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This document discusses cash and receivables management for Aavin Diary, an Indian dairy company. It aims to analyze the company's liquidity and cash flow positions through ratio analysis of financial statements from 2008-2013. Key ratios examined include current ratio, quick ratio, and inventory turnover ratio to evaluate the company's short-term financial health and ability to meet obligations. The document outlines the objectives, scope, and methodology of the study which utilizes secondary financial data to calculate ratios and assess Aavin Diary's cash management practices.
This document discusses cash and receivables management for Aavin Diary, an Indian dairy company. It aims to analyze the company's liquidity and cash flow positions through ratio analysis of financial statements from 2008-2013. Key ratios examined include current ratio, quick ratio, and inventory turnover ratio to evaluate the company's short-term financial health and ability to meet obligations. The document outlines the objectives, scope, and methodology of the study which utilizes secondary financial data to calculate ratios and assess Aavin Diary's cash management practices.
This document discusses cash and receivables management for Aavin Diary, an Indian dairy company. It aims to analyze the company's liquidity and cash flow positions through ratio analysis of financial statements from 2008-2013. Key ratios examined include current ratio, quick ratio, and inventory turnover ratio to evaluate the company's short-term financial health and ability to meet obligations. The document outlines the objectives, scope, and methodology of the study which utilizes secondary financial data to calculate ratios and assess Aavin Diary's cash management practices.
Cash and receivables management is important because unless the cash and receipt management is managed effectively, monitored efficiently planed properly and reviewed periodically at regular intervals to remove bottleneck if any the company cannot earn profits and increase its turnover. 1.3 Objectives of the study To meet the Cash Disbursement needs. To know the sources of Cash Inflow and uses of Cash Outflow in Aavin Diary. To determine how short term / current obligations of the Company are met by the Liquidity Ratio. To offer suggestions and recommendations to improve the cash position of Aavin diary.
1.4 Scope and limitation of the study Scope of the study This study helps to take short term financial decision. It indicates the cash requirement needed for plant or equipment expansion programmes. To find strategies for efficient management of cash. It helps to meet routine cash requirement to finance the transaction. It reveals the liquidity position of the firm by highlighting the various sources of cash audits uses.
1.5 RESEARCH METHODOLOGY A research design is the arrangement of conditions for collection and analysis of data in a manner that aims to combine relevance to the research purpose with economy in procedure. DATA COLLECTION: The required data for the study are basically secondary in nature and data are collected from the audited annual reports of the company. AREA OF STUDY The study was carried out in the Aavin diary. 2
PERIOD OF STUDY The sources of data are from annual reports of the company from the year 2008 to 2012- 2013. TOOLS USED Ratio analysis Ratio analysis is a technique of analysis and interpretation of financial statement. It is the process of establishing and interpreting various ratios for helping in making certain decision. It is only a means of better understanding of financial strength and weakness of a firm. It aims at making use of quantitative information for decision-making. It is a yardstick, which measures relationship between two variables. Ratios are simply a means of highlighting in arithmetical terms the relationship between figures drawn from various financial statements. In other words, a financial ratio is the relationship between two accounting figures expressed mathematically. Ratio analysis is the most important method of financial analysis. The two aspects of the financial strength of any business are the short term and long term. CLASSIFICATION OF RATIO Ratio may be classified into the four categories as follows Liquidity Ratio a) Current Ratio b) Quick Ratio or Acid Test Ratio c) Absolute Liquidity Ratio Activity Ratio or Turnover Ratio a) Stock Turnover Ratio b) Debtors or Receivables Turnover Ratio c) Average Collection Period d) Creditors or Payables Turnover Ratio e) Average Payment Period f) Fixed Assets Turnover Ratio 3
g) Working Capital Turnover Ratio 2. Cash flow statement 3. Fund flow statement 4. Trend analysis 5. Correlation LIQUIDITY RATIO It refers to the ability of the firm to meet its current liabilities. The liquidity ratio, therefore,
are also called 'Short-term Solvency Ratio'. These ratios are used to assess the Short-term financial position of the concern. They indicate the firm's ability to meet its current obligation out of current resources. Liquidity ratio includes : 1. Current Ratio 2. Quick Ratio or Acid Test Ratio 3. Absolute Liquid Ratio 4
1. Current Ratio Current ratio may be defined as the relationship between current assets and current liabilities. Current ratio is a measure of the firm's short-term solvency. The basic components of this ratio are current assets and current liabilities. Current assets are those assets the amount of which can be realized within a period of one year. Current liabilities are those amount which are payable with in a period of one year. The formula used for calculating current ratio can be expressed as follows: Current Ratio=Current Assets/Current Liabilities A current ratio of 2:1 is considered as satisfactory. A relatively high current ratio is an indication that the firm is liquid and has the ability to pay its current obligations in time as and when they become due. On the other hand, a relatively low current ratio represents that the liquidity position of the firm is not good and the firm shall not be able topay its current liabilities in time without facing difficulties. The ratio is computed to judge the ability of the concern to meet its current obligation. 2. Quick Ratio or Acid Test Ratio Quick ratio, also known as Decisive Test ratio or Liquid ratio is a measure of judging the liquidity. The term 'liquidity' refers to the ability of a firm to pay its short-term obligation as and when they current due. Quick ratio may be defined as the relationship between quick/liquid assets and current or liquid liabilities. Current assets include inventories and prepaid expenses, which are not easily convertible into cash within a short period. So for calculating quick ratio cannot take inventories and prepaid expenses. The formula used for calculating quick ratio can be expressed as follows:- Quick Ratio = Quick Assets/Current Liabilities An acid test ratio of 1:1 is considered satisfactory as a firm can easily meet all its current liabilities. A higher ratio indicates sound financial position and vice - versa.
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3. Absolute Liquid Ratio This ratio analyses the position of cash in current assets. Absolute liquid assets include cash in hand and cash at bank and marketable securities or temporary investments. It is also known as cash position ratio. The formula used for calculating absolute liquid ratio can be expressed as follows: Absolute Liquid Ratio= Absolute Liquid Assets/ Current Liabilities [Absolute Liquid Ratio= Cash& Bank + Marketable Securities/Current Liabilities] The acceptable norm for this ratio is 50% or 0.5:1 or 1:2 i.e. Re.l worth absolute liquid assets are considered adequate to pay Rs.2 worth current l iabilities in time asall the creditors are not expected to demand cash at the same time and then cash may also be realized from debtors and inventories. ACTIVITY RATIO OR TURNOVER RATIO These ratios are calculated on the bases of 'cost of sales' or sales, therefore, these ratios are also called as 'Turnover Ratio'. Turnover indicates the speed or number of times the Capital employed has been rotated in the process of doing business. Higher turnover ratio indicates the better use of capital or resources and in turn leads to higher profitability. It includes the following 1. Working Capital Turnover Ratio Working Capital Turnover ratio indicates the velocity of the utilization of net working capital. This ratio measures the efficiency with which the working capital is being used by a firm. A higher ratio indicates efficient utilization of working capital and low ratio indicates other inefficient utilization of working capital. The ratio is computed to test the efficiency with which the net working capital is utilized. In other words, this ratio indicates whether working capital is efficiently used in making sales. This ratio can be calculated as 6
Working Capital Turnover Ratio= Sales/ Net Working Capital An increasing ratio indicates that working capital is more active than it has been in the past while a decreasing ratio indicates that the company is using working capital less economically 2. Inventory Turnover Ratio Inventory turnover ratio also known as stock velocity is normally calculated as sales/average inventory or cost of goods sold/average inventory. It would indicate whether inventory has been efficiently used or not. The purpose is to see whether only the required minimum funds have been locked up in inventory. This ratio helps in understanding the time taken for clearing the stocks. In other words, Inventory Turnover Ratio indicates the number of times the stock has been turned over during the period and evaluates the efficiency with which a firm is able to manage its inventory. Inventory Turnover Ratio=Net Sales/ Average Inventory A high inventory turnover ratio is indicative of good inventory management because more frequently the stocks are sold; the lesser amount of money is required to finance the inventory. A lower inventory turnover ratio suggests an inefficient inventory management because a low inventory turnover ratio implies over- investment in inventories, dull business, and poor quality of goods, stock accumulations, accumulation of obsolete and slow moving goods and low profit as compared to total investments. A higher turnover does not always bring high net income or profit. Sometimes high turnover may be obtained by lowering the selling price but that will not increase the profit. However, a high ratio is better than a low ratio. 3. Debtors Turnover Ratio Debtor's turnover ratio indicates the velocity of debt collection of firm. In simple words, it indicates the number of times average debtors are turned over during a year. Debtor's turnover ratio is also known as Debtors velocity or Receivables Turnover ratio. The liquidity position of the firm depends on the quality of debtors to 7
a great extend. It measures how fast debts are collected. The ratio is used to analyze the operational efficiency of the concern. It is calculated by the following formula: Debtors Turnover Ratio = Net Credit Sales/ Average Debtors Trade Debtors = Sundry Debtors + Bills Receivables and Accounts Receivables. Average Debtors = Opening Debtors + Closing Debtors/ 2 But when the information about opening and closing balance of trade debtors and credit sales is not available, then the debtors' turnover ratio can be calculate by dividing the total sales by the balance of debtors (inclusive of bills receivables). It is calculated by the following formula: Debtors Turnover Ratio = Total Sales / Debtors Debtors' velocity indicates the number of times the debtors are turned over during a year. Generally, the higher the value of debtors turnover the more efficient is the management of debtors/ sales or more liquid are the debtors. Similarly, low debtors turnover ratio implies inefficient management of debtors/sales and less liquid debtors. 4. Creditors Turnover Ratio In the course of business operations, a firm has to make credit purchases and incur short - term liabilities. A supplier of goods, i.e., creditors, is naturally interested in finding out how much time the firm is likely to take in repaying its trade creditors. In other words Creditors turnover ratio shows that the time given to the firm by the creditors to make payment for the credit purchases. Creditors Turnover Ratio is also known as Creditors Velocity or Payable Turnover Ratio. This ratio can be calculated by the following formula: Creditors Turnover Ratio = Creditors Purchases/ Average Accounts Payable If the information about credit purchases is not available, the figure of total purchases may .be taken as the numerator and the creditors include sundry creditors 8
and bills payable. In this case, Creditors Turnover Ratio can be calculated by the following formula Creditors Turnover Ratio = Purchases/ Total Creditors The ratio indicates the velocity with which the creditors are turned over in relation to purchases. Generally, higher the creditors velocity better it is or otherwise lower the creditors velocity, less favorable the results. 5. Average Collection Period The average collection period represents the average number of days for which the firm has to wait before its receivables are converted into cash. Average collection period is a measure of receivables turnover. This ratio shows the credit and collection policies of the firm and the effectiveness of collection policies. It is calculated as follows: Average Collection Period = Days in a year (365)/ Debtors Turnover Ratio It measures the quality of debtors. Generally, the shorter the average collection period the better is the quality of debtors. A short collection period implies quick payment by debtor. Similarly, a higher collection period implies an inefficient collection performance, which in turn adversely affects the liquidity or short term paying capacity of a firm out of its current liabilities. Moreover, longer the average collection periods, larger are the chances of bad debts. 6. Average Payment Period This ratio represents the average number of days taken by the firm to pay to its creditors. For calculating the average disbursement period, the number of days in a year is divided by the creditors' turnover ratio. It can be calculated as follow Average payment Period = Days in a year / Creditors Turnover Ratio In the study, it is assumed that whole purchases are on credit basis. Generally, lower the ratio, the better is the liquidity position of the firm and higher the ratio, less liquid is the position of the firm. However, a higher payment period also implies 9
greater credit period enjoyed by the firm and consequently larger the benefit reaped from credit suppliers. This will also lead to lesser discount facilities and higher prices for the credit purchases.
Limitation of the study 1. The analysis is based on figures present in the internal records only. 2. It consumes more time and requires lots of expenditure. More time is needed to do this study. 3. This study is limited to the consumption pattern of the various user departments. 4. This study is limited to five years only. i.e. 2008-2009 to 2012-2013 5. The data collected for computation has been in quantitative terms rather than qualitative as it involves cost aspect.
2.4 REVIEW OF LITERATURE A tight cash management policy leads to a rise in the financial transaction costs of the firm. As suggested by Briggs and Singh (2000), if a firm decides to hold small amounts of cash, it has to have access to the money and capital markets or sell assets. The cost of both these options would induce a company to use these alternatives sparingly. On the other hand, if a firm holds more cash than necessary, it will incur the opportunity costs of money. The transaction models assume that a firm follows a cash management policy which tries to minimize these costs, or maximize the profits from cash management. In addition to this inventory theoretic approach, the other theories presented in the monetary theory are the production, wealth, and agency theories based on the theory of the firm. Financial theory considers the cash management problem in the framework of the valuation and capital structure of a firm. As we will see, there have been many attempts to model the cash management problem. This is not an easy task on a theoretical level because of its complicated nature in practice, too. The management of cash flows requires careful analysis and coordination of many interacting factors. A cash manager must make interrelated decisions about the allocation of monetary assets while simultaneously keeping up with institutional financial constraints, such as those affecting average cash balances and cash management costs. Because of the complexity of the decision processes of cash 10
management, the survey research tries to increase awareness of the practical issues of cash management. The basic behavioral models presented in monetary theory can also be seen as a background for the many subsequent normative models which have been developed for cash management planning and decision-making purposes. Such normative models generally try to optimize the split between cash and marketable securities based on the firms needs for cash, the predictability of these needs, the interest rate on marketable securities, and the cost of a transfer to cash and vice versa.
Monetary theoretic approach to cash management Monetary economists are interested in the cash management of firms. The objective has been to describe the mechanism of the demand for money by firms, because it differs from the behavior of other economic agents. Researchers have tried to find a stable relationship between the quantity of money and its determinants in order to forecast demand for money. A narrow definition of cash management consists of financial transactions, which means the purchasing or selling of financial securities or borrowing or repaying of capital. Many behavioral models describe especially the behavior of these operations.
Inventory theoretic approach to cash management
Numerous theories have been evinced to explain the cash management behavior of firms. Almost all of these theories can be generalized into a proposition of the existence of a stable relationship between a few important independent variables and the stock of money demanded (on the theoretical background of these relationships, see e.g. Harris 1981 and Cuthbertson 1988). The two basic transaction models most commonly accepted in the financial literature are the deterministic Baumol-Tobin and the stochastic Miller-Orr inventory models. These models are presented in monetary theory and are consistent with the theory of the firm. (Baumol 1952, Tobin 1956, and Miller and Orr 1966). Baumol (1952) suggested that cash balances could be treated in the same way as inventories of goods. A stock of cash is its holders inventory, and like an inventory of a commodity, cash is held because it can be given up at the appropriate moment, serving then as its processors part of the bargain in an exchange. The firm is presumed to hold the amount 11
of money, which minimizes the interest cost by holding money rather than investing it in short-term investments and the transaction costs associated with transferring between securities and cash. In this framework the firm is assumed to finance its expenditures by selling securities or by borrowing and the firm has a steady stream of expenditures but has no receipts. In practice, the behavior is more complicated and the cash balances are the result of the imperfect synchronization of expenditures and receipts, which are often uncertain. This uncertainty is included in the stochastic cash management model derived by Miller and Orr (1966). This approach permits net cash flows to fluctuate in a completely stochastic way. Unfortunately, this feature is offset by the fact that the model is only capable of dealing with two types of assets cash and marketable securities and does not incorporate payables. Both models referred to above imply that there are economies of scale in the use of money or, equivalently, that the elasticity of the demand for money with respect to transactions is less than one. In these models the scale operator is transactions volume, mostly measured by sales. There are, however, also alternative measures presented in the demand for money literature, such as wealth, production, and market capitalization. In their model, Attanasio et al.(2002) measured transaction costs with the time costs. The cash manager is assumed to need time to make transactions and that money is a way of saving on transaction time, and optimal money balances are chosen in order to trade off the time cost of transactions against the cost of holding money instead of an interest-bearing asset yielding a nominal return per period. The cash manager chooses money to minimize the sum of the cost of transaction time and forgone interest, subject to a transaction technology. Frazer (1964) concluded that the effect of increasing firm size is to reduce bank indebtedness as a percentage of assets, weaken the precautionary motive for holding cash relative to other assets, and transfer cash as a percentage of assets to securities.
As Scaglione and Pracheer (2002) point out, with emphasis on cash generation and preservation, treasurers of firms will be called upon to ensure that the companys financial objectives are being met efficiently. As a result, they should implement best practices in treasury and financial risk management to maximize cash flow and transparency effectively. Initially, key areas that treasurers should focus on to meet 12
this objective include bank management and structure, cash forecasting, financial tools, and technology.
According to the evidence of their study, Shin and Soenen (1998) found that 1. a strong negative association exists between the firms NTC and its profitability, and 2. individual firms stock returns are significantly negatively correlated with the length of the firms NTC. The results concerning NTC indicated that it is also closely related to the issue of firm valuation and the creation of shareholder value.
According to Lee (2001), cash management involves the administration of liquid assets and liabilities, and the raising of funds to finance a business. Cash-flow control is therefore crucial to ensuring that a business remains liquid and able to meet payment obligations. This is carried out through the effective management of cash receipts and payments, cash balances and cash transfers between the different parts of a business. REFERENCES 1. Briggs, G.P. and S. Singh 2000. Is cash king? Afp Exchange. 20:2, 32-39. 2. Harris, L. 1981. Monetary Theory. McGraw-Hill Inc. 3. Cuthbertson, K. 1988. The Supply and Demand for Money. Basil Blackwell Ltd. 4. Baumol, W.J. 1952. The transactions demand for cash: An inventory theoretic approach. Quarterly Journal of Economics. (November), 545-556. 5. Tobin, J. 1956. The interest-elasticity of transaction demand for cash. Review of Economics and Statistics (August), 241-247. 6. Miller, M.H. and D. Orr 1966. A model of the demand for money by firms. Quarterly Journal of Economics. (August), 413-434. 7. Attanasio, O.P., L. Guiso, and T. Japelli 2002. The demand for money, financial innovation, and the welfare cost of inflation: an analysis with household data. Journal of Political Economy.110:2, 317-351 8. Lee, J. 2001. The cash management conundrum. Asiamoney. 12:2, 80-82. 9. Scaglione, A. and B. Pracheer 2002. Renewing the focus on cash preservations considerations for a streamlined approach to cash management. Afp Exchange. 22:1, 48-50. 13
10. Frazer, Jr., W.J. 1964. The financial structure of manufacturing corporations and the demand for money - some empirical findings. Journal of Political economy 72, 176-183. 11. Shin, H-H. and L.A. Soenen 1998. Efficiency of working capital management and corporate profitability. Financial Practice & Education. 8:2, 37-45.