Description
.It covers asset cycle,working capital management,inventory management,ratios comparison,credit management,liquidity and cash flows,net working capital
Short term Financing and its management
Lupin and Piramal Healthcare
0
INDEX
Sr.no Topic 1 Introduction 2 Current asset cycle 3 Working capital financing 4 Cash and Liquidity management 5 Credit management 6 Inventory management 7 Comparison of ratios 8 Findings
Page no. 2 5 8 13 15 18 19 22
1
i
INTRODUCTION Short term finance management can be divided into (i) (ii) (iii) (iv) Working capital management Cash and liquidity management Credit management Inventory management
Short term financial management is differing from the long term financial management in terms of the timing of cash. Short term financial decisions typically involve cash flow within a year or within the operating cycle of the firm whereas the long term financial decisions like buying capital equipments or issuing debentures involve cash flow over an extended period of time (5 to 15 years or even more).There are two concepts of working capital Gross working capital: This capital is the total of all current assets. The current assets constituents are inventories (raw material, Work-in-process, finished goods etc.), trade Debtors, loan and advances and cash and bank balances. The current assets are having two characteristics short life span and swift transformation into other asset form. Net working capital : This capital is the difference between current assets and current liabilities. The current liabilities constituents are sundry creditors, trade advances, borrowing etc. Working capital management is a significant facet of financial management. Its importance stems from two reasons: -Investment in current assets represents a substantial portion of total investment. - Investment in current assets and the level of current liabilities have to be geared quickly to change in sales. To be sure, fixed asset investment and long term financing are also responsive to variation in sales. However, this relationship is not as close and direct as it is in the case of working capital components.
2
The importance of short term capital management is reflected in the fact that financial managers spend a great deal of time in managing current assets and current liabilities.
negotiating favourable credit terms
arranging short term finances
monitoring the investment in inventoriies controlling the cash movement administering accounts recievables
Current asset Current asset is a item in a balance sheet item which equals the sum of cash and cash equivalents, account receivable, inventory etc that could be converted to cash in less than one year. These current assets are important to most companies as a source of funds for day to day operations. Current assets have a short life span. Cash balance may be held ideal for a week or two, accounts receivable may have a life span of 30 to 60 days, and inventories may be held for 1 to 60 days. Life span of current assets depends upon the time required in the activities of procurement, production, sales, collection and the degree of synchronization among them. Optimal level of current assets involves a tradeoff between costs that rise with current assets and fall with current assets. These are carrying cost referred as carrying cost and the latter as shortage costs.
3
Carrying costs are mainly in the nature of the cost of financing a higher level of current assets. Shortage costs are mainly in the form of disruption in production schedule, loss of sales and the loss of customer goodwill.
Current assets cycle: Each current asset is swiftly transformed into finished goods (may involve several stages of work-in-process). Finished goods generally sold on credit, are converted into accounts receivable and finally account receivable, on realization, generate cash. This short life span of working capital components and their swift transformation from one form into another has certain implication like -Decisions relating to working capital management are repetitive and frequent. -The difference between profit and present value is insignificant. -The close interaction among working capital components implies that efficient management of one component cannot be undertaken without simultaneous consideration of other components.
4
CURRENT ASSET CYCLE
Factors influencing working capital requirement The working capital needs of a firm are influenced by numerous factors like 1. Nature of Business: Working capital requirement of a firm are closely related to the nature of its business. A service firm, like an electricity undertaking has a short operating cycle and which sells predominantly on cash basis and has modest working capital requirements. 2. Seasonality of operations: Firms which have marked seasonality in their operations usually have highly fluctuating working capital requirements. This occur mainly in firm who manufacture products which are highly demanded in a particular season. Eg .ceiling fans manufacturing firms have higher working requirements in summer month and decrease significantly during the winter months.
5
3. Production policy: A firm marked by pronounced seasonal fluctuations in its sales may pursue a production policy which may reduce the sharp variations in working capital requirements. Firm can maintain a steady production throughout the year. Such a production policy may be dampening the fluctuations in working capital requirements. 4. Market conditions: The degree of competition prevailing in the market place has an important bearing on working capital needs. If the market is strong and competition weak, a firm can manage with a smaller inventory of finished goods because customers can be served with some delay. 5. Condition of supply: The inventory of raw materials, spares and stores depends on the condition of supply. If the supply is prompt and adequate, the firm can manage with small inventory. If supply is unpredictable the firm can acquired stocks as and when they are available and carry larger inventory, on an average.
Operating cycle and Cash cycle The investment in working capital is influenced by the following events in the operating cycle of the firm: ? ? ? ? ? Purchase of raw materials Payment of raw materials Manufacture of goods Sale of finished goods Collection of cash for sales
The firm begins with the purchase of raw materials which are paid for after a delay which represents the accounts payable period. The firm converts the raw material into finished goods and then sells the same. The time lag between purchase of raw materials and the collection of cash for sales is referred to as the operating cycle, whereas the time length between the payment for raw material purchases and the collection of cash for sales is referred to as the cash cycle.
6
7
WORKING CAPITAL FINANCING
Short –term sources of finance, more or less exclusively support the current assets. The investment in raw material, stock-in-process, finished goods & receivables (the principal constituents of current assets) often varies a great deal during the course of the year. The sources of finance that are used to support current assets: ? ? ? ? ? ? ? Accruals Trade credit Working capital advance by commercial banks Regulation of bank finance Inter corporate deposits Short-term loans from financial institutions Commercial paper
1) Accruals ? the major accrual items are wages & taxes. ? the amounts owed but not yet paid are shown as accrued wages on the balance sheet. ? in the interim, the taxes owed but not paid can be shown as accrued taxes. ? accruals vary with the level of activity of the firm. ? when activity levels expand, accruals increase & when the activity levels contracts, accruals decrease. ? they are treated as part of „spontaneous financing?. 2) Trade Credit ? it represents credit extended by the supplier of goods & services. ? it is a spontaneous source of financing. ? it is an important source of financing, representing 25-50% of shortterm financing. ? the confidence of the suppliers is the key to securing trade credit.
8
? the things a supplier considers before giving credit are: (a) Earnings record over a period of time (b) Liquidity position of the firm (c) Record of payment
3) Working capital advance by commercial banks ? it represents the most important source of financing current assets. ? there are these following aspects of this source of finance: a) Application & processing -a customer seeking an advance is required to submit an appropriate application form there are different types of application forms for different categories of advances. -it is processed by the Bank manager or his field staff. b) Sanction & Terms & Conditions ? once an application is duly processed it is duly put up for sanction to the appropriate Authority (Branch Manager, Regional Manager, GM). ? if sanction is given, along with the sanction of advance, the Bank, specifies the terms & conditions applicable to the advance. c) Forms of Bank Finance ? working capital is provided by commercial in three ways: (i) Cash credits/ overdrafts
? a pre-determined credit limit is specified by the bank. ? borrower can draw as often as required, not exceeding the credit. ? he can also repay the amount partially or fully, as & when he desires. ? interest is charged only on the running balance, not on the limit sanctioned. ? thus, highly attractive from the borrower`s point of view.
9
(ii)
Loans
? advances of fixed accounts credited to the current account of the borrower or ? released to him in cash. ? interest is charged on the entire loan amount. ? loans are payable only on demand or periodic installments.
(iii) ? ? ? ?
Purchase or Discount of Bills
a bill arises out of a trade transaction. seller of goods draws the bill on purchaser. the bill may be payable on demand or after a usance period of 90 days. on acceptance of the bill by the purchaser, the seller offers it to the bank for discounts/purchases. ? when the bank discounts or purchases the bill it releases the funds to the seller, & presents the bill to the purchaser on the due & gets its payments.
(iv)
Letter of Credit
? the bank helps its customer to obtain credit from its (customer`s) suppliers. ? the bank undertakes the responsibility to honor the obligation of it customer, should ? the customer fails to do so. ? its an indirect form of financing as compared to overdraft, cash credit, loans & bills ? purchasing & discounting, which are direct forms of financing.
10
Note that, in direct form of financing, the bank assumes risks, as well as provides financing. d) Security ? For working capital advances, commercial banks seek security either in the form of ? hypothecation or in the form of pledge. ? Hypothecation: borrows money against security of movable property, usually inventories. ? Pledge: owner of the goods, deposits goods with the lender as security for borrowing. e) Margin Amount ? Banks do not provide 100% finance. ? they insist that customer should bring a portion of the required finance from the other Sources, this portion is called as the margin amount.
4) Regulation of Bank Finance A) Tandom Committee Recommendations (i) Norms for Current Assets (ii) Maximum Permissible Bank Finance (iii) Emphasis on loan system (iv) Periodic information & reporting system B) Present Practice: The salient features of the practice presently followed by banks with respect to working capital financing are as follows: (i) Assessment of working capital requirement a) Projected Balance Sheet Method b) Cash Budget Method c) Turnover Method (ii) Current Ratio Norm
11
(iii) (iv)
Benchmark of 1.33 is accepted. Emphasis on loan system Financial Follow-up Reports
5) Inter-Corporate deposits -deposit made by one company with another, normally for a period up to 6 months. -Three types: (a) Call deposits (b) Three-months deposits (c) Six months deposits. -characteristics of such deposits: a) Lack of regulation b) Secrecy c) Importance of personal contacts 6) Short-term loans from financial institutions -financial institutions like insurance companies provide short-term loans to manufacturing companies with an excellent track record.
7) Commercial Paper Short term unsecured promissory notes which are issued by firms which enjoy fairly high credit ratings. Maturity period is 90-180 days. It is a sold at a discount from its face value and redeemed at the face value.
12
CASH AND LIQUIDITY MANAGEMENT
Cash the most liquid asset is of vital importance to the daily operations of business firms. While the proportion of corporate assets held in the form of cash is very small, often between 1-4%,its efficient management is crucial to the solvency of business in a very important sense. Cash is the focal point of fund flow in a business. In view of its importance, it is generally referred to as the “life blood of the business enterprise” Better cash levels can be achieved by speeding collections and delaying disbursements.
Investment of surplus funds
Companies often have surplus funds for short periods of time before they are required for capital expenditures, loan repayment or some other purpose. Instead of keeping it in current funds which does not fetch any interest, companies invest them in a variety of short term instruments like term deposits with banks, market mutual funds etc.
Investment portfolios
ready cash segment • reserve for company's cash account • meant to augment cash resources to meet unanticiapted operational needs • must be highly liquid controllable cash segment • part of investment which is meant for knowable outflows like taxesdividend etc • investments must be matched in size and maturity to known future outflows free cash segment • part of investment which is neither meant for unforeseen cash requirements nor to meet known future outflows • investment is done only to generate income • it is not concerned with liquidity or maturity
13
Criteria for evaluating investment instruments 1. Safety:- A high degree of safety is essential for an instrument to be considered for inclusion in the short term investment portfolio of the company. Treasury bills are the safest of all instruments. 2. Liquidity:- the liquidity of an instrument refers to the ability of the investor to convert it into cash at a short notice without incurring a loss. An instrument may be quite safe if it is held to the maturity but it may not be possible to sell it prematurely without suffering a loss. 3. Yield:- it is return earned from it by way of interest, dividend, and capital appreciation. The return must be measured in post tax terms. 4. Maturity:- it refers to the life of instrument. The maturity period influences the segment into which investment is made.
14
CREDIT MANAGEMENT While business firm like to sell on cash, the pressure of competition and the force of custom persuades them to sell on credit. Firms grants credit to facilitate sales. It is valuable to customers as it augments their resources- it is particularly appealing to those customers who cannot borrow from other sources or find it very expensive or inconvenient ro do so.
Credit Management in India
Trade credit management is divided into 3 broad areas 1. Credit policy 2. Credit analysis 3. Control of accounts receivables CREDIT POLICY a. Very few companies have attempted a systematic articulation nd formalization of their credit policies. The following statements is made by a company in its annual report “our credit policy seeks to maximize sales growth consistent with an acceptable degree risk” b. Credit period offered by firm varies from 0-60 days c. The practice of offering cash discount for payment is not very common
CREDIT ANALYSIS a. Prospective customers are generally required to furnish 2-3 trade references. However, the follow up these references is not very common.
15
b. The financial statements of the prospective customers are, in general, not analyzed in detail. c. The larger business firms usually classify their customers into several credit categories. One large pharmaceutical concern uses following classification A – completely reliable customers B – highly reliable customers C – slightly risky customers D – doubtful customers
CONTROL OF RECEIVABLES a. Monitoring and controlling of accounts receivables is neither very thorough nor systematic. Very few firms have a well defined systems for monitoring and controlling accounts recievables. b. The measures commonly employed whether accounts receivable are „in control? are ? Bad debt losses ? Average collection period ? Ageing schedule ROOM FOR IMPROVEMENT 1. Management of receivables must be accorded the importance it deserves. 2. Credit policies need to be articulated in explicit terms and revised periodically 3. There should be better coordination between sales, production and finance departments
16
4. Firms granting credit should examine the published statement of prospective customer with great rigour, references must be examined and necessary follow up should be taken 5. A well defined collection program must be developed
17
INVENTORY MANAGEMENT
There are 3 type of inventories:I. II. III. Raw materials Work in progress Finished goods
Inventories represent the 2nd largest asset category for manufacturing companies,next only to plant and equipments. The proportion of inventory to total assets generaaly varies between 15-30%. Given substantial investment inventories, the importance of inventory management cannot be over emphasized. Recently there has been advancements in field of inventory management. The more important ones are listed below:1. Material requirement planning 2. Just in Time 3. Electronic data interchange and bar coding
18
Comparison of financial ratios of Lupin and Piramal healthcare
Lupin
Current ratio Acid test ratio Debt-equity ratio Debt to total asset Interest coverage ratio Receivable turnover ratio Receivable turnover (in days) Payable turnover ratio Payable turnover (in days) Inventory turnover ratio Inventory turnover (in days) Operating cycle(in days) Cash cycle (in days) Total asset turnover ratio Gross profit margin Pretax margin Net profit margin Rate of returns Rate of equity ROI 1.76 1.04 0.86 0.31 14.9 5.32 68.8 3.36 109 3.27 111.6 180 71 0.95 17.17 16.05 13.28 12.6 35.21 18.11
Piramal
1.2 0.95 1.02 0.27 9.3 6.88 53 3.84 95 6.88 53 106 11 0.91 18.14 10.5 9.82 8.2 21.33 15.43
Current ratio: Current assets/ current liabilities A higher current ratio is considered to be a sign of financial strength. Bankers in India have used a norm of 1.33. Acid test ratio: (Current assets-inventories)/Current liabilities It is a fairly stringent measure of liquidity as it excludes inventory, perhaps least liquid of current assets.If we compare the companies on the basis of current ratio and acid test ratio. Lupin has a better figure for both ratios. This implies that lupin has a better financial health according to liquidity ratio
19
Operating Cycle
180 160 140 120 100 80 60 40 20 0 lupin piramal recievable turnover (in days) inventory cycle (in days)
Lupin has a longer operating cycle due to its high inventory cycle which it has to maintain in its business in CIS.
200 180 160 140 120 100 80 60 40 20 0 Piramal healthcare Lupin operating cycle (in days) account payable period (in days) Cash cycle(in days)
Piramal healthcare manages its cash cycle in a better way, as it can be seen cash cycle is very low in comparison with Lupin.
20
FINDINGS
Both the Companies have a healthy cash flow despite spending on acquisitions and capacity expansions during the year. Many of the pharmaceuticals have started re-looking at their working capital cycles and decided to reduce their inventory levels. This has in some ways affected the performance of companies like Piramal in the custom manufacturing business. Lupin?s Indian business has morphed into a lean marketing machine, with almost negligible capital expenditure and tight working capital management. On the working capital front, in case of Lupin, there was tremendous optimization as it is increased by only 20% whilst the dimensions of the company?s operations increased by 38%., whereas in case of Piramal,it increased at the rate of 15.45% while the Company`s operations increased at 14%. Overall interest payments were Rs. 499 Mn for FY 2008-09, reflecting an average cost of borrowing of 6% for the year. The total debt at the year stood at Rs. 8,870 Mn, and the debt-equity ratio improved from 65% to 62%,Whereas in case of Piramal, the debt-equity ratio increased from 66% to 102%. This happened since Piramal being a Research oriented Company, has invested a major chunk of their capital in their drug discovery programs, which can yield profits in the long term. Lupin has cash flow from investing activities like sales of investments and loans and advances to subsidiary companies. The total current assets, loans and advances of Rs. 23,477 Mn which include Rs. 18,037 of current assets and loans and advances.In case of Piramal, the total current assets, loans and advances of Rs. 27,361.5 Mn which include Rs. 14,907.6 Mn of current assets and loans and advances. Account receivable ideally have a span of 30 to 60 days and Lupin has a receivable days of 69 days which is higher than the ideal days because the company have a presence in CIS countries and these countries have long credit period.Whereas Piramal has a receivable days of 53 days, which is well within the standard norms.
21
Thus if we analyse both companies, in this multi parametric problem it cannot be concluded which company enjoys a better financial health as both have their advantages and disadvantages.
22
doc_563189564.docx
.It covers asset cycle,working capital management,inventory management,ratios comparison,credit management,liquidity and cash flows,net working capital
Short term Financing and its management
Lupin and Piramal Healthcare
0
INDEX
Sr.no Topic 1 Introduction 2 Current asset cycle 3 Working capital financing 4 Cash and Liquidity management 5 Credit management 6 Inventory management 7 Comparison of ratios 8 Findings
Page no. 2 5 8 13 15 18 19 22
1
i
INTRODUCTION Short term finance management can be divided into (i) (ii) (iii) (iv) Working capital management Cash and liquidity management Credit management Inventory management
Short term financial management is differing from the long term financial management in terms of the timing of cash. Short term financial decisions typically involve cash flow within a year or within the operating cycle of the firm whereas the long term financial decisions like buying capital equipments or issuing debentures involve cash flow over an extended period of time (5 to 15 years or even more).There are two concepts of working capital Gross working capital: This capital is the total of all current assets. The current assets constituents are inventories (raw material, Work-in-process, finished goods etc.), trade Debtors, loan and advances and cash and bank balances. The current assets are having two characteristics short life span and swift transformation into other asset form. Net working capital : This capital is the difference between current assets and current liabilities. The current liabilities constituents are sundry creditors, trade advances, borrowing etc. Working capital management is a significant facet of financial management. Its importance stems from two reasons: -Investment in current assets represents a substantial portion of total investment. - Investment in current assets and the level of current liabilities have to be geared quickly to change in sales. To be sure, fixed asset investment and long term financing are also responsive to variation in sales. However, this relationship is not as close and direct as it is in the case of working capital components.
2
The importance of short term capital management is reflected in the fact that financial managers spend a great deal of time in managing current assets and current liabilities.
negotiating favourable credit terms
arranging short term finances
monitoring the investment in inventoriies controlling the cash movement administering accounts recievables
Current asset Current asset is a item in a balance sheet item which equals the sum of cash and cash equivalents, account receivable, inventory etc that could be converted to cash in less than one year. These current assets are important to most companies as a source of funds for day to day operations. Current assets have a short life span. Cash balance may be held ideal for a week or two, accounts receivable may have a life span of 30 to 60 days, and inventories may be held for 1 to 60 days. Life span of current assets depends upon the time required in the activities of procurement, production, sales, collection and the degree of synchronization among them. Optimal level of current assets involves a tradeoff between costs that rise with current assets and fall with current assets. These are carrying cost referred as carrying cost and the latter as shortage costs.
3
Carrying costs are mainly in the nature of the cost of financing a higher level of current assets. Shortage costs are mainly in the form of disruption in production schedule, loss of sales and the loss of customer goodwill.
Current assets cycle: Each current asset is swiftly transformed into finished goods (may involve several stages of work-in-process). Finished goods generally sold on credit, are converted into accounts receivable and finally account receivable, on realization, generate cash. This short life span of working capital components and their swift transformation from one form into another has certain implication like -Decisions relating to working capital management are repetitive and frequent. -The difference between profit and present value is insignificant. -The close interaction among working capital components implies that efficient management of one component cannot be undertaken without simultaneous consideration of other components.
4
CURRENT ASSET CYCLE
Factors influencing working capital requirement The working capital needs of a firm are influenced by numerous factors like 1. Nature of Business: Working capital requirement of a firm are closely related to the nature of its business. A service firm, like an electricity undertaking has a short operating cycle and which sells predominantly on cash basis and has modest working capital requirements. 2. Seasonality of operations: Firms which have marked seasonality in their operations usually have highly fluctuating working capital requirements. This occur mainly in firm who manufacture products which are highly demanded in a particular season. Eg .ceiling fans manufacturing firms have higher working requirements in summer month and decrease significantly during the winter months.
5
3. Production policy: A firm marked by pronounced seasonal fluctuations in its sales may pursue a production policy which may reduce the sharp variations in working capital requirements. Firm can maintain a steady production throughout the year. Such a production policy may be dampening the fluctuations in working capital requirements. 4. Market conditions: The degree of competition prevailing in the market place has an important bearing on working capital needs. If the market is strong and competition weak, a firm can manage with a smaller inventory of finished goods because customers can be served with some delay. 5. Condition of supply: The inventory of raw materials, spares and stores depends on the condition of supply. If the supply is prompt and adequate, the firm can manage with small inventory. If supply is unpredictable the firm can acquired stocks as and when they are available and carry larger inventory, on an average.
Operating cycle and Cash cycle The investment in working capital is influenced by the following events in the operating cycle of the firm: ? ? ? ? ? Purchase of raw materials Payment of raw materials Manufacture of goods Sale of finished goods Collection of cash for sales
The firm begins with the purchase of raw materials which are paid for after a delay which represents the accounts payable period. The firm converts the raw material into finished goods and then sells the same. The time lag between purchase of raw materials and the collection of cash for sales is referred to as the operating cycle, whereas the time length between the payment for raw material purchases and the collection of cash for sales is referred to as the cash cycle.
6
7
WORKING CAPITAL FINANCING
Short –term sources of finance, more or less exclusively support the current assets. The investment in raw material, stock-in-process, finished goods & receivables (the principal constituents of current assets) often varies a great deal during the course of the year. The sources of finance that are used to support current assets: ? ? ? ? ? ? ? Accruals Trade credit Working capital advance by commercial banks Regulation of bank finance Inter corporate deposits Short-term loans from financial institutions Commercial paper
1) Accruals ? the major accrual items are wages & taxes. ? the amounts owed but not yet paid are shown as accrued wages on the balance sheet. ? in the interim, the taxes owed but not paid can be shown as accrued taxes. ? accruals vary with the level of activity of the firm. ? when activity levels expand, accruals increase & when the activity levels contracts, accruals decrease. ? they are treated as part of „spontaneous financing?. 2) Trade Credit ? it represents credit extended by the supplier of goods & services. ? it is a spontaneous source of financing. ? it is an important source of financing, representing 25-50% of shortterm financing. ? the confidence of the suppliers is the key to securing trade credit.
8
? the things a supplier considers before giving credit are: (a) Earnings record over a period of time (b) Liquidity position of the firm (c) Record of payment
3) Working capital advance by commercial banks ? it represents the most important source of financing current assets. ? there are these following aspects of this source of finance: a) Application & processing -a customer seeking an advance is required to submit an appropriate application form there are different types of application forms for different categories of advances. -it is processed by the Bank manager or his field staff. b) Sanction & Terms & Conditions ? once an application is duly processed it is duly put up for sanction to the appropriate Authority (Branch Manager, Regional Manager, GM). ? if sanction is given, along with the sanction of advance, the Bank, specifies the terms & conditions applicable to the advance. c) Forms of Bank Finance ? working capital is provided by commercial in three ways: (i) Cash credits/ overdrafts
? a pre-determined credit limit is specified by the bank. ? borrower can draw as often as required, not exceeding the credit. ? he can also repay the amount partially or fully, as & when he desires. ? interest is charged only on the running balance, not on the limit sanctioned. ? thus, highly attractive from the borrower`s point of view.
9
(ii)
Loans
? advances of fixed accounts credited to the current account of the borrower or ? released to him in cash. ? interest is charged on the entire loan amount. ? loans are payable only on demand or periodic installments.
(iii) ? ? ? ?
Purchase or Discount of Bills
a bill arises out of a trade transaction. seller of goods draws the bill on purchaser. the bill may be payable on demand or after a usance period of 90 days. on acceptance of the bill by the purchaser, the seller offers it to the bank for discounts/purchases. ? when the bank discounts or purchases the bill it releases the funds to the seller, & presents the bill to the purchaser on the due & gets its payments.
(iv)
Letter of Credit
? the bank helps its customer to obtain credit from its (customer`s) suppliers. ? the bank undertakes the responsibility to honor the obligation of it customer, should ? the customer fails to do so. ? its an indirect form of financing as compared to overdraft, cash credit, loans & bills ? purchasing & discounting, which are direct forms of financing.
10
Note that, in direct form of financing, the bank assumes risks, as well as provides financing. d) Security ? For working capital advances, commercial banks seek security either in the form of ? hypothecation or in the form of pledge. ? Hypothecation: borrows money against security of movable property, usually inventories. ? Pledge: owner of the goods, deposits goods with the lender as security for borrowing. e) Margin Amount ? Banks do not provide 100% finance. ? they insist that customer should bring a portion of the required finance from the other Sources, this portion is called as the margin amount.
4) Regulation of Bank Finance A) Tandom Committee Recommendations (i) Norms for Current Assets (ii) Maximum Permissible Bank Finance (iii) Emphasis on loan system (iv) Periodic information & reporting system B) Present Practice: The salient features of the practice presently followed by banks with respect to working capital financing are as follows: (i) Assessment of working capital requirement a) Projected Balance Sheet Method b) Cash Budget Method c) Turnover Method (ii) Current Ratio Norm
11
(iii) (iv)
Benchmark of 1.33 is accepted. Emphasis on loan system Financial Follow-up Reports
5) Inter-Corporate deposits -deposit made by one company with another, normally for a period up to 6 months. -Three types: (a) Call deposits (b) Three-months deposits (c) Six months deposits. -characteristics of such deposits: a) Lack of regulation b) Secrecy c) Importance of personal contacts 6) Short-term loans from financial institutions -financial institutions like insurance companies provide short-term loans to manufacturing companies with an excellent track record.
7) Commercial Paper Short term unsecured promissory notes which are issued by firms which enjoy fairly high credit ratings. Maturity period is 90-180 days. It is a sold at a discount from its face value and redeemed at the face value.
12
CASH AND LIQUIDITY MANAGEMENT
Cash the most liquid asset is of vital importance to the daily operations of business firms. While the proportion of corporate assets held in the form of cash is very small, often between 1-4%,its efficient management is crucial to the solvency of business in a very important sense. Cash is the focal point of fund flow in a business. In view of its importance, it is generally referred to as the “life blood of the business enterprise” Better cash levels can be achieved by speeding collections and delaying disbursements.
Investment of surplus funds
Companies often have surplus funds for short periods of time before they are required for capital expenditures, loan repayment or some other purpose. Instead of keeping it in current funds which does not fetch any interest, companies invest them in a variety of short term instruments like term deposits with banks, market mutual funds etc.
Investment portfolios
ready cash segment • reserve for company's cash account • meant to augment cash resources to meet unanticiapted operational needs • must be highly liquid controllable cash segment • part of investment which is meant for knowable outflows like taxesdividend etc • investments must be matched in size and maturity to known future outflows free cash segment • part of investment which is neither meant for unforeseen cash requirements nor to meet known future outflows • investment is done only to generate income • it is not concerned with liquidity or maturity
13
Criteria for evaluating investment instruments 1. Safety:- A high degree of safety is essential for an instrument to be considered for inclusion in the short term investment portfolio of the company. Treasury bills are the safest of all instruments. 2. Liquidity:- the liquidity of an instrument refers to the ability of the investor to convert it into cash at a short notice without incurring a loss. An instrument may be quite safe if it is held to the maturity but it may not be possible to sell it prematurely without suffering a loss. 3. Yield:- it is return earned from it by way of interest, dividend, and capital appreciation. The return must be measured in post tax terms. 4. Maturity:- it refers to the life of instrument. The maturity period influences the segment into which investment is made.
14
CREDIT MANAGEMENT While business firm like to sell on cash, the pressure of competition and the force of custom persuades them to sell on credit. Firms grants credit to facilitate sales. It is valuable to customers as it augments their resources- it is particularly appealing to those customers who cannot borrow from other sources or find it very expensive or inconvenient ro do so.
Credit Management in India
Trade credit management is divided into 3 broad areas 1. Credit policy 2. Credit analysis 3. Control of accounts receivables CREDIT POLICY a. Very few companies have attempted a systematic articulation nd formalization of their credit policies. The following statements is made by a company in its annual report “our credit policy seeks to maximize sales growth consistent with an acceptable degree risk” b. Credit period offered by firm varies from 0-60 days c. The practice of offering cash discount for payment is not very common
CREDIT ANALYSIS a. Prospective customers are generally required to furnish 2-3 trade references. However, the follow up these references is not very common.
15
b. The financial statements of the prospective customers are, in general, not analyzed in detail. c. The larger business firms usually classify their customers into several credit categories. One large pharmaceutical concern uses following classification A – completely reliable customers B – highly reliable customers C – slightly risky customers D – doubtful customers
CONTROL OF RECEIVABLES a. Monitoring and controlling of accounts receivables is neither very thorough nor systematic. Very few firms have a well defined systems for monitoring and controlling accounts recievables. b. The measures commonly employed whether accounts receivable are „in control? are ? Bad debt losses ? Average collection period ? Ageing schedule ROOM FOR IMPROVEMENT 1. Management of receivables must be accorded the importance it deserves. 2. Credit policies need to be articulated in explicit terms and revised periodically 3. There should be better coordination between sales, production and finance departments
16
4. Firms granting credit should examine the published statement of prospective customer with great rigour, references must be examined and necessary follow up should be taken 5. A well defined collection program must be developed
17
INVENTORY MANAGEMENT
There are 3 type of inventories:I. II. III. Raw materials Work in progress Finished goods
Inventories represent the 2nd largest asset category for manufacturing companies,next only to plant and equipments. The proportion of inventory to total assets generaaly varies between 15-30%. Given substantial investment inventories, the importance of inventory management cannot be over emphasized. Recently there has been advancements in field of inventory management. The more important ones are listed below:1. Material requirement planning 2. Just in Time 3. Electronic data interchange and bar coding
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Comparison of financial ratios of Lupin and Piramal healthcare
Lupin
Current ratio Acid test ratio Debt-equity ratio Debt to total asset Interest coverage ratio Receivable turnover ratio Receivable turnover (in days) Payable turnover ratio Payable turnover (in days) Inventory turnover ratio Inventory turnover (in days) Operating cycle(in days) Cash cycle (in days) Total asset turnover ratio Gross profit margin Pretax margin Net profit margin Rate of returns Rate of equity ROI 1.76 1.04 0.86 0.31 14.9 5.32 68.8 3.36 109 3.27 111.6 180 71 0.95 17.17 16.05 13.28 12.6 35.21 18.11
Piramal
1.2 0.95 1.02 0.27 9.3 6.88 53 3.84 95 6.88 53 106 11 0.91 18.14 10.5 9.82 8.2 21.33 15.43
Current ratio: Current assets/ current liabilities A higher current ratio is considered to be a sign of financial strength. Bankers in India have used a norm of 1.33. Acid test ratio: (Current assets-inventories)/Current liabilities It is a fairly stringent measure of liquidity as it excludes inventory, perhaps least liquid of current assets.If we compare the companies on the basis of current ratio and acid test ratio. Lupin has a better figure for both ratios. This implies that lupin has a better financial health according to liquidity ratio
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Operating Cycle
180 160 140 120 100 80 60 40 20 0 lupin piramal recievable turnover (in days) inventory cycle (in days)
Lupin has a longer operating cycle due to its high inventory cycle which it has to maintain in its business in CIS.
200 180 160 140 120 100 80 60 40 20 0 Piramal healthcare Lupin operating cycle (in days) account payable period (in days) Cash cycle(in days)
Piramal healthcare manages its cash cycle in a better way, as it can be seen cash cycle is very low in comparison with Lupin.
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FINDINGS
Both the Companies have a healthy cash flow despite spending on acquisitions and capacity expansions during the year. Many of the pharmaceuticals have started re-looking at their working capital cycles and decided to reduce their inventory levels. This has in some ways affected the performance of companies like Piramal in the custom manufacturing business. Lupin?s Indian business has morphed into a lean marketing machine, with almost negligible capital expenditure and tight working capital management. On the working capital front, in case of Lupin, there was tremendous optimization as it is increased by only 20% whilst the dimensions of the company?s operations increased by 38%., whereas in case of Piramal,it increased at the rate of 15.45% while the Company`s operations increased at 14%. Overall interest payments were Rs. 499 Mn for FY 2008-09, reflecting an average cost of borrowing of 6% for the year. The total debt at the year stood at Rs. 8,870 Mn, and the debt-equity ratio improved from 65% to 62%,Whereas in case of Piramal, the debt-equity ratio increased from 66% to 102%. This happened since Piramal being a Research oriented Company, has invested a major chunk of their capital in their drug discovery programs, which can yield profits in the long term. Lupin has cash flow from investing activities like sales of investments and loans and advances to subsidiary companies. The total current assets, loans and advances of Rs. 23,477 Mn which include Rs. 18,037 of current assets and loans and advances.In case of Piramal, the total current assets, loans and advances of Rs. 27,361.5 Mn which include Rs. 14,907.6 Mn of current assets and loans and advances. Account receivable ideally have a span of 30 to 60 days and Lupin has a receivable days of 69 days which is higher than the ideal days because the company have a presence in CIS countries and these countries have long credit period.Whereas Piramal has a receivable days of 53 days, which is well within the standard norms.
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Thus if we analyse both companies, in this multi parametric problem it cannot be concluded which company enjoys a better financial health as both have their advantages and disadvantages.
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