Working Capital Management
CHAPTER – I INTRODUCTION 1. 1. WORKING CAPITAL MANAGEMENT Working capital may be regarded as life blood of a business.
Working capital management is a process of planning and controlling the level and mix of the current assets of the firm as well as financing these assets. A study of working capital is of major importance to internal and external analysis because of its close relationship with the day-to-day operation of a business. Even in a well-established business with a long history of successful operation, careful attention to the management of working capital results in greater profitability.
Funds which are needed for short term purpose for the purchase of raw materials, payment of wages and other day-to-day expenses are known as working capital. The goal of working capital management is to manage each of the firm’s current assets and current liabilities. Working capital is also known as circulating capital or current capital or revolving capital. Capital required for a business can be classified under two main categories viz; ? Fixed capital ?Working capital Every business needs funds for two purposes for its establishment and carryout its day-to-day operations.
Long-term funds are required to create production facilities such as purchase of plant, machinery, land, building, furniture’s, etc. , Investment in these assets represent that part of the firms capital which is permanently blocked and it is called as fixed capital. Funds are also needed for short-term purpose for the purchase of raw materials, payment of wages and other day-to-day expenses. These funds are known as working capital. The working capital may rightly to be called as the circulating or revolving capital, because current asset keep revolving fast and are being constantly onverted into cash and this cash flows out again in exchange for other current assets. 1. 1. 1. DEFINITIONS According to Genestenberg “Circulating capital means current assets of a company that are changed in the ordinary course of business from one from to another”. According to the Institute of Chartered Accountant of India “Working capital means the funds available from day-to-day operations of an enterprise”. In the words of Shubin, “Working capital is the amounts of funds necessary to cover the cost of operating the enterprise”. 1. 1. 2. TYPES OF WORKING CAPITAL a) Permanent working capital It means the minimum amount of investment in all current assets which is regarded at all times to carry on minimum level of current asset is known as permanent working capital. Tandon committee has named it as “Core current assets” Features of permanent working capital 1. Amount of permanent working capital remains in the business in one form or another. 2. There is a positive correlation between the amount of permanent working capital and the size of the business. 3. Permanent working capital should be financial out of long term funds. (b) Temporary working capital
This is also called the fluctuating or variable working capital. The amount of temporary working capital keeps on changing depending upon the changes in production and sales. The extra working capital required to support the changing production and sales activities is known as temporary working capital. (c)Gross working capital It is the amount of funds invested in various components of current assets. This concept has type following advantages. 1. Financial management is mainly concerned with management of current assets ( Gross working capital) 2. It enables a firm to release the greatest returns on its investments. . It enables a firm to plan and control the funds at its disposal. 4. It helps in the fixation of various areas of financial responsibility. (d) Net working capital In a narrow sense, the term working capital refers to the net working capital. Net working capital is the excess of current assets over current liabilities. Net working capital=Current assets-Current liabilities Net working capital being a qualitative concept indicates. ?The liquidity position of the firm and source of funds ?Suggests the extent to which working capital needs may be financed by permanent source of funds.
Excessive liquidity is also bad. It may be due to mismanagement of current assets. Therefore prompt and timely action has to be taken by the management to improve and correct imbalances in the liquidity position of the firm. (e) Balance Sheet working capital The balance sheet working capital is one, which is calculated from the items appearing in the balance sheet. Gross working capital and net working capital are examples of the balance sheet working capital. (f) Cash working capital Cash working capital is one, which is calculated from the items appearing in the profit and loss account.
Its shows the real flows of money or value at a particular time and is considered to be the most realistic approach in working capital management. The cash working capital indicates the adequacy of the cash flow, which is an essential pre-requisite of a business. 1. 1. 3. THE NEED FOR WORKING CAPITAL The need for working capital cannot be over emphasized. Every business needs some amount of working capital. The need for working capital arises due to the time gap between production and realization of cash from sales. There is an operating cycle involved in the sales and realization of cash.
Working capital is needed for the following purposes: ?For the purchase of raw materials, components and spares. ?To pay wages and salaries. ?To incur day-to-day expenses and overhead cost such as fuel, power and office expenses, etc. , ? To meet the selling cost as packing, advertising, etc. , ?To provide credit facilities to the consumers. ?To maintain the inventories of raw material, work-in-progress, stores and spares and finished stock. 1. 1. 4. IMPORTANCE OF ADEQUATE WORKING CAPITAL (a) Solvency of the Business Adequate working capital helps in maintaining solvency of the business by providing uninterrupted flow of production. b) Good Will Sufficient working capital enables a business concern to make prompt payment and hence helps in creating and maintaining good will. (c)Cash Discount Adequate working capital enables the firm in to avail cash discount facilities offered to it by the suppliers. The amount of cash discount reduces the cost of purchase. (d)Credit Worthiness It enables the firm to operate its business more efficiency because there is on easy and favorable terms. (e)Expansion of Markets A firms which have adequate working capital, create favorable market condition.
This is so because purchasing its requirements in bulk. When prices were lower and holding its inventories for higher. Profits are increased. (f)High Morale Adequacy of working capital creates an environment of security, confidents, high morale etc, and creates over all efficiency in business. 1. 1. 5. DRAWBACKS OF INADEQUATE WORKING CAPITAL When working capital is inadequate, a firm faces the following problems. ?It may not be able to take advantage of profitable business opportunities. ?It can not buy its requirements in bulk and cannot avail of discounts. ?It will not be able to pay its dividends. It cannot afford to increase its cash sales and may have restricted its activities to credit sales only. ?It becomes impossible to utilize efficiently the fixed assets due to non-availability of liquid funds. ?The rate of return on investments also falls with the shortage of working capital. 1. 1. 6. DRAWBACKS OF EXCESS WORKING CAPITAL When there is too much working capital it is also dangerous excessive working capital raises the following problems. ?A firm may be tempted to over trade and lose heavily. ?There may be an imbalance between liquidity and profitability ?
The excess of working capital may lead to carelessness about cost of production. ?Excessive working capital means funds are idle. When funds are idle, no profit is earned . When it is so, the rate of return on investment goes down. 1. 1. 7. OPERATING CYCLE Modern business enterprises produce goods in anticipation . Goods produced are not immediately. Cash for sale is also realized immediately, Operating cycle is involved from the time of purchase of raw materials to the time realization of cash for sales made. Following stages are usually found in an operating cycle of a manufacturing firm Conversion of cash into raw materials. ?Conversion raw materials. ?Conversion of work in-progress into finished goods. ?Conversion of finished goods into debtors through sales ?Conversion of debtors into cash. This cycle will be repeated again and again. The operation cycle of manufacturing business can be shown as in the following chart. There are time gaps between purchases of raw materials and production; production and sales; sales and realization of cash. Thus the need for working capital arises due to the time gap between purchases of raw materials and realization of cash from sales. . 1. 8. FACTORS AFFECTING WORKING CAPITAL There are no set of rules or formulae to determine the working capital requirements of firms. A large number of factors each have a different influence working capital need of firms. The following are the determinants of working capital. (a)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. (b)Size of Business
The working capital requirements of a concern are directly influenced by the size of its business which may be measured in terms of scale of operations. Greater the size of a business unit, generally larger will be the requirements of working capital. (c)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. (d)Sales and demand condition The working capital heads of a firm are related to its sales.
Sales depend on demand conditions. Most firms experience seasonal and cyclical fluctuations in the demand for their products and services. Dealing periods of peak demand increasing production may be expensive for the firm. (e)Manufacturing Cycle The manufacturing cycle starts with purchase and use of raw materials and completes with the production of finished goods. The level of working capital depends upon the time required to manufacture goods. (f)Price level changes Changes in the price level also affect the working capital requirements.
Generally, the rising prices will require the firm to maintain larger amount of working capital as more funds will be required to maintain the same current assets. 1. 1. 9. METHODS OF FORECASTING WORKING CAPITAL In preparing working capital forecast, the following information is required. 1. Cost to be defrayed on materials, wages and overheads. 2. Length of time during which raw materials are to remain in stock before they put to production. 3. Length of production cycle 4. Length of sale cycle denoting that the period of time finished goods has to stay in the warehouse before sales. . Period of credit availed of from creditors 6. Time lag involved in the payment of wages and overhead expenses. 1. 1. 10. SOURCES OF WORKING CAPITAL The following are the sources of working capital (a)Trade Credit Trade credit is a short term credit facility extended by suppliers of raw materials and other suppliers. It is a common source. It is an important source. Either open account credit or acceptance credit may be adopted. In the former as per business custom credit is extended to the buyers, the buyer is not signing any debt instrument as such. (b)Commercial Banks
Commercial banks are the next important source of working capital finance. Commercial banking in the country is broad based and fairly developed. Straight loans, cash credits, hypothecation loans, pledge loans, overdrafts and bill purchase and discounting are the principal forms of working capital finance provided by commercial banks. (c)Finance Companies Finance Companies are abundant in the country. About 50,000 companies exist at present. They provide service almost similar to banks, though not they are banks. They provide need based loans and sometimes arrange loans from others for customers.
Interest rate is higher. But timely assistance may be attained. (d)Indigenous Bankers Indigenous bankers are also abundant and provide financial assistance to small business and trades. They change exorbitant rates of interest by very much understanding. (e)Public Deposits Public deposits are unsecured deposits raised by business for periods exceeding a year but not more than three years by manufacturing concerns and not more than 5 years by non-banking finance companies. The RBI is regulating deposit taking by these companies in order to protect the depositors.
Quantity restriction is placed at 25% of paid up capital and free services for deposits solicited from public are prescribed for non-banking manufacturing concerns. The rates of interest ceiling are also fixed. This form of working capital financing is resorted to by well established companies. (f)Advances from customers Advances from customers are normally demanded by producers of costly goods at the time of accepting orders for supply of goods. Contractor might also demand advances from customers where sellers market prevail advances from customers may be insisted.
In certain cases to ensure performance of contract in advance may be insisted. 1. 2. INDUSTRY PROFILE India is the world’s second largest producer of cement after china, with cement companies adding nearly eight million tones (MT) capacity in April 2009, taking the total installed capacity to 219 MT and despatch of 16. 65 million tones during April 2009. a few of the leading manufacturers are the India cements, Ultra tech cements, Dalmia cements, Holcim etc. With the boost given by the government to various infrastructure projects, road networks and housing facilities, growth in the cement consumption is anticipated in the coming years.
Another 50 MT capacity is likely to be added this year, according to industry sources. Continuous technological upgrading and assimilation of latest technology has been going on in the cement industry. Presently, 93 percent of the total capacity in the industry is based on modern and environment-friendly dry process technology and only 7 percent of the capacity is based on old wet and semi-dry process technology. There is tremendous scope for waste heat recovery in cement plants and thereby reduction in emission level.
Government initiatives in the infrastructure sector, coupled with the housing sector boom and urban development, continue being the main drivers of growth for the Indian cement industry. ?Increased infrastructure spending has been a key focus area over the last five years indicating good times ahead for cement manufacturers. ?The government has increased budgetary allocation for roads under National Highways Development Project (NHDP). ?Appointing a coal regulator is looked upon as a positive move as it will facilitate timely and proper allocation of coal (a key raw material) blocks to the core sectors, cement being one of them. . 3. INDIA CEMENTS LIMITED The India Cements Ltd was established in 1946 and the first plant was setup at Sankarnagar in Tamilnadu in 1949. Since then it has grown in stature to seven plants spread over Tamilnadu and Andhra Pradesh. The capacities as on March 2002 have increased multifold to 9 million tons per annum. The founders of the India cements limited are Shri Sankaralinga Iyer and Shri T. S. Narayanaswami. 1. 3. 1. Name of the Associate /Subsidiary Companies
Industrial Chemicals & Monomers Ltd Subsidiary Company ICL Securities Ltd Subsidiary Company ICL Financial Services Ltd Subsidiary Company ICL International Ltd Subsidiary Company Trishul Concrete Products Ltd Subsidiary Company Coromandel Electric Company Ltd Associate Company Unique Receivable Management Private Limited Associate Company Coromandel Sugars Ltd Associate Company India Cements Capital Ltd Associate Company Raasi Cement Ltd Associate Company The overall capacity utilization of the company was at a record 105% and was higher than the capacity utilization of some of the majors in the country. During the year, the company had successfully completed the conversion of the Sankaridurg Unit from wet process to dry process and the new plant has stabilized quickly. 1. 3. 2. Vision ICL Vision is “to be the market leader in the manufacture of world class cement, by adopting innovative technologies for sustainable development”. 1. 3. 3. Mission ICL provides quality product through A clear understanding of customer needs ?Continuous research and development of current and emerging technologies. 1. 3. 4. Company Highlights ?The Company is the largest producer of cement in South India. ?The Company’s plants are well spread with three in Tamilnadu and four in Andhra Pradesh which cater to all major markets in South India and Maharashtra. ?The Company is the market leader with a market share of 28% in the South. It aims to achieve a 35% market share in the near future. The Company has access to huge limestone resources and plans to expand capacity by de-bottlenecking and optimization of existing plants as well as by acquisitions. The Company has a strong distribution network with over 10,000 stockists of whom 25% are dedicated. ?The Company has well established brands- Sankar Super Power, Coromandel Super Power and Raasi Super Power. ?Regional offices in all southern states and Maharasthra offices/representative in every district. 1. 4. MAIN THEME OF PROJECT 1. 4. 1. Need for the study Working capital is needed in every organization to meet day-to-day business activities. Since there is a time lag between the sale of produce and realization of cash, every organization requires sufficient amount of working capital to met the daily requirement, to tackle the problem as and when arises for the smooth running of business. 1. 4. 2. Objectives of study
The study of working capital analysis of THE INDIA CEMENTS LIMITED has been undertaking the following objectives. ?To find out the profitability position of the company. ?To find out the liquidity and solvency position of the company. ?To study, the working capital position of the company. ?To offer, suggestions for improving the working capital position of the concern. 1. 4. 3. Scope of the study The study relates to the existing system of finance and working capital analysis in THE INDIA CEMENTS LIMITED. The study gives an idea about the working capital position of the company. The study will also be useful for improving the working capital position of the Company.
The study will helpful for management in decision making relating to Working capital. 1. 4. 4. Limitations of the study ?The analysis was made with the help of the secondary data collected from the company. ?The period of study is 5 years from 2003-04 to 2007-08. ?The credit sales & purchases were not separately given so all the sales and purchases are assumed to be credit sales & purchases. CHAPTER – II RESEARCH METHODOLOGY 2. 1. Research design Research design is the specification of methods and procedures for acquiring the information needed to structure or to solve the given problem. Analytical research technique was adopted in the project.
Generally analytical studies are designed to analyze something and it collects data for a definite purpose. 2. 2. Period of study This study contains the working capital analysis for the period of five years from 2003-2004 to 2007-2008. The accounting year is starting from 1st April to 31st March. 2. 3. Sources of data The study is based on secondary data obtained from the published Annual reports of the company, comprising of profit and loss account and balance sheet. The internet is the main sources of data collection. 2. 4. Tools used Tools used to analysis are ratio analysis and fund flow statement. CHAPTER – III ANALYSIS AND INTERPRETATION 3. 1. RATIO ANALYSIS Ratio analysis is a widely used technique of analyzing financial statements.
It simply refers to analysis of financial statements by computing ratios. It is the process of establishing and interpreting various ratios for helping in making certain decisions. Ratio analysis may be defined as the process of computing and interpreting relationship between the items of financial statement for arriving at conclusions about the financial position and performance of an enterprise. It helps in understanding the financial health and trend of a business. The following are the four steps involved in the ratio analysis ? Selection of relevant data from the financial statements depending upon the objectives of analysis. ?Calculation of appropriate ratios from the data. Comparison of the calculated ratios with the ratio of the same firm in the past, on the ratios developed from projected financial statements. ?Interpretation of the ratios. USES AND SIGNIFICANCE OF RATIO ANALYSIS The important advantages of accounting ratio or ratio analysis are explained under the following heads: •UTILITY TO MANAGEMENT Ratio analysis helps the management in (a) formulating the policies, (b) forecasting and planning, (c) decision making, (d) knowing the trends of business, (e) measuring efficiency and (f) controlling. •UTILITY TO SHAREHOLDERS AND INVESTORS An investor would normally assess the financial position of a business before he invests his money in it.
He is interested in the safety, security and profitability of his investment. Accounting ratios help the prospective investors in selecting best companies to invest their funds. Ratios enable the shareholders to evaluate the performance and future prospects of the company. On the basis of some ratios, they are able to calculate the price of their shares. •UTILITY TO CREDITORS The creditors or suppliers are those who supply goods to firm on credit basis. They are interested in the liquidity position of the firm. To known the liquidity position or short term financial position, they use liquidity ratios. •UTILITY TO EMPLOYEES The employees are interested in the profitability of the company.
Their wages, fringe benefits, working conditions etc. are related to the profits earned by the company. They want to ascertain the profitability for demanding wage increase and other benefits. For understanding the profitability of the company, profitability ratios come to their help. •UTILITY TO GOVERNMENT The government uses ratio analysis for studying the cost structure of the industries. On the basis of this study, the government can formulate various policies. It can implement the price control measures to protect the interest of consumers. 3. 1. 1. CURRENT RATIO Current ratio is defined as the ratio of current asset to current liabilities.
It shows the relationship between total current assets and total current liabilities. The objective of computing this ratio is to measure the ability of obligations in time. The current ratio of 2:1 is considered satisfactory or ideal. Current assets Current ratio=___________________ Current liabilities TABLE 3. 1. 1 CURRENT RATIO (Rs. in lakhs) YearCurrent AssetsCurrent LiabilitiesRatio 2003-2004 130817. 59 19751. 31 6. 62 2004-2005 136844. 89 30727. 42 4. 45 2005-2006 151241. 62 37312. 68 4. 05 2006-2007 171751. 40 43399. 14 3. 95 2007-2008 214941. 24 98353. 24 2. 19 Sources: Annual report of THE INDIA CEMENTS LIMITED. Table 3. 1. 1 shows the current ratio of THE INDIA CEMENTS LIMITED.
The standard norm is 2:1. The current ratio is much higher than standard from 2003-2004 to 2006-2007. The highest ratio was 6. 62 in the year 2003-2004 and the lowest ratio was 2. 19 in the year 2003-2004. The ratio shows that the current assets are more than current liabilities to pay-off debts. This shows that the company is enjoying credit worthiness. CHART 3. 1. 1 3. 1. 2 QUICK RATIO/LIQUID RATIO Quick ratio is also known as acid test ratio. Liquid ratio is the ratio of liquid assets to current liabilities. It establishes the relationship between quick assets and current liabilities. It is the measure of the instant paying ability of the business enterprises.
The objective of computing this ratio is to measure the ability of the firm to meet its short term liabilities as and when due without depending upon the realization of stock. The quick ratio of 1:1 is considered as satisfactory or ideal. Quick (or) liquid assets Liquid ratio= ____________________ Current liabilities TABLE 3. 1. 2 LIQUID RATIO (Rs. in lakhs) YearLiquid AssetsCurrent LiabilitiesRatio 2003-2004 117351. 56 19751. 31 5. 94 2004-2005 118854. 77 30727. 42 3. 87 2005-2006 131943. 78 37312. 68 3. 53 2006-2007 148944. 01 43399. 14 3. 43 2007-2008 181920. 19 98353. 24 1. 85 Sources: Annual report of THE INDIA CEMENTS LIMITED. Table 3. 1. 2 shows the quick ratio of THE INDIA CEMENTS LIMITED. The highest ratio was 5. 94 in the year 2003-2004 and the lowest ratio was 1. 85 in the year 2003-2004.
The quick ratio of the company was more than the standard norm. The ratio shows liquid assets are more than the current liabilities to pay-off short term liabilities. It indicated that short term creditors are in a much secured position. CHART 3. 1. 2 3. 1. 3 DEBT-EQUITY RATIO Debt equity ratio indicates the relative proportion of debt and equity in financing the assets of a firm. In short, it expresses the relationship between debt (external equity) and equity (internal equity). This ratio is also known as External – Internal Equity Ratio. The standard norm is 2:1. It is calculated as follows: Long term debt Debt-equity ratio= ____________________ Equity TABLE 3. 1. 3 DEBT EQUITY RATIO (Rs. n lakhs) YearLong term debtEquityRatio 2003-2004 209263. 61 167316. 73 1. 25 2004-2005 198724. 18 159705. 10 1. 24 2005-2006 152523. 10 201945. 02 0. 76 2006-2007 205875. 47 220853. 34 0. 93 2007-2008 181150. 58 332110. 82 0. 55 Sources: Annual report of THE INDIA CEMENTS LIMITED. Table 3. 1. 3 shows the debt-equity ratio of THE INDIA CEMENTS LIMITED. The highest ratio was 1. 25 in the year 2003-2004 and the lowest ratio was 0. 55 in the year 2003-2004. In the year 2003-2004 and 2004-2005, the borrowing is more when compared with equity. From 2005-2006 to 2007-2008, the equity is more when compared with borrowings. CHART 3. 1. 3 3. 1. 4 PROPRIETORY RATIO
Proprietory ratio establishes the relationship between shareholders’ or proprietors’ fund and total asset. This ratio shows how much funds have been contributed by the shareholders in the total asset of the firm. Proprietory ratio is also known as equity ratio or net-worth ratio. Generally a ratio of 0. 5:1 or above is considered ideal. It is computed by using the following formula. Shareholders’ fund Proprietory ratio= ___________________ Total Asset TABLE 3. 1. 4 PROPERITORY RATIO (Rs. in lakhs) YearShareholder’s fundTotal AssetRatio 2003-2004 167316. 73 381209. 93 0. 44 2004-2005 159705. 10 363058. 87 0. 44 2005-2006 201945. 02 366664. 57 0. 55 2006-2007 220853. 34 432757. 84 0. 51 2007-2008 332110. 82 535832. 86 0. 2 Sources: Annual report of THE INDIA CEMENTS LIMITED. Table 3. 1. 4 shows the properitory ratio of THE INDIA CEMENTS LIMITED. The ratio shows an increasing trend. The proprietor’s contribution in to the total assets is less than half in 2003-2004 and 2004-2005. The proprietor’s contribution in to the total assets from 2005-2006 to 2007-2008 is up to the required level. CHART 3. 1. 4 3. 1. 5 FIXED ASSET RATIO A fundamental principle of sound financing policy is that all fixed assets must be financed out of long term funds. Short term funds should not be used for purchasing fixed assets. They shall be used only for working capital requirement.
If the short term funds are used in the purchase of fixed assets, it will affect the liquidity position. It is computed as follows: Fixed asset (after depreciation) Fixed Asset Ratio= ________________________________ Long term funds TABLE 3. 1. 5 FIXED ASSET RATIO (Rs. in lakhs) YearFixed AssetLong Term FundsRatio 2003-2004 233387. 44 376580. 34 0. 62 2004-2005 220484. 55 358429. 28 0. 62 2005-2006 211497. 00 354468. 12 0. 60 2006-2007 293858. 26 426728. 81 0. 69 2007-2008 403937. 17 513261. 40 0. 79 Sources: Annual report of THE INDIA CEMENTS LIMITED. T able 3. 1. 5 shows the fixed asset ratio of THE INDIA CEMENTS LIMITED. The highest ratio was 0. 9 in the year 2007-2008 and the lowest ratio was 0. 60 in the year 2005-2006. The fixed asset ratio is less than 1:1; it means that the entire fixed assets have been purchased out of long term funds. Through out the study period the fixed asset ratio is satisfactory. CHART 3. 1. 5 3. 1. 6 GROSS PROFIT RATIO This the ratio of gross profit to sales expressed as a percentage. It is also known as gross margin. The main objective of computing this ratio is to determine the efficiency in trading or production activity. Another objective is determining the selling price. It is calculated as follows: Gross profit Gross profit ratio= ______________ * 100 Net sales TABLE 3. 1. 6
GROSS PROFIT RATIO (Rs. in lakhs) YearGross profitNet SalesRatio 2003-2004 74065. 52 122541. 08 61 2004-2005 79355. 45 137427. 79 58 2005-2006 114585. 40 181875. 53 63 2006-2007 181318. 85 260439. 47 70 2007-2008 253335. 05 353704. 35 72 Sources: Annual report of THE INDIA CEMENTS LIMITED. Table 3. 1. 6 shows the gross profit ratio of THE INDIA CEMENTS LIMITED. The highest ratio was 72 in the year 2007-2008 and the lowest ratio was 58 in the year 2004-2005. The ratio shows an increasing trend during the study period except in the year 2004-2005. Increases in gross profit ratio indicate that the company is earning a higher margin on its sales. CHART 3. 1. 3. 1. 7 NET PROFIT RATIO Net profit ratio is the ratio of net profit earned by a business and its net sales. It measures overall profitability. Net profit ratio indicates efficiency as well as profitability of a business. It determines the returns to the owners. Higher the ratio is the profitability. This means returns to shareholders. It is calculated as follows: Net profit Net profit ratio = ______________ * 100 Net sales TABLE 3. 1. 7 NET PROFIT RATIO (Rs. in lakhs) YearNet profitNet SalesRatio 2003-2004 -31242. 05 122541. 08 -25 2004-2005 -30783. 93 137427. 79 -22 2005-2006 -26252. 62 181875. 53 -14 2006-2007 4656. 63 260439. 47 2 007-2008 52732. 02 353704. 35 15 Sources: Annual report of THE INDIA CEMENTS LIMITED. Table 3. 1. 7 shows the net profit ratio of THE INDIA CEMENTS LIMITED. The highest ratio was 15 in the year 2007-2008 and the lowest ratio was -25 in the year 2003-2004. In first three years, there has been a loss and net profit ratio has been moving in an increasing trend . The profitability of the firm has been showing a gradual return to the owners. CHART 3. 1. 7 3. 1. 8 RETURN ON INVESTMENT When a firm invests money in business, it naturally expects adequate return on its investment. Therefore, the firm wants to know how much profit is earning on its investment.
It is for knowing this, ROI is computed. ROI measures the overall profitability. It establishes the relationship between profit or return and investment. It computed as follows: Profit before interest and tax Return on investment= _____________________________ * 100 Capital employed TABLE 3. 1. 8 RETURN ON INVESTMENT (Rs. in lakhs) YearProfit before interest and taxCapital employedRatio 2003-2004 -13838. 88 361577. 45 -3. 83 2004-2005 -5882. 29 332473. 26 -1. 77 2005-2006 -4041. 21 329351. 89 -1. 23 2006-2007 49196. 36 392404. 94 1. 25 2007-2008 89278. 04 444068. 23 20. 10 Sources: Annual report of THE INDIA CEMENTS LIMITED. Table 3. 1. shows the return on investment of THE INDIA CEMENTS LIMITED. The highest ratio was 20. 10 in the year 2007-2008 and the lowest ratio was -3. 83 in the year 2003-2004. The return on investment was increasing from -3. 83 to 20. 10. The company was earned a high return on investment in the year 2007-2008 during the study period. It indicates the efficiently the capital employed in business is utilized. CHART 3. 1. 8 3. 1. 9 RETURN ON SHAREHOLDERS’ FUND This is the ratio of net profit to shareholders’ fund or net worth. It measures the profitability from the shareholders’ point of view. It indicates how effectively the shareholders’ funds have been utilized by the company. It is calculated as follows:
Net profit after interest and tax Return on shareholders’ fund = _____________________________ * 100 Shareholders’ fund TABLE 3. 1. 9 RETURN ON SHAREHOLDERS’ FUND (Rs. in lakhs) YearNet Profit after interest and taxShareholders’ fundRatio 2003-2004 -31242. 05 167316. 73 -19 2004-2005 -30783. 93 159705. 10 -19 2005-2006 -26252. 62 201945. 02 -13 2006-2007 4656. 63 220853. 34 2 2007-2008 52732. 02 332110. 82 16 Sources: Annual report of THE INDIA CEMENTS LIMITED. Table 3. 1. 9 shows the return on shareholders’ fund of THE INDIA CEMENTS LIMITED. The highest ratio was 16 in the year 2007-2008 and the lowest ratio was -19 in the year 2003-2004.
The return on shareholders’ fund was increasing from -19 to16. In first three years, there has been a loss to the shareholders’ and return on shareholders’ fund has been moving in an increasing trend. The return to shareholders’ indicates better utilization of owners’ fund. CHART 3. 1. 9 3. 1. 10 DEBTORS TURNOVER RATIO Debtors’ turnover ratio indicates the velocity of debt collection of firm. Trade debtors are expected to be converted into cash within a short period and are include in current assets. Hence the liquidity of a concern to pay its short-term obligations in time depends upon the quality of its trade debtors. Net credit sales Debtors turnover ratio= ___________________
Average trade debtors Opening trade debtors +Closing trade debtors Average trade debtors= _________________________________________ 2 TABLE 3. 1. 10 DEBTORS TURNOVER RATIO (Rs. in lakhs) YearNet Credit SalesAverage Trade DebtorsRatio 2003-2004 122541. 08 13492. 52 9. 08 2004-2005 137427. 79 16427. 74 8. 37 2005-2006 181875. 53 21198. 54 8. 58 2006-2007 260439. 47 25039. 86 10. 40 2007-2008 353704. 35 28564. 16 12. 38 Sources: Annual report of THE INDIA CEMENTS LIMITED. Table 3. 1. 10 shows the debtors turnover ratio of THE INDIA CEMENTS LIMITED. The highest ratio was 12. 38 in the year 2007-2008 and the lowest ratio was 8. 37 in the year 2004-2005.
The increased ratio shows that the debtors are converted into cash and decreasing ratio shows that the credit sales get decreased when compared to average debtors. CHART 3. 1. 10 3. 1. 11 CREDITORS TURNOVER RATIO Creditors’ turnover ratio is also known as payable turnover ratio. This ratio indicates the velocity with which the creditors are turned over to in relation to the purchase. A supplier of goods, i. e. , creditors is naturally interested in finding out how much time the firm in likely to taken in repaying its trade creditors. Generally, higher the creditors’ velocity better it is or otherwise lower the creditors’ velocity, unfavorable will be the results. Net credit purchase Creditors turnover ratio= ___________________ Average trade creditors
Opening trade creditors +Closing trade creditors Average trade creditors= _________________________________________ 2 TABLE 3. 1. 11 CREDITORS TURNOVER RATIO (Rs. in lakhs) YearNet Credit PurchaseAverage Trade CreditorsRatio 2003-2004 12859. 31 17153. 77 0. 75 2004-2005 14674. 60 13399. 01 1. 10 2005-2006 18988. 48 13306. 10 1. 43 2006-2007 24220. 72 13341. 54 1. 82 2007-2008 31294. 80 38785. 95 0. 81 Sources: Annual report of THE INDIA CEMENTS LIMITED. Table 3. 1. 11 shows the creditors’ turnover ratio of THE INDIA CEMENTS LIMITED. The ratios showed an increasing trend except 2007-2008. The lowest ratio was found at 0. 75 in the year 2003-2004 and the highest ratio was found at 1. 2 in the year 2006-2007 which shows a better settlement regarding dues. CHART 3. 1. 11 3. 1. 12 INVENTORY TURNOVER RATIO Inventory or stock turnover ratio shows the relationship between costs of goods sold and average inventory or stock. It is also called as merchandise turnover ratio. It indicates the number of times the stock is turnover or converted into sales. The objective of stock turnover ratio is to know how efficiently the stock or inventory is utilized. Stock turnover ratio is computed by the following formula: Cost of goods sold Inventory turnover ratio= _______________________ Average stock Opening stock + Closing stock Average stock= ___________________________ 2 TABLE 3. 1. 12
INVENTORY TURNOVER RATIO (Rs. in lakhs) YearCosts of goods soldAverage inventoryRatio 2003-2004 48475. 56 13170. 70 3. 68 2004-2005 58072. 34 15728. 08 3. 69 2005-2006 67290. 13 18643. 98 3. 61 2006-2007 79120. 62 21052. 62 3. 76 2007-2008 100369. 30 27914. 22 3. 60 Sources: Annual report of THE INDIA CEMENTS LIMITED. Table 3. 1. 12 shows the inventory turnover ratio of THE INDIA CEMENTS LIMITED. The ratio shows the fluctuation trend from 2003-2004 to 2007-2008. The increased ratio reveals that the company is maintaining more stock level. The decreased ratio shows the average inventory is not raised when compared to sales level. CHART 3. 1. 12 3. 1. 3 FIXED ASSET TURNOVER RATIO A business enterprise purchases fixed assets for carrying out the business. Without fixed assets, it cannot make sales and profits. Thus sales depend on how fixed assets are utilized in business. For knowing whether fixed asset are effectively, utilized or not, fixed asset turnover ratio is used. Fixed asset turnover ratio establishes the relationship between net sales and fixed assets. It measures the efficiency with which a firm is utilizing its fixed assets in producing sales. It is computed as follows: Net sales Fixed asset turnover ratio=___________________ Fixed asset TABLE 3. 1. 13 FIXED ASSET TURNOVER RATIO Rs. in lakhs) YearNet SalesFixed AssetRatio 2003-2004 122541. 08 233387. 44 0. 53 2004-2005 137427. 79 220484. 55 0. 62 2005-2006 181875. 53 211497. 00 0. 86 2006-2007 260439. 47 293858. 26 0. 89 2007-2008 353704. 35 403937. 17 0. 88 Sources: Annual report of THE INDIA CEMENTS LIMITED. Table 3. 1. 13 shows the fixed asset turnover ratio of THE INDIA CEMENTS LIMITED. The ratio shows an increasing trend except in the year 2007-2008. The highest ratio was 0. 89 in the year 2006-2007 and the lowest ratio was 0. 53 in the year 2003-2004. It was increased from 0. 53 to 0. 89. It indicates the better utilization of fixed asset. CHART 3. 1. 13 3. 1. 4 INVENTORY TO CURRENT ASSET The ratio indicates the amount of investment in inventory per rupee of current assets investment. It also indicates the state of liquidity positions of current assets. Generally an increasing proportion of inventory is an indication of inefficient inventory management. The higher the proportion of inventory to current assets lowers the liquidity. Average inventory Inventory to current asset= ___________________ Current assets TABLE 3. 1. 14 INVENTORY TO CURRENT ASSET (Rs. in lakhs) YearAverage inventoryCurrent AssetsRatio 2003-2004 13170. 70 130817. 59 0. 10 2004-2005 15728. 08 136844. 89 0. 11 2005-2006 18643. 98 51241. 62 0. 12 2006-2007 21052. 62 171751. 40 0. 12 2007-2008 27914. 22 214941. 24 0. 13 Sources: Annual report of THE INDIA CEMENTS LIMITED. Table 3. 1. 14 shows the inventory to current asset ratio of THE INDIA CEMENTS LIMITED. The ratio shows an increasing trend. The highest ratio was 0. 13 in the year 2007-2008 and the lowest ratio was 0. 10 in the year 2003-2004. The lowest ratio indicates the inventory was managed efficiently. CHART 3. 1. 14 3. 1. 15 INVENTORY TO SALES This ratio explains the manner in which a company’s inventory is turning. The inventory to sales ratio indicates the efficiency with which inventory turns in the sales.
However the ratio more efficiently the inventory is said to be managed. The high ratio indicates the unsound liquidity position of the company. Average inventory Inventory to sales= ___________________ Net sales TABLE 3. 1. 15 INVENTORY TO SALES (Rs. in lakhs) YearAverage inventoryNet SalesRatio 2003-2004 13170. 70 122541. 08 0. 11 2004-2005 15728. 08 137427. 79 0. 11 2005-2006 18643. 98 181875. 53 0. 10 2006-2007 21052. 62 260439. 47 0. 08 2007-2008 27914. 22 353704. 35 0. 08 Sources: Annual report of THE INDIA CEMENTS LIMITED. Table 3. 1. 15 shows the inventory to sales of THE INDIA CEMENTS LIMITED. The highest ratio was 0. 08 in the year 2007-2008 and the lowest ratio was 0. 11 in the year 2003-2004.
It was decreased from 0. 11 to 0. 08. It indicates the inventory was managed efficiently because more frequently the stock was sold. CHART 3. 1. 15 3. 1. 16 WORKING CAPITAL TURNOVER RATIO Current assets will change with change in sales. This means working capital is related with sales. The relation between sales and working capital is called working capital turnover ratio. This ratio shows how many times the working capital is turned over to produce sales. Working capital turnover ratio is computed by the following formula: Net sales Working capital turnover ratio= ___________________ Working capital TABLE 3. 1. 16 WORKING CAPITAL TURNOVER RATIO (Rs. n lakhs) YearNet SalesWorking CapitalRatio 2003-2004 122541. 08 111066. 28 1. 10 2004-2005 137427. 79 106117. 47 1. 30 2005-2006 181875. 53 113928. 94 1. 60 2006-2007 260439. 47 128352. 26 2. 02 2007-2008 353704. 35 116588. 00 3. 03 Sources: Annual report of THE INDIA CEMENTS LIMITED. Table 3. 1. 16 shows the working capital turnover ratio of THE INDIA CEMENTS LIMITED. The highest ratio was 3. 03 in the year 2007-2008 and the lowest ratio was 1. 10 in the year 2003-2004. There is an increasing trend in working capital and it indicates that the company is generating a lot of sales compared to the money it uses to fund the sales. CHART 3. 1. 16 3. 2. FUND FLOW STATEMENT
The fund flow statement is a statement which reveals the method by which the business has been financed and how it has used its funds between two balance sheet dates. In the words if Foulke:”A statement of sources and application of funds is a technical device, designed to analyze the changes in the financial conditions of a business enterprise between two balance sheet dates”. MANAGERIAL USES OF FUND FLOW STATEMENT Fund flow statement is an invaluable analytical tool for a financial manager for the purpose of evaluating of funds by a firm and also to assess sources of such funds. Following are the important managerial uses of fund flow statement. The foremost use of the fund flow statement is to explain the reasons for changes in the asset and liabilities between two balance sheet dates. ?Fund flow statement gives details about the funds obtained and used in past. Based upon this detail, manager can take correct actions at appropriate times. ?Fund flow statement act as a control device when compared with budgeted figures. It also gives guidance to the financial manager for taking remedial action if there is any deviation. ?It helps the management to formulate various financial policies – viz dividend, bonus etc. ?With the help of the fund flow statement, financial and leading institutions can easily evaluate the credit worthiness and repaying capacity of the borrowing company. It enables the management to reformulate the firm’s financial activity on the basis of the statement. 3. 2. 1 STATEMENT OF CHANGES IN WORKING CAPITAL FOR THE YEAR ENDED 2004 AND 2005 (Rs. in lakhs) Particulars20042005Effect on working capital _____________________ Increase Decrease Current assets Inventories 13466. 03 17990. 12 4524. 09 Real estate-projects in progress 2440. 74 2170. 03 270. 71 Sundry debtors 14517. 02 18338. 45 3821. 43 Cash and Bank balance 372. 23 292. 06 80. 17 Loans and advances 100021. 57 98054. 23 1967. 34 Total current assets(A) 130817. 59 136844. 89 Current Liabilities Current liabilities 19632. 48 30585. 61 10953. 3 Provision for taxation 118. 83 141. 81 22. 98 Total current liabilities(B) 19751. 31 30727. 42 Working Capital (A-B) 111066. 28 106117. 47 Decrease in working capital 4948. 81 4948. 81 111066. 28 111066. 28 13294. 33 13294. 33 Sources: Annual report of THE INDIA CEMENTS LIMITED. Adjusted P/L A/C Particulars (Rs. in lakhs) Particulars (Rs. in lakhs) To Balance b/d 31242. 05 By Dividend received 19. 61 To Depreciation 7876. 95 By Interest on investment 127. 97 To Provision for taxation 141. 81 By Income from subsidiary 1409. 64 By Profit on sale of asset 431. 68 By Funds lost in operation 6487. 98 By Balance c/d 30783. 93 39260. 81 9260. 81 Sources: Annual report of THE INDIA CEMENTS LIMITED. 3. 2. 2 FUND FLOW STATEMENT OF ICL FOR THE YEAR ENDED 31ST MARCH 2005 SOURCES (Rs. in lakhs) APPLICATIONS (Rs. in lakhs) Issue of shares 0. 06 Repayment of secured loan 8762. 05 Sale of fixed asset 12092. 89 Repayment of unsecured loan 1777. 38 Decrease in working capital 4948. 81 Purchase of investment 14. 35 Fund lost in operation 6487. 98 17041. 76 17041. 76 Sources: Annual report of THE INDIA CEMENTS LIMITED. In the year 2004, working capital was Rs. 111066. 28. But in the year 2005, working capital was Rs. 106117. 47. Thus there is a decrease in working capital of Rs. 4948. 81.
A decrease in working capital is observed due to significant decrease in current liabilities, loans and advances and cash and bank balance. An increase is observed in Inventories and sundry debtors. The net result is decrease in Working capital. 3. 2. 3. STATEMENT OF CHANGES IN WORKING CAPITAL FOR THE YEAR ENDED 2005 AND 2006 (Rs. in lakhs) Particulars20052006Effect On Working Capital ______________________ Increase Decrease Current assets Inventories 17990. 12 19297. 84 1307. 72 Real estate-projects in progress 2170. 03 2084. 38 85. 65 Sundry debtors 18338. 45 24058. 62 5720. 17 Cash and Bank balance 292. 06 4362. 18 4070. 12 Loans and advances 8054. 23 101438. 60 3384. 37 Total Current assets(A) 136844. 89 151241. 62 Current Liabilities Current liabilities 30585. 61 37312. 68 6727. 07 Provision for taxation 141. 81 – 141. 81 Total current liabilities(B) 30727. 42 37312. 68 Working Capital (A-B) 106117. 47 113928. 94 Increase in working capital 7811. 47 7811. 47 113928. 94 113928. 94 14624. 19 14624. 19 Sources: Annual report of THE INDIA CEMENTS LIMITED. Adjusted P/L A/C Particulars (Rs. in lakhs) Particulars (Rs. in lakhs) To Balance b/d 3078. 93 By Dividend received 21. 23 To Depreciation 7886. 95 By Interest on investment 545. 55 To Loss on sale of fixed asset 9. 76
By Income from subsidiary 23963. 10 To Funds from operation 39806. 86 By Balance c/d 26252. 62 50782. 50 50782. 50 Sources: Annual report of THE INDIA CEMENTS LIMITED. 3. 2. 4 FUND FLOW STATEMENT OF ICL FOR THE YEAR ENDED 31ST MARCH 2006 SOURCES (Rs. in lakhs) APPLICATIONS (Rs. in lakhs) Issue of shares 5218. 14 Repayment of secured loan 44189. 93 Sale of fixed asset 8987. 55 Repayment of unsecured loan 2011. 15 Funds from operation 39806. 86 Increase in working capital 7811. 47 54012. 85 54012. 85 Sources: Annual report of THE INDIA CEMENTS LIMITED. In the year 2005, working capital was Rs. 106117. 47. But in the year 2006, working capital was Rs. 113928. 94.
Thus there is an increase in working capital of Rs. 7811. 47. An increase in working capital is observed due to increase in inventories, loans and advances, sundry debtors and cash balances and decrease in current Liabilities. The net result is Increase in Working capital. 3. 2. 5. STATEMENT OF CHANGES IN WORKING CAPITAL FOR THE YEAR ENDED 2006 AND 2007 (Rs. in lakhs) Particulars20062007Effect On Working Capital ______________________ Increase Decrease Current Assets Inventories 19297. 84 22807. 39 3509. 55 Real estate-projects in progress 2084. 38 2042. 47 41. 91 Sundry debtors 24058. 62 26021. 09 1962. 47 Cash and Bank balance 4362. 18 23018. 2 18656. 14 Loans and advances 101438. 60 97862. 13 3576. 47 Total Current Assets(A) 151241. 62 171751. 40 Current Liabilities Current liabilities 37312. 68 40352. 90 3040. 22 Provision for taxation – 3046. 24 3046. 24 Total Current Liabilities(B) 37312. 68 43399. 14 Working Capital (A-B) 113928. 94 128352. 26 Increase in working capital 14423. 32 14423. 32 128352. 26 128352. 26 24128. 16 24128. 16 Sources: Annual report of THE INDIA CEMENTS LIMITED. Adjusted P/L A/C Particulars (Rs. in lakhs) Particulars (Rs. in lakhs) To Depreciation 10262. 88 By Balance b/d (26252. 62) To Provision for taxation 3046. 24 By Dividend received 25. 0 To Discount on issue of shares 48812. 78 By Interest on investment 173. 98 To Proposed dividend 3046. 24 By Funds from operation 195180. 25 To Transfer to reserve 99102. 86 To Balance c/d 4656. 63 168927. 63 168927. 63 Sources: Annual report of THE INDIA CEMENTS LIMITED. 3. 2. 6. FUND FLOW STATEMENT OF ICL FOR THE YEAR ENDED 31ST MARCH 2007 SOURCES (Rs. in lakhs) APPLICATIONS (Rs. in lakhs) Issue of shares 4460. 16 Repayment of secured loan 23739. 81 Fund from operation 195180. 25 Repayment of unsecured loan 77092. 18 Purchase of fixed asset 82361. 26 Purchase of investment 2023. 84 Increase in working capital 14423. 32 199640. 61 199640. 61
Sources: Annual report of THE INDIA CEMENTS LIMITED. In the year 2007, working capital was Rs. 128352. 26. But in the year 2006, working capital was Rs. 106117. 47. Thus there is an increase in working capital of Rs. 14423. 32. An increase in working capital is observed due to significant increase in cash balance, sundry debtors and inventories and decrease in loans and advances and current Liabilities . The net result is Increase in Working capital. 3. 2. 7. STATEMENT OF CHANGES IN WORKING CAPITAL FOR THE YEAR ENDED 2007 AND 2008 (Rs. in lakhs) Particulars20072008Effect On Working Capital ______________________ Increase Decrease Current assets Inventories