation more precise and accurate the values of mean, and C.V. have been computed from the ratios.
Limitations of the study:
In a research design selected in the study, there is a great chance of personal bias in the selection of sample companies. However, it is attempted to be as objective and impartial to obtain reliable and meaningful results from final analysis. This study is based on secondary data taken from FIVE STAR PHARMA database as well
published annual reports of the said companies and as such its finding depends entirely on the accuracy of such data. Moreover, the data were processed to 12 months on an average basis wherever required. The study is largely based on the financial tool of ratio analysis, which has its own limitations that also applies to this study. Executives, who were interviewed, sometime became very reluctant to share the information on their privacy policy ground. As an alternative, it was possible to
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52 collect some relevant information through general discussion with top management finance executives. Hence, the conclusions drawn in the present study should be taken in the light of these deficiencies of data.
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CHAPTER-3
LITERATURE REVIEW
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54 Working capital management is a very important component of corporate finance because it directly affects the liquidity and profitability of the company. It deals with current assets and current liabilities. Working capital management is important due to many reasons. For one thing, the current assets of a typical manufacturing firm accounts for over half of its total assets. For a distribution company, they account for even more. Excessive levels of current assets can easily result in a firm’s realizing a substandard return on investment. However firms with too few current assets may incur shortages and difficulties in maintaining smooth operations (Horne and Wachowicz, 2000). Efficient working capital management involves planning and controlling current assets and current liabilities in a manner that eliminates the risk of inability to meet due short term obligations on the one hand and avoid excessive investment in these assets on the other hand (Eljelly, 2004). Many surveys have indicated that managers spend considerable time on day-to-day problems that involve working capital decisions. One reason for this is that current assets are short-lived investments that are continually being converted into other asset types (Rao 1989). With regard to current liabilities, the firm is responsible for paying these obligations on a timely basis. Liquidity for the on going firm is not reliant on the liquidation value of its assets, but rather on the operating cash flows generated by those assets (Soenen, 1993). Taken together, decisions on the level of different working capital components become frequent, repetitive, and time consuming. Working Capital Management is a very sensitive area in the field of financial management (Joshi, 1994). It involves the decision of the amount and composition of current assets and the financing of these assets. Current assets include all those assets that in the normal course of business return to the form of cash within a short period of time, ordinarily within a year and such temporary investment as may be readily converted into cash upon need. The Working Capital Management of a firm in part affects its profitability. While designing the Project the following articles published in international Journals, were reviewed. This paper is presented on the basis of four major dimensions of Working Capital. Many researchers have studied working capital from different views and in different environments. The following ones were very interesting and useful for our research: A survey conducted by Gitman, Moses, and White reveals that Lockboxes were widely used to accelerate the collection process. Virtually alllarge firms use lockbox S.D.SCHOOL OF COMMERCE AHMEDABAD M.COM(SEM-IV) 2011-2012
55 systems as do a large percentage of smaller firms. This somewhat lower use by smaller firms is a reflection of the costs versus the gains from lockbox systems. The survey farther reveals that to bring collected funds together for use, over one-half of all large firms use concentration banking, with wire transfers and depository transfer checks being the primary means of moving funds from one bank to another. The survey was also extended to management of disbursement. The survey says the primary tools for the management of cash outflows are zero-balance accounts and centrally controlled disbursing. Central control of disbursements is the major tool for about 70 percent of large firms. The vast majority of larger firms use zero-balance accounts, although smaller firms use them less frequently. [see Gitman, Managerial Financial Management, 8th Edition, Thomson, 1998, pp. 350-390] A questionnaire survey by Smith and Sell [see “Working Capital Management in Practices” published in 1978] indicate that 68% of the respondent firm used either cost balancing models or computerized inventory control. The survey evidence reports that the basic models of inventory management are widely used. A survey by Besley and Osteryoung revels that the vast majority of the firm sell output via trade credit, 87% of the manufacturing firms reported that 91 to 100 percentages of their sales are made on a credit basis. [see Besley and Osteryoung, “Account Receivable Management,” pp. 79-95] The Survey by Hill, Wood & Sorenson indicates that a firm once set, rarely consider changes in its terms of sale. They also found that when competitors change terms, other sellers typically will “follow the leader”. [see N. Hill, “A Generalized Cash Flow Approach to Short-term Financial Decision,” Journal of Finance,Vol.38, No. 2 (May 1983), pp. 349-60] Another survey by Farragher on 33 firms reveled that most of the firm uses the traditional form of financing. The researchers had also found that thereis a growing interest among the firm in using Factoring as an alternative means of financing. [See E. Farragher, “Factoring Account Receivable,” Journal of Cash Management (March/April 1986), Page 39] Afza and Nazir (2009) made an attempt in order to investigate the traditional relations between working capital management policies and a firm’s profitability for a sample of 204 non-financial firms listed on Karachi Stock Exchange (KSE) for the period 1998-2005.The study found significant different among their working capital S.D.SCHOOL OF COMMERCE AHMEDABAD M.COM(SEM-IV) 2011-2012
56 requirements and financing policies across different industries. Moreover, regression result found a negative relationship between the profitability of firms and degree of aggressiveness of working capital investment and financing Annales Universitatis Apulensis Series Oeconomica, 12(1), 2010 policies. They suggested that managers could crease value if they adopt a conservative approach towards working capital investment and working capital financing policies. Lazaridis and Tryfonidis (2006) have investigated the relation between working capital management and corporate profitability of listed company in the Athens Stock Exchange. A sample of 131 listed companies for period of 2001-2004 was used to examine this relationship. The result from regression analysis indicated that there was a statistical significance between profitability, measured through gross operating profit, and the cash conversion cycle. From those results, they claimed that the managers could create value for shareholders by handling correctly the cash conversion cycle and keeping each different component to an optimum level.
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CHAPTER-4
DATA PRESENTATION AND DATA ANALYSIS
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Data source
Data collection was through literature survey and expert opinion. Literature survey includes the collection of data from various sources like bank agreement and statement, handbooks as well as study material. A part of data` s was collected from primary data and other was collected from the secondary data.
Primary sources
Information gathered by interview and discussions with the head and employees of various departments and my project guide.
Secondary sources
? ? ? ? Company annual report. Published information on finance. Internal circulation booklets. Company Websites
DATA ANALYSIS AND INTERPRETATION
Ratio Analysis is a powerful tool o financial analysis. Alexander Hall first presented it in 1991 in Federal Reserve Bulletin. Ratio Analysis is a process of comparison of one figure against other, which makes a ratio and the appraisal of the ratios of the ratios to make proper analysis about the strengths and weakness of the firm’s operations. The term ratio refers to the numerical or quantitative relationship between two accounting figures. Ratio analysis of financial statements stands for the process of determining and presenting the relationship of items and group of items in the statements. Ratio analysis can be used both in trend analysis and static analysis. A creditor would like to know the ability of the company, to meet its current obligation and therefore would think of current and liquidity ratio and trend of receivable. Major tool of financial are thus ratio analysis and Funds Flow analysis. Financial analysis is the process of identifying the financial strength and weakness of the firm by properly establishing relationship between the items of the balance sheet and the profit account
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59 The financial analyst may use ratio in two ways. First he may compare a present ratio with the ratio of the past few years and project ratio of the next year or so. This will indicate the trend in relation that particular financial aspect of the enterprise. Another method of using ratios for financial analysis is to compare a financial ratio for the company with for industry as a whole, or for other, the firm’s ability to meet its current obligation. It measures the firm’s liquidity. The greater the ratio, the greater the firms liquidity and vice-versa. A ratio can be defined as a numerical relationship between two numbers expressed in terms of (a) proportion (b) rate (c) percentage. It is also define as a financial tool to determine an interpret numerical relationship based on financial statement yardstick that provides a measure of relationship between two variable or figures.
Meaning and Importance: Ratio analysis is concerned to be one of the important financial tools for appraisal of financial condition, efficiency and profitability of business. Here ratio analysis id useful from following objects.
1. Short term and long term planning
2. Measurement and evaluation of financial performance
3. Stud of financial trends
4. Decision making for investment and operations
5. Diagnosis of financial ills
6. Providing valuable insight into firms financial position or picture
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ADVANTAGES & DISADVANTAGES OF RATIO ANALYSIS :
Advantages: The following are the main advantages derived of ratio analysis, which are obtained from the financial statement via Profit & Loss Account and Balance Sheet.
a) The analysis helps to grasp the relationship between various items in the financial statements. b) They are useful in pointing out the trends in important items and thus help the management to forecast c) With the help of ratios, inter firm comparison made to evolve future market strategies. d) Out of ratio analysis standard ratios are computed and comparison of actual with standards reveals the variances. This helps the management to take corrective action. e) The communication of that has happened between two accounting the dates are revealed effective Action. f) Simple assessments of liquidity, solvency profitability efficiency of the firm are indicted by ratio analysis. Ratios meet comparisons much more valid.
Disadvantages: Ratio analysis is to calculate and easy to understand and such statistical calculation stimulation thinking and develop understanding. But there are certain drawbacks and dangers they are.
i)There is a trendy to use to ratio analysis profusely. ii)Accumulation of mass data obscured rather than clarifies relationship. iii) Wrong relationship and calculation can lead to wrong conclusion.
1. In case of inter firm comparison no two firm are similar in size, age and product unit.(for example) one firm may purchase the asset at lower price with a higher return
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61 and another firm witch purchase the asset at asset at higher price will have a lower return) 2. Both the inter period and inter firm comparison are affected by price level changes. A change in price level can affect the validity of ratios calculated for different time period. 3. Unless varies terms like group profit, operating profit, net profit, current asset, current liability etc., are properly define, comparison between two variables become meaningless. 4. Ratios are simple to understand and easy to calculate. The analyst should not take decision should not take decision on a single ratio. He has to take several ratios into consideration.
STANDARDS OF COMPARISION: 1. Ratios calculated from the past financial statements of the same firm. 2. Ratio developed using the projected or perform financial statement of the same firm 3. Ratios of some selected firm especially the most progressive and successful, at the same point of time. 4. Ratios of the industry to which the firm belongs.
IMPORTANCE OF RATIO ANALYSIS In the preceding discussion in the form, we have illustrated the compulsion and implication of important ratios that can be calculated from the Balance Sheet and Profit & Loss account of a firm. As a tool of financial management, they are of crucial significance. The importance of ratio analysis lies in the fact and enables the drawing of inferences regarding the performance of a firm. Ration analysis is a relevant in assessing the performance of a firm in respect of the following aspect.
CAUTION IN USING RATIOS 1. It is difficult to decide on the proper bases of comparison. 2. The comparison rendered difficult because of difference in situation of two companies or of one-company for different years. 3. The price level change make the interpretation of ratios invalid S.D.SCHOOL OF COMMERCE AHMEDABAD M.COM(SEM-IV) 2011-2012
62 4. The difference in the definition of items in the balance sheet and Profit & Loss statement make the interpretation of ratios difficult. 5. The ratios calculated at a point of time are less informative and defective as they suffer from sort term changes. 6. The ratios are generally calculated from the past financial statement and thus are no indicators of Future.
CURRENT RATIO : The relationship of current assets to current liabilities is
known as current ratio. It is also known as banker’s ratio or working capital ratio.
1. CURRENT RATIO It is relationship between firm’s current assets and current liability.
Current assets Current ratio = _______________________________ Current liability
TABLE – 1 STATEMENT SHOWING CURRENT RATIO Rs.
YEAR
CURRENT ASSETS CURRENT LIABILITIES CURRENT RATIO 12012339.59 9875695.78 3478204.91 3076638.35 16015687.23 15409430.47 10151656.05 15887448.20
2007-2008
2008-2009
2009-2010
2010-11
1.33
1.56
2.91
5.16
SOURCE: SECONDARY DATA FROM FIVE STAR ANNUAL REPORTS
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INTERPRETATION
The current ratio is a test of the short term solvency of the business enterprise since this ratio assumes current assets could be converted into cash to meet current liabilities.
Current ratio during the year 2007-2008 was 1.33 and it increased constantly up to 201011 by 1.56 , 2.91 , 5.16 here Five star has 5th times assets then liabilities in the year of 2010-11
CHART – 1 CURRENT RATIO
current ratio
6 5 PERCENTAGE 4 3 2 1 0 2007-08 2008-09 2009-10 2010-11 YEARS
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CASH MANAGEMENT
Introduction Cash management is one of the key areas of working capital management. Cash is the liquid current asset. The main duty of the finance manager is to provide adequate cash to all segments of the organization. The important reason for maintaining cash balances is the transaction motive. A firm enters into variety of transactions to accomplish its objectives which have to be paid for in the form of cash. Meaning of cash The term “cash” with reference to cash management used in two senses. In a narrower sense it includes coins, currency notes, cheques, bank drafts held by a firm. n a broader sense it also includes “near-cash assets” such as marketable securities and time deposits with banks.
Objectives of cash management:
There are two basic objectives of cash management. They are? To meet the cash disbursement needs as per the payment schedule. ? To minimize the amount locked up as cash balances.
Basic problems in Cash Management:
Cash management involves the following four basic problems. ? Controlling level of cash ? Controlling inflows of cash ? Controlling outflows of cash and ? Optimum investment of surplus cash. ? Determining safety level for cash:
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65 The finance manager has to take into account the minimum cash balance that the firm must keep to avoid risk or cost of running out of funds. Such minimum level may be termed as “safety level of cash”. The finance manager determines the safety level of cash separately both for normal periods and peak periods. Under both cases he decides about two basic factors. They are-
Desired days of cash: It means the number of days for which cash balance should be sufficient to cover payments.
Average daily cash flows: This means average amount of disbursements which will have to be made daily.
Criteria for investment of surplus cash: In most of the companies there are usually no formal written instructions for investing the surplus cash. It is left to the discretion and judgment of the finance manager. While exercising such judgment, he usually takes into consideration the following factors-
Security: This can be ensured by investing money in securities whose price remains more or less stable.
Liquidity: This can be ensured by investing money in short term securities including short term fixed deposits with banks.
Yield: Most corporate managers give less emphasis to yield as compared to security and liquidity of investment. So they prefer short term government securities for investing surplus cash.
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66 Maturity: It will be advisable to select securities according to their maturities so the finance manager can maximize the yield as well as maintain the liquidity of investments.
CASH RATIO It is relationship between cash and current liabilities.
Cash Cash ratio = _______________________ Current liabilities
TABLE – 2 STATEMENT SHOWING CASH RATIO Rs.
YEAR CASH
813541.98 3003725.65 1693041.14 9170192.80
2007-2008
2008-2009
2009-2010
2010-2011
CURRENT LIABILITIES
12012339.59 9875695.78 3478204.91 3076638.35
CASH RATIO
0.067
0.30
0.48
2.98
SOURCE: SECONDARY DATA FROM BHEL ANNUAL REPORTS
INTERPRETATION
The Cash ratio of FIVE STAR in the 2007-2011 was fluctuation in 2010-2011 it was 2.98 times and in 2006-2007 it was 0.30 times and 2008-2009 it was reduced to 0.48.
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67 The standard norms of absolute quick ratio are 0.5:1. From the above table the firms not maintain the sufficient level of quick assets because of the day-to-day expenses. It is fluctuating between the standard norms for this ratio is 1:2 means for every 2 rupees of current Liabilities, Company must have 1 rupee of cash and bank balance and marketablesecurities.
CASH RATIO
CASH
3
PERCENTAGE
2 1 0 2007- 2008- 2009- 201008 09 10 11
YEARS
\
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68
RECEIVABLES MANAGEMENT
Introduction: Receivables constitute a significant portion of the total assets of the business. When a firm seller goods or services on credit, the payments are postponed to future dates and receivables are created. If they sell for cash no receivables created.
Meaning: Receivable are asset accounts representing amounts owed to the firm as a result of sale of goods or services in the ordinary course of business.
Purpose of receivables: Accounts receivables are created because of credit sales. The purpose of receivables is directly connected with the objectives of making credit sales. The objectives of credit sales are as follows? ? ? Achieving growth in sales. Increasing profits. Meeting competition.
Factors affecting the size of Receivables: The main factors that affect the size of the receivables are? ? ? Level of sales. Credit period. Cash discount.
Costs of maintaining receivables: The costs with respect to maintenance of receivables are as follows-
Capital costs: This is because there is a time lag between the sale of goods to customers
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69 and the payment by them. The firm has, therefore to arrange for additional funds to meet its obligations.
Administrative costs: Firm incur this cost for manufacturing accounts receivables in the form of salaries to the staff kept for maintaining accounting records relating to customers.
Collection costs: The firm has to incur costs for collecting the payments from its credit customers.
Defaulting costs: The firm may not able to recover the over dues because of the inability of customers. Such debts treated as bad debts.
Receivables management: Receivables are direct result of credit sale. The main objective of receivables management is to promote sales and profits until that point is reached where the ROI in further funding of receivables is less than the cost of funds raised to finance that additional credit (i.e.; cost of capital). Increase in receivables also increases chances of bad debts. Thus, creation of receivables is beneficial as well as dangerous. Finally management of accounts receivable means as the process of making decisions relating to investment of funds in this asset which result in maximizing the overall return on the investment of the firm.
Receivables management and Ratio Analysis: Ratio Analysis is one of the important techniques that can be used to check the efficiency with which receivables management is being managed by a firm. The most important ratios for receivables management are as follows-
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70 DEBTORS TURNOVER RATIO: Debtors constitute an important constituent of current assets and therefore the quality of the debtors to a great extent determines a firm’s liquidity. It shows how quickly receivables or debtors are converted into cash. In other words, the DTR is a test of the liquidity of the debtors of a firm. The liquidity of firm’s receivables can be examined in two ways they are DTR and Average Collection Period. It indicates the number time debtors turned over each year. Generally the higher value of debtor’s turnover shows high efficiency to manage the credit management.
Total sales Debtors turnover ratio = ______________________________ Debtors
TABLE –3 STATEMENT SHOWING DEBTORS TURNOVER RATIO Rs.
YEAR TOTAL SALES DEBTORS DEBTOR TURNOVER RATIO 3.11 3.68 0.69 0.49
38029989.34 12212965.73 31004127.36 8426880.24 2862505.99 4101413.16 2350703.00 4702051.34
2007-2008
2008-2009
2009-2010
2010-2011
SOURCE: SECONDARY DATA FROM FIVE STAR ANNUAL REPORTS INTERPRETATION Debtors constitute an important constituent of current assets and therefore the quality of the debtors to a great extent determines a firm’s liquidity. It shows how quickly receivables or debtors are converted into cash. In other words, the DTR is a test of the liquidity of the debtors of a firm. The liquidity of firm’s receivables can be examined in
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71 two ways they are DTR and Average Collection Period. .The higher the ratio, the better it is, since it would indicate that debts are being collected promptly.
In the year 2010 - 2011 the debt is 0.49 comparing to the previous year came downwards.
CHART- 3 DEBTOR TURNOVER RATIO
4
PERCENT AGE
2 0 2007- 2008- 2009- 201008 09 10 11
YEARS
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DEBTORS
72
DEBT COLLECTION PERIOD
Debtor’s collection period is nothing but the period required to collect the money from the customers after the credit sales. A speed collection reduces the length of operating cycle and vice versa. The more quickly the customers pay, the less risk from bad debts, the lower the expenses of collection and more liquid the nature of of this asset.
It indicates the speed with which debts are collected. Days/months in a year Debt collection period = _______________________________ Debtor’s turnover ratio
TABLE – 4 Rs.
YEAR DAYS DEBT TURNOVER RATIO DEBT COLLECTION PERIOD 118 99 529 745 2007-2008 365 3.11 2008-2009 365 3.68 2009-2010 365 0.69 2010-2011 365 0.49
SOURCE: SECONDARY DATA FROM FIVE STAR ANNUAL REPORTS
INTERPRETATION The debt collection period of BHEL in the 2007-2008 was 118 days and in goes to 2010 - 2011 it was increased in (5.31%) 745 days. Standard Debt Collection Period of a firm is less than 90 days. But, above tables consists of increased of DCP in rapidly.
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CHART – 4 DEBT COLLECTION PERIOD
DTCP
1000 500
No. of Days
0 2007- 2008- 2009- 201008 09 10 11
YEARS
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DTCP
74
TABLE –5 CASH TO CURRENT ASSETS RATIO Rs.
YEAR CASH CURRENT ASSETS CAS CURRENT ASSETS RATIO TO 0.050 0.19 0.16 0.57
16015687.23 15409430.47 10151656.05 15887448.20
2007-2008
813541.98
2008-2009
3003725.65
2009-2010
1693041.14
2010-2011
9170192.80
SOURCE: SECONDARY DATA FROM BHEL ANNUAL REPORTS
INTERPRETATION The Cash to current assets turnover ratio of FIVE STAR was fluctuating during the year 2007 – 2011. It was upward in (2007– 2009) was 0.05 times to 0.19 times and it was goes up in 2010 – 2011 is 0.57 times.
CHART -5 CASH TO CURRENT ASSETS RATIO
CASH TO CURRENT ASSETS RATIO
0.6 0.5 0.4 PERCENTAG 0.3 E 0.2 0.1 0 200708 2008- 200909 10 YEARS 201011
C.C.A.R
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TABLE –6 CASH TURNOVER RATIO Rs.
YEAR SALES CASH
813541.98 3003725.65 1693041.14 9170192.80
2007-2008
38029989.34
2008-2009
31004127.36
2009-2010
2862505.99
2010-2011
2350703.00
CASH TURNOVER RATIO 46.74 10.32 1.69 0.25
SOURCE: SECONDARY DATA FROM FIVE STAR ANNUAL REPORTS
INTERPRETATION The cash turnover ratio in the years 2007-2011 it was on fluctuating ratios, in the year 2010-2011 it was decrease 0.25
CASH TURNOVER RATIO
60
PERCENTAGE
40 20
C.T.R
0 2007- 2008- 2009- 201008 09 10 11 YEARS
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76
INVENTORY MANAGEMENT
Introduction: Inventories are stock of the product a company is manufacturing for sale and components. That makeup the products. The various forms in which inventories exist in a manufacturing company are: Raw-materials, work-in-process, finished goods. ?
Raw-Materials: - Are those basic inputs that are converted into finished products through the manufacturing process. Raw-materials inventories are those units, which have been purchased and stored for future production.
? ?
Work-In-Process inventories are semi-manufactured products. The represent products that need more work before they become finished products for sale. Finished Goods inventories are those completely manufactured products, which are ready for sale. Stocks of raw-materials and work-in-process facilitate production which stock of finished goods is required for smooth marketing operations. These inventories serve as a link between production and consumption of goods.
?
Stores and spares are also maintained by some firms. This includes office and plant cleaning materials like soaps, brooms, oil, fuel, light, bulbs etc. These materials do not directly enter in production. But are necessary for production process.
Need to holding inventory The question of managing inventories arises only when the company holds inventories. Maintaining inventories involves tying up of the company's funds and incurrence of storage and handling cost. It is expensive to maintain inventories, why does company hold inventories? There are three general motives for holding inventories.
1. Transaction Motive: - Emphasizes the need to maintain inventories to facilitate smooth production and sales operations.
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2. Precautionary motive: - Necessitates holding of inventories to guard against the risk of unpredictable changes in demand and supply forces and other factors. 3. Speculative motive: - Influences the decision to increase or reduce inventory levels to take advantages of price influences. A company should maintain adequate stock of materials for a continuous supply to the factory for the uninterrupted production. It is not possible for a company to procure raw materials whenever it is needed. A time lag exists between demand for materials and its supply. Also there exists uncertainty in procuring raw materials in time on many occasions. The procurement of materials may be delayed because of such factors as strike, transport disruption or short supply. Therefore, the firm should maintain sufficient stock of raw materials at a given time to stream line production.
Objective of Inventory Management In the context of inventory management the firm is faced with the problem of meeting two conflicting needs ; ? To maintain a large size of inventory for sufficient and smooth production and sales operations. ? To maintain a minimum investment in inventories to maximize profitability.
Both excessive and inadequate inventories are not desirable. These are two dangerous points within which the firm should operate. The objective of inventory management should be to determine and maintain optimum level of inventory investment. The optimum level of inventory will lie between the two danger points of excessive and inadequate inventories. The firm should always avoid a situation of over investment or under investment in inventories. The major dangerous of over investment are, ? ? ?
Unnecessary tie-up of the firms funds losses of profit Excessive carrying cost Risk of quality
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78 The aim of inventory management thus should be to avoid excessive and inadequate levels of inventories and to maintain sufficient inventory for smooth production and sales operations. Efforts should be made to place an order at the right time with the right source to acquire the right quantity at the right price and quality. An effective inventory management should ?
Ensure a continuous supply of raw materials to facilitate uninterrupted production.
? Maintain sufficient stock of raw materials in periods of short supply and anticipate price changes. ? Maintain sufficient finished goods inventory for smooth sales operations and efficient customer service. ? Minimize the carrying cost and time. ? Control investment in inventories and keep it at an optimum level.
Inventory management techniques : In managing inventories the firm objective should be in consonance with the shareholders' wealth maximization principle. To achieve this firm should determine the optimum level of inventory. Efficiently controlled inventories make the firm flexible. Inefficient inventory control results in unbalanced inventory and inflexibility-the firm ma sometimes run out of stock and sometimes may pileup unnecessary stocks. This increases level of investment and makes the firm unprofitable.
To manage inventories efficiency, answers should be sought to the following two questions. 1) How much should be ordered?
2) When should it be ordered? S.D.SCHOOL OF COMMERCE AHMEDABAD M.COM(SEM-IV) 2011-2012
79 The first question how much to order, relates to the problem of determining economic order quantity (EOQ), and is answered with an analysis of costs of manufacturing certain level of inventories. The second question when to order arise because of determining the reorder point.
Inventory turnover Ratio:Inventory turnover ratio indicates the efficiency of the firm in producing and selling its products. It is calculated by dividing the cost of goods sold by the average inventory. The average inventory is the average of open and closing balance of inventory.
It indicates the inventories turning into receivables through sales. Sales Inventory turnover ratio =__________________________ Inventory
TABLE –7 INVENTORY TURNOVER RATIO Rs.
YEAR SALES INVENTORY
2082529.04 2565319.68 12.08 724831.25 3.94 201443.55 11.66
2007-2008
38029989.34
2008-2009
31004127.36
2009-2010
2862505.99
2010-2011
2350703.00
INVENTORY TURNOVER RATIO
18.26
SOURCE: SECONDARY DATA FROM FIVE STAR ANNUAL REPORT
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80 INTERPRETATION This ratio indicates the liquidity of the inventory, that is, how quickly, on the average, the inventory was sold during the year and consequently the significance of the inventory for the debt paying purposes.
A high stock turnover ratio is generally considered desirable because it is indicative of efficient performance since an improvement in the ratio shows hat volume of sales has been either maintained or increased without additional investment in stock.
Inventory turnover of
FIVE STAR for 2008 – 2009 was 12.08 In 2009-2010 the
inventory turnover ratio was down up to 3.37 and it was high in 2010-2011 at 11.66.
CHART –7 INVENTORY TURNOVER RATIO
20 15 10 5 0 ITR 2010-11 2009-10 2008-09 2007-08
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TABLE –8 INVENTORY HOLDING PERIOD
YEAR DAYS MONTH YEAR INVENTORY TURNOVER RATIO INVENTORY HOLDING PERIOD / IN
2007-2008
2008-2009
2009-2010
2010-2011
365
365
365
365
18.26
12.08
3.94
11.66
20
30
93
31
SOURCE: SECONDARY DATA FROM FIVE STAR ANNUAL REPORTS
INTERPRETATION Inventory holding period of FIVE STAR is varying on every year. In the year of 200708 to 2009-10 it’s increased in 4.65% (20 to 93) and 2010-11 it’s decreased by 31
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CHART –8 INVENTORY HOLDING PERIOD
200 180 160 140 120 100 80 60 40 20 0 IHP
2010-11 2009-10 2008-09 2007-08
TABLE-9 WORKING CAPITAL TURNOVER RATIO Rs.
YEAR SALES NET WORKING CAPITAL WORKING CAPITAL TURNOVER RATIO 9.49 5.60 0.43 0.18
4003347.64 5533734.69 6673451.14 12810809.85
2007-2008
38029989.34
2008-2009
31004127.36
2009-2010
2862505.99
2010-2011
2350703.00
SOURCE: SECONDARY DATA FROM BHEL ANNUAL REPORTS
S.D.SCHOOL OF COMMERCE AHMEDABAD
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83 INTERPRETATION Working capital turnover ratio for the year 2010 - 2011 was 0.18 times. It is lower when comparing the past three years. The working capital management has to improve by more concentration on collection strategies.
CHART-9 WORKING CAPITAL TURNOVER RATIO
10 8 PERCENTAGE 6 4
WCTR
2 0 2007- 2008- 2009- 201008 09 10 11 YEARS
TABLE –10 WORKING CAPITAL FOR TREND ANALYSIS Rs.
YEAR CURRENT ASSETS CURRENT LIABILITIES WORKING CAPITAL
4003347.64 5533734.69 6673451.14 12810809.85 12012339.59 9875695.78 3478204.91 3076638.35 16015687.23 15409430.47 10151656.05 15887448.20
2007-2008
2008-2009
2009-2010
2010-2011
S.D.SCHOOL OF COMMERCE AHMEDABAD
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84 SOURCE: SECONDARY DATA FROM BHEL ANNUAL REPORTS
INTERPRETATION
In this current asset is fluctuating 2007-2011 Whereas Current Liabilities of Five Star Pharma is down constantly. Working capital is Increasing.
CHART – 10 WORKING CAPITAL FOR TREND ANALYSIS
VALUES
18000000 16000000 14000000 12000000 10000000 8000000 6000000 4000000 2000000 0 2007- 2008- 2009- 201008 09 10 11
YEARS
CA WC
CL
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TABLE –11 ANALYSIS OF VARIOUS COMPONENTS IN WORKING CAPITAL CURRENT ASSETS Rs in lakhs Particulars inventories Sundry debtors C& B balance Other assets Loans and advances
20072008 20082009 20092010 20102011
20.82
25.65
7.25 41.01 16.00 -36.32
21.24 47.02 57.00 -18.13
122.13 84.26 5.00 -9.06 19.00 -14.13
CHART – 11 ANALYSIS OF VARIOUS COMPONENTS IN WORKING CAPITAL
GRAPH 11.1 INVENTORY
30 25 20 PERCENTA 15 GE 10 5 0 2007- 2008- 2009- 201008 09 10 11 YEARS
INVENTORIES
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GRAPH 11.2 SUNDRY DEBTORS
140 120 100 PERCENTAGE 80 60 40 20 0 2007-08 2008-09 2009-10 YEARS 2010-11
GRAPH 11.3 CASH AND BANK BALANCES
60 50 40 PERCENTAGE 30 20 10 0 200708 200809 200910 YEARS 201011
INVENTORIES
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GRAPH 11.4 LOANS AND ADVANCES
40 PERCENTAGE 20 0 2007-08 2008-09 2009-10 YEARS 2010-11 LOAN & ADV.
GROSS PROFIT RATIO :
Gross profit margin shows the company can return income at the gross level. This ratio helps to control inventory usage and production performance and fixing unit price of goods.
TABLE – 12 ANALYSIS OF GROSS PROFIT RATIO Rs. Particulars Gross Profit /
2007-2008
48294492.18
2008 - 2009
41773757.53
2009-2010
31022789.84
2010-2011
30043433.68
Profit before tax Total Sales Gross Profit ratio
38029989.34 31004127.36 2862505.99 2350703.00
1.27
1.35
10.84
12.78
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GRAPH 12 GROSS PROFIT RATIOS
14 2010-11, 1278% 12 2009-10, 1084% 10
8
6
4 2007-08, 127% 2 2008-09, 135%
0 2007-08 2008-09 2009-10 2010-11
INTERPRETATION
In the analysis of Gross profit ratio Five star must control production expenses in future. Comparison of 2007-08 to 2010-11 margin profit ratio will goes up 1.27 to 12.78.
NET PROFIT RATIO:
As every business is to earn profit, this ratio is very important because it measures the profitability of sales. A business may yield high gross income but low net income because of increasing operating and non-operating expenses. This situation can easily be detected by calculating this ratio.
The profits used for this purpose may be profits after/before tax. To obtain this ratio, the figure of net profits after tax is divided by the figure of net profits after tax is divided by
S.D.SCHOOL OF COMMERCE AHMEDABAD
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89 the figure of sales the ratio is also known as sales margin as we can ascertain with its help the margin which the sales leave later deducting all the expenses. The unit of expression is percentage, as is the case with profitability ratios.
TABLE – 13
ANALYSIS OF NET PROFIT RATIO Rs. Particulars Net Profit Profit after tax Net Sales Net Profit ratio /
5834169.72 38029989.34 1812400.71 31004127.36 5887693.70 2862505.99 7233550.81 2350703.00
2007-2008
2008 - 2009
2009-2010
2010-2011
0.153
0.058
2.05
3.077
GRAPH 13 NET PROFIT RATIOS
3.5 3 2.5 % 2 1.5 1 0.5 0 2007-08 2008-09 2009-10
YEARS
2010-11
S.D.SCHOOL OF COMMERCE AHMEDABAD
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90 SOURCE: SECONDARY DATA FROM BHEL ANNUAL REPORTS
INTERPRETATION
In this period of research of study Net profit of the Five star company goes upwards from 2009 to 2011 comparing previous year achievements.
Gross Profit to Net Profit Ratio
Analysis of ratio’s G.P. to N.P is very important in every firm. It helps to find out the cost of expense increased in production or administrative level and other hand it helps to control in overall financial expenses.
TABLE – 14
ANALYSIS OF G.P. TO N.P RATIO Rs in lakhs Particulars Gross Profit Net Profit G.P. - N.P. RATIO
2007-2008
482.94 58.34 8.27
2008 - 2009
417.73
2009-2010
310.22
2010-2011
300.43
18.12 23.04
58.87 5.27
72.33 4.15
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GRAPH 14 G.P. TO N.P. RATIO
500 400 300 200 100
N.P. G.P.
0 2007-08 2008-09 2009-10 2010-11 G.P. N.P. %
%
YEARS
INTERPRETATION
In this period of research of study Gross Profit and Net Profit are equal. Five star could not control his marginal and administrative cost. There is High variation and it does not stable.
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Projection of changes in working capital (2007-2008).
Particulars A) Current Assets a) Inventories b) Sundry debtors c) Cash and bank d) Loans & advances Total Current Assets B)Current Liabilities & Provisions (1) CREDITORS FOR GOODS AS PER LIST (2) CREDITOR FOR EXPENSES AS PER LIST (3)Debtors having Credit Balance Total Current Liabilities Net Current Assets
2006-07
1636475.17 7336194.74 582184.25 2500481.23 12055335.39
2007-08 2082529.04 12212965.73 813541.98 906650.48 16015687.23
Increase 446053.87 4876770.99 231357.73
Decrease
1593830.75
7083596.24 4081840.54 33364.03
8006834.87 3975510.82 29993.90
923238.63 106329.72 3370.13
11198800.81 856534.58
12012339.59
4003347.64 5663882.44 2517069.38 3146813.06
Increase in working capital
3146813.06
Interpretation:
This statement shows the increase in Working Capital in the year 2007-08 by increase in cash & bank balance, inventories & debtors.
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Projection of changes in working capital (2008-2009). Particulars
A) Current Assets a) Inventories b) Sundry debtors c) Cash and bank d) Loans & advances Total Current Assets
B)Current Liabilities & Provisions (1) CREDITORS FOR GOODS AS PER LIST (2) CREDITOR FOR EXPENSES AS PER LIST (3)Debtors having Credit Balance 8006834.87 3975510.82 29993.90 5444602.36 3850906.44 580186.98
2007-08
2082529.04 12212965.73 813541.98 906650.48
2008-09
2565319.68 8426880.24 3003725.65 1413504.90
Increase
482790.64
Decrease
3786085.49
2190183.67 506854.42
16015687.23
15409430.47
2562232.51 124604.38 550193.08
Total Current Liabilities
Net Current Assets
12012339.59 4003347.64
9875695.78 5533734.69
5866665.62 4336278.57
Increase in working capital
1530387.05
1530387.05
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Projection of changes in working capital (2009-2010). Particulars
A) Current Assets a) Inventories b) Sundry debtors c) Cash and bank d) Loans & advances Total Current Assets
B)Current Liabilities & Provisions (1) CREDITORS FOR GOODS AS PER LIST (2) CREDITOR FOR EXPENSES AS PER LIST (3)Debtors having Credit Balance
2008-09
2565319.68 8426880.24 3003725.65 1413504.90
15409430.47
2009-10
724831.25 4101413.16
Increase
Decrease
1840488.43 4325467.08 1310684.51
1693041.14 3632370.50
2218865.6
10151656.05
5444602.36 3850906.44 580186.98 9875695.78 5533734.69
504638.88 2868751.00 104815.03 3478204.91 6673451.14
4939963.48 982155.44 475371.95
Total Current Liabilities
Net Current Assets
8616356.47
7476640.02 1139716.45
Increase in working capital
1139716.45
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Projection of changes in working capital (2010-2011). Particulars
A) Current Assets a) Inventories b) Sundry debtors c) Cash and bank d) Loans & advances Total Current Assets
B)Current Liabilities & Provisions (1) CREDITORS FOR GOODS AS PER LIST (2) CREDITOR FOR EXPENSES AS PER LIST (3)Debtors having Credit Balance 504638.88 2868751.00 104815.03 729095.00 2347543.35 0.00 724831.25 4101413.16 1693041.14 3632370.50 10151656.05 201443.55 4702051.34 9170192.80 1813760.51 15887448.20
2009-2010
2010-2011
Increase
Decrease
523387.7 600638.18 7477151.66 1818609.99
224456.12 521207.65
104815.03
Total Current Liabilities
Net Current Assets
3478204.91 6673451.14
3076638.35 12810809.85
8703812.52
2566453.81 6137358.71
Increase in working capital
6137358.71
Interpretation: This statement shows the increase in Working Capital in the year 2005-06 by increase in cash & bank balance, & debtors.
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FIVESTAR PHARMACEUTICALS (A DIV. OF SAKET PROJECTS LTD.) PROFIT & LOSS ACCOUNT FOR THE PERIOD 1ST April 2008 TO 31 ST MARCH 2011
PARTICULARS INCOME Income from operations Sales Pharma net of returns Job Work
RUPEES AS ON 31/03/08
RUPEES AS ON 31/03/09
RUPEES AS ON 31/03/10
RUPEES AS ON 31/03/11
38029989.34 9229473.16
31004127.36 10542249.77
2862505.99 26199767.66 1037433.48 923082.71 -359685.82 30663104.02
2350703.00 27380076.76 0.00 312653.92 0.00 30043433.68
Finish Goods Sales
Other Income Increase in Stock of Work in Process & Finished Goods TOTAL [A]
0
1035029.68 53568.64 48348060.82
0
227380.40 -352834.28 41420923.25
EXPENSES Manufacturing Exp. Administrative & Other Expenses Selling & Distribution Expenses Interest Finish Goods Purchase 36714304.73 2158005.21 866828.78 215605.73 329408.18 752221.45 26317.00 TOTAL 40284152.63 34587885.67 2126026.67 878682.76 35526.64 0.00 0.00 24621.00 37628121.74 18736358.28 2076488.54 120642.00 0.00 919143.00 0.00 642730.00 37102.50 22532464.32 17854927.24 2158623.63 139952.00 0.00 0.00 0.00 263451.00 26309.00 20443262.87
Fringe Benefit Tax
Loss on Sale of Asset Fringe Benefit Tax
Profit /(LOSS) before Depreciation [A - B] Add/Less :- Depreciation ADD :- Previous Year Income Net Profit /(LOSS) trasnsfer to Balance Sheet
8063908.19 2229738.47 0.00 5834169.72
3792801.51 2209305.00 228904.20 1812400.71
8130639.70 2242946.00 0.00 5887693.70
9600170.81 2366620.00 0.00 7233550.81
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FIVESTAR PHARMACEUTICALS (A DIV. OF SAKET PROJECTS LTD.) BALANCE SHEET AS ON 1ST APRIL 2008 TO 31ST MARCH 2011
Particulars
RUPEES AS ON 31/03/08
RUPEES AS ON 31/03/09
RUPEES AS ON 31/03/10
RUPEES AS ON 31/03/11
SOURCES OF FUNDS 1. Loan Funds Unsecured Loans Total 3 81740026.70 81740026.70 80020593.79 80020593.79 76183625.79 76183625.79 75894507.79 75894507.79
1. Fixed Assets a. Gross Block b. Less : Depreciation c. Net Block Investment 2. Current Assets, Loans and Advances a. Investories b. Sundry Debtors c. Cash and Bank Balances d. Loans and Advances 6 7 8 9 2082529.04 12212965.73 813541.98 906650.48 16015687.23 Less : Current Liabilities & Provisions Net Current Assets 4. Miscellaneous Expenses (to the extent not written off or adjested) 10 12012339.59 4003347.64 2565319.68 8426880.24 3003725.65 1413504.90 15409430.47 9875695.78 5533734.69 724831.25 4101413.16 1693041.14 3632370.50 10151656.05 3478204.91 6673451.14 201443.55 4702051.34 9170192.80 1813760.51 15887448.20 3076638.35 12810809.85 4 33582916.01 2229738.47 31353177.54 54500.00 32100442.29 2209305.00 29891137.29 54500.00 33045092.54 2242946.00 30802146.54 54500.00 33975839.64 2366620.00 31609219.64 54500.00
11
46329001.52 81740026.70
44541221.81 80020593.79
38653528.11 76183625.79
31419978.30 75894507.79
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Conclusion
FINDING
1) Standard current ratio is 2:1 and for industry it is 5.16:1. Five star ratio is satisfactory.
2) Debtors of the company were high; they were increasing year by year, so more funds were blocked in debtors. But now recovery is becoming faster.
3) Debtors turnover ratio is fluctuating from 2005-06 to 2009-10, which means inventory is not utilized in better way so it is not a good sign for the company.
5) Inventory turnover ratio is improving from 2009-10 to 2010-11.increase in ratio is beneficial for the company because as ratio increases the number of days of collection for debtors decreases.
6) Working capital turnover ratio is continuously decreasing that shows decreasing needs of working capital. The study is basically done to have a deep knowledge about WORKING CAPITAL of the Five Star Pharma is having an appropriate working capital management of the organizations. NET PROFIT growth rate is 30% in 2010-11, it is showing a nominal increase in net profit as compared to last year. The GROSS PROFIT of Five star is more Fluctuating 2007 – 2009 The firm DCP is decreasing every year which is major concern for firm as lower the DCP lower the chances of bad debts. DTR is also decreasing in 2007-08 it was 3.11 times now it has drop down to 0.49 times.
Current ratio is Acceptable thet is 5.16 in 2010-2011 it is very high. Company must have 1 rupee of cash and bank balance and marketable securities. Five Star improve their long term debt
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SUGGESTIONS
1)It can be said that overall financial position of the company is Good but it is required to be improved from the point of view of profitability.
2) Net operating cycle is increasing that means there is a need to make Improvements in receivables/debtors management.
3) Company should stretch the credit period given by the suppliers.
4) Company should try to increase Volume based sales so as to stand in the competition.
Since the Five Star is a profit making company and the interests of the investors are also safe so for making more profit and for increasing the net profit as well as gross profit the organization should curtail its operating, administrative & non productive expense. Company is having good marketability, profitability and liquidity so the company can raise its fund. Company should not forget its ‘Quality Policy’ i.e. we at Five Star, should aim to achieve and sustain excellence in all our activities. We are committed to total customer satisfaction by providing producers and services which meet or exceed the customer expectation.
Modernization of the manufacturing facilities, stress on technological innovation and training of employees at all levels shall be continuous process in Five Star.
LIMITATIONS
? ? The study does not consider the market fluctuations in all its calculations. Analysis is very much dependent on the companies internal bulletin.
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BIBLIOGRAPHY
Reports
? Annual Report (2007-2011)
Websites
? ? www.saketprojects.com as on 30th April 2012
Internet
Books
? ? ? Financial Management “Prassanna Chandra” Afza, T., Nazir, M., 2009. Impact of aggressive working capital management policy on firms’ profitability, The IUP Journal of Applied Finance, 15(8), 20-30 Lazaridis, I., Tryfonidis, D., 2006. Relationship between working capital management and profitability of companies listed in the Athens Stock Exchange, Journal of Financial Management and Analysis, 19(1), 26-35
S.D.SCHOOL OF COMMERCE AHMEDABAD
M.COM(SEM-IV) 2011-2012
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