201

NMIMS University School of Business Management

V. L. Mehta Road, Vile Parle (West), Mumbai- 400056

Project Report on
Declaration
TRADE FINANCE carried at
I hereby declare that the report on “TRADE FINANCE” that has been submitted to NMIMS
SUBMITTED BY: CORPORATE GUIDE:
University School of Business Management and Bank of India, Sion (west), Mumbai towards
[Relationship Beyond Banking]
ABHINAV KUMAR Mr.
Partial Fulfillment of myM.V.RANGNEKAR
Master of Business Administration Programme is my original and
Branch Office :MALAD (W),MUMBAI
bonafide work
MBA,NMIMS. Chief
Manager(Officiating),
I also certify that to the best of knowledge and beliefs this work has not been worried out another
BOI
person or group of person or an
MALAD WEST
Project Report on FACULTY GUIDE :
organization as a whole.
[Type the document subtitle]

[Type the abstract of the document here. The

abstract is typically a short summary of the
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 ACKNOWLEDGEMENT
NARSEE MONJEE INSTITUTE OF MANAGEMENT STUDIES,VILE
PARLE (W),MUMBAI
At the very onset, I must express my profound gratitude to Chief Manager - Mr.M.V.Rangnekar
who has given me an opportunity to carry out this project work.

I wish to express my deep sense of gratitude to my Guide, Ms. S. Nigudkar, Manager (Credit)
for his able guidance and useful suggestions, which helped me in completing the project work, in
time.

Words are inadequate in offering my thanks to the Project Trainees and Project Assistants, BOI
for their encouragement and cooperation in carrying out the project work.

I would like to express my sincere gratitude to my college for allowing me to do this project with
sufficient time.

Finally, yet importantly, I would like to express my heartfelt thanks to my beloved parents for
their blessings, my friends/classmates for their help and wishes for the successful completion of
this project.

Abhinav Kumar

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 EXECUTIVE SUMMARY

Banking Industry which is basically my concern industry around which my project has to be
revolved is really a very complex industry.

I am Abhinav Kumar. I did my summer training with Bank of India (www.bankofindia.com)

from April 12, 2010 to June 04, 2010.

I was assigned the task of analyzing the credit health of organizations that approach Bank of
India for credit facilities. After analyzing credit health, the credit rating is determined. On the
basis of credit rating, the interest rate guidelines circular is consulted to fix a price for the credit
facilities i.e. determine the interest rate. This would entail analysis of past and present financial
statements, Balance Sheet, Cash Flow Statements, examination of Profitability statements,
projected financial statements and CMA data.

After doing this study learned that the financial health and credit rating are theoretical methods
for determining the right interest rate. However, in practice, banks consider other factors such as
history with client, market reputation and future benefits with clients. Thus, a difference exists
between theory and practice.

I learnt a lot during the project. Firstly it provided me much needed corporate exposure (working
with team, business communication, prioritizing work). Though we are continuously given inputs
on soft skills and business communication during our program; but there is no better place to
hone these skills than the workplace.

3
 TABLE OF CONTENT

ACKNOWLEDGEMENT

EXECUTIVE SUMMARY

CHAPTER 1-INTRODUCTION TO THE INDUSTRY

1.1 BANKING INDUSTRY IN INDIA
5

1.2 OVERVIEW OF BANK OF INDIA

5

1.3 BANK OF INDIA

7

1.4 PERFORMANCE HIGHLIGHTS FOR BANK OF INDIA

9

CHAPTER 2- WORKING CAPITAL FINANCING (CREDIT DEPARTMENT)

2.1 PROJECT OBJECTIVE
10

2.2 INTRODUCTION TO WORKING CAPITAL FINANCING

10

2.2.1 ESTIMATING WORKING CAPITAL NEEDS

14

2.2.2 WORKING CAPITAL LIMITS

20

2.2.3 LOAN ASSESMENT

21

2.3 METHODOLOGY
22

2.4 SCHEDULE
23

2.5 SCOPE OF STUDY

23

2.4 LIMITATIONS
23

CHAPTER 3-PROPOSAL
3.1 PENGUIN ELECTRONICS INDUSTRIES
24
4
3.2 COMPANY REQUEST
26

3.3 COMMENTS IN BRIEF ABOUT FINANCIAL POSITION OF THE COMPANY

29

3.4 ASSESMENT AND JUSTIFICATION OF PROPOSED LIMITS

31

ANNEXURE

BIBLIOGRAPHY

AUTHOR’S PROFILE

CHAPTER 1-INTRODUCTION TO THE INDUSTRY

Banking Industry In India

There have been major structural changes in the financial sector since banking sector reforms
were introduced in India in 1992. Since then Banks have been lending aggressively providing
funds towards infrastructure sector. Major policy measures include phased reductions in statutory
pre-emption like cash reserve and statutory liquidity requirements and deregulation of interest
rates on deposits and lending, except for a select segment. The diversification of ownership of
banking institutions is yet another feature which has enabled private shareholding in the public
sector banks, through listing on the stock exchanges, arising from dilution of the Government
ownership. Foreign direct investment in the private sector banks is now allowed up to 74 per
cent.

The co-existence of the public sector, private sector and the foreign banks has generated
competition in the banking sector leading to a significant improvement in efficiency and
customer service.

Overview of Bank of India

Background
Bank of India was founded on 7th September, 1906 by a group of eminent businessmen from
Mumbai. The Bank was under private ownership and control till July 1969 when it was
nationalized along with 13 other banks.

5
Beginning with one office in Mumbai, with a paid-up capital of Rs.50 lacs and 50 employees, the
Bank has made a rapid growth over the years and blossomed into a mighty institution with a
strong national presence and sizable international operations. In business volume, the Bank
occupies a premier position among the nationalized banks.

Manpower is the key factor for the success of any organization. Bank of India has a dedicated
family of about 40155 qualified / skilled employees who will and always will be delighted to

extend their services to the customers with heartfelt efforts. The Bank is a Public Sector Unit
with 64.47% Share Capital held by the Government of India. The Bank came out with its Initial

Public Offer (IPO) in 1997. Presently 35.53 % of Share Capital is presently held by Institutions,
Individuals and Others.

The Bank has over the years earned the reputation of being a techno-savvy Bank and is one of
the front runners amongst public sector bank in the field of technology. It is one of the pioneer
public sector banks, which have Core Banking Solution implemented in 2593 branches covering
95.6%of domestic business mix. Bank’s revamped web-site using latest Next Generation Web
2.0 technology was launched. Around 35000 ATMs made available to our card holders through
owned as well as shared ATMs network. SMS alerts for cheque book request and any debits in
accounts through any of the delivery channel like ATM, Internet Banking provided to all
customers. Solar Power System implemented at 143 locations to overcome acute power shortages
and erratic power supply as well as Bank’s commitment towards ‘Go Green’.

Overview of Bank

Items 2006-07 2007-08 2008-09

Business Mix 206673 264805 334440

Deposits 119882 150012 189708

Advances 86791 114793 144732

6
 Table 1:Overview of Bank

1.3 BANK OF INDIA

VISION

“To Become The Bank Of Choice For Corporates, Medium Business And
Upmarket Retail Customers And Developmental Banking For Small Business,
Mass Market And Rural Markets”

MISSION

“To provide superior banking service to niche markets globally, while

providing cost effective, responsive service to others in our role as a
development bank, and in doing so, meet the requirements of our
stakeholders.

QUALITY POLICY

We ,at Bank Of India , are committed to become the bank of choice by

providing SUPERIOR, PRO-ACTIVE, INNOVATIVE, STATE-OF-THE-ART Banking
services with an attitude of care and concern for the customers and patrons.

BRANCH NETWORK AS ON 31.03.10

Head Office Mumbai Metropolitan

628

7
Urban 607 Zonal Offices
48

Semi Urban 701 Rural

1271

Total 3207 Foreign

( Inc.Rep.Office) 29

Extension Counters 57 Total Outlets

3264

RISK MANAGEMENT

• Basel II preparedness: Bank has migrated to Basel II norms as per RBI

guidelines for computation of capital charge from 31.03.08.Steps have
been initiated in preparation for advanced approaches.
• Risk Management Architecture and Risk Management Policies, Tools
and Processes put in place.
• Implementation of Credit Risk Management Software Project started.
Validation of rating model and migration analysis done on regular
basis.
• Stress Testing is carried out on half yearly basis.

CAPITAL ADEQUACY FOR BANK OF INDIA

ADEQUACY OF MARCH . Mar-
CAPITAL 07 Mar-08 Mar-09 Mar-10 10
BASE
BASEL I L II
1372
TIER 1 CAPITAL 5825 9409 12466 13843 5

8
 TIER 2 CAPITAL 4667 5303 5745 7255 7218
2094
TOTAL CAPITAL 10492 14712 18211 21098 3
2749
TOTAL ASSETS 141817 178830 225502 274966 66
1618
RISK WEIGHTED 89261 122221 139931 167008 57
CRAR-TIER 1(%) 6.53 7.7 8.91 8.29 8.48
CRAR-TIER 2(%) 5.22 4.34 4.1 4.34 4.46
CRAR(%) 11.75 12.04 13.01 12.63 12.94

1.4 PERFORMANCE HIGHLIGHTS FOR BANK OF INDIA

ANNUAL ANNUAL
Mar-10 Mar-09
NET PROFIT 1741.07 3007.35
OPERATING PROFIT 4704.77 5456.8
GROSS NPA(%) 2.85 1.71
NET NPA(%) 1.31 0.44
CAPITAL ADEQUACY
RATIO(%)
BASEL I 12.63 13.21
BASEL II 12.94 13.01
RETURN ON AVG
ASSETS(%) 0.7 1.49
COST TO INCOME
RATIO(%) 43.81 36.18
TOTAL BUSINESS 401079 334440
TOTAL DEPOSITS 229762 189708
GROSS CREDIT 171317 144732
CASA RATIO(%) 32 31
AVG COST OF 5.16 5.76

9
DEPOSITS(%)
AVG.YIELD ON ADVANCES 8.42 9.78
CREDIT DEPOSIT
RATIO(%) 74.56 76.29
NET INTEREST MARGIN(%) 2.51 2.97
BUSINESS PER
EMPLOYEE(IN Cr) 10.11 8.33
EPS(Rs.) 33.15 57.26

CHAPTER 2 – Working Capital Financing

2.1 PROJECT OBJECTIVE

• The project is aimed at evaluating the financial status of Penguin
Electronics ltd.
• Studying the working capital management at Penguin Electronics Ltd.
and estimating the working capital requirements for 2008-2009 and
then forecasting for 2009-2010.

2.2 INTRODUCTION TO WORKING CAPITAL FINANCING

FINANCING OF WORKING CAPITAL
The funds that are deployed on short term are mainly used for the working
capital or operating purposes. For the day-to-day operations, a firm will have
to provide money towards the purchase of raw material, payment of salaries
10
of employees, to extent the credit to buyers of goods as well as to meet
other day-to-day obligations. However the firm can secure part of these
funds from its own suppliers of raw material and other needed suppliers.
Therefore, from the total requirement of funds for the operational purposes,
the credit the firm can obtain from others is deducted; the difference would
be the amount of money the firm has to find against the working capital
requirements.

Ratio Analysis of various factors will be done. With the help of ratio analysis
liquidity and profitability of the firm is analyzed.

BALANCED WORKING CAPITAL POSITION

The firm should maintain a sound working capital position. It should have
adequate working capital to run its business operations. Both excessive as
well as inadequate working capital positions are dangerous from the firm’s
point of view.

Excessive working capital means holding costs and idle funds, which earn
no profits for the firm. The dangers of excessive working capital are as
follows:

• It results in unnecessary accumulation of inventories. Thus, chances of

inventory mishandling, waste, theft and losses increase.
• It is an indication of defective credit policy and slack collection period.
Consequently, higher incidence of bad debts results, which adversely
affects profits.
• Excessive working capital makes management complacent which
degenerates into managerial inefficiency.
• Tendencies of accumulating inventories tend to make speculative
profits grow. This may tend to make dividend policy liberal and difficult
to cope with in future when the firm is unable to make speculative
profits.
Inadequate working capital is also bad as it not only impairs the firm’s
profitability but also results in production interrupts and in efficiencies and
sales disruptions. Inadequate working has the following dangers:

• It stagnates growth. It becomes difficult for the firm to undertake

profitable projects for non-availability of working capital funds.

11
 • It becomes difficult to implement operating plans and achieve the
firm’s profit target.
• Operating inefficiencies creep in when it becomes difficult even to
meet day-to-day commitments.
• Fixed assets are not efficiently utilized for the lack of working capital
funds
• Paucity of working capital funds render the firm unable to avail
attractive credit opportunities etc.
• The firm looses its reputation when it is not in a position to honor its
short-term obligations. As a result, the firm faces tight credit terms.

An enlightened management should, therefore maintain the right amount of

working capital on a continuous basis. A firm’s net working capital position is
not only important as an index of liquidity but it is also used as a measure of
the firm’s risk. Risk in this regard means chances of the firm’s being unable
to meet its obligation on due date. The lenders consider a positive net
working capital as a measure of safety. All other things being equal, the
more the net working capital a firm has, the less likely that it will default in
meeting it current financial obligations.

DETERMINANTS OF WORKING CAPITAL

Nature of business:

The working capital requirement of the firm is closely related to the nature of
its business. A service firm, like an electricity undertaking or a transport
corporation, which has a short operating cycle and which sells predominantly
on cash basis, has a modest working capital requirement. On the other hand,
a manufacturing concern like a machine tools unit, which has a long
operating cycle and which sells largely on credit, has a very substantial
working capital requirement.

12
Seasonality of operations:

Firms, which have marked seasonality in their operations usually, have highly
fluctuating working capital requirements. If the operations are smooth and
even through out the year the working capital requirement will be constant
and will not be affected by the seasonal factors.

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.

Market conditions:

The market competitiveness has an important bearing on the working capital

needs of a firm. When the competition is keen, a large inventory of finished
goods is required to promptly serve customers who may not be inclined to
wait because other manufactures are ready to meet their needs. In view of
competitive conditions prevailing in the market the firm may have to offer
liberal credit terms to the customers resulting in higher debtors. Thus, the
working capital requirements tend to be high because of greater investment
in finished goods inventory and account receivables. On the other hand, a
monopolistic firm may not require larger working capital. It may ask
customer to pay in advance or to wait for some time after placing the order.

Conditions of Supply:

The time taken by a supplier of raw materials, goods, etc. after placing an
order, also determines the working capital requirement. If goods as soon as
or in a short period after placing an order, then the purchaser will not like to
maintain a high level of inventory f that good. Otherwise, larger inventories
should be kept e.g. in case of imported goods.

13
Business Cycle Fluctuations:

Different phases of business cycle i.e., boom, recession, recovery etc. also
effect the working capital requirement. In case of recession period there is
usually dullness in business activities and there will be an opposite effect on
the level of wor5king capital requirement. There will be a fall in inventories
and cash requirement etc.

Credit policy:

The credit policy means the totality of terms and conditions on which goods
are sold and purchased. A firm has to interact with two types of credit
policies at a time. One, the credit policy of the supplier of raw materials,
goods, etc., and two, the credit policy relating to credit which it extends to its
customers. In both the cases, however, the firm while deciding the credit
policy has to take care of the credit policy o the market. For example, a firm
might be purchasing goods and services on credit terms but selling goods
only for cash. The working capital requirement of this firm will be lower than
that of a firm, which is purchasing cash but has to sell on credit basis.

Operating Cycle:

Time taken from the stage when cash is put into the business up to the stage
when cash is realized.

Thus, the working capital requirement of a firm is determined by a host of

factors. Every consideration is to be weighted relatively to determine the
working capital requirement.

Further, the determination of working capital requirement is not once a

whole exercise; rather a continuous review must be made in order to assess
the working capital requirement in the changing situation. There are various
reasons, which may require the review of the working capital requirement
e.g., change in credit policy, change in sales volume, etc.

ISSUES IN WORKING CAPITAL MANAGEMENT

14
Working capital management refers to the administration of all components
of working capital – cash, marketable securities, debtors (receivables), and
stock (inventories) and creditors (payables). The financial manager must
determine levels and composition of current assets. He must see that right
sources are tapped to finance current assets, and that current liabilities are
paid in time.

There are many aspects of working capital management which make it an

important function of the financial manager.

• Time. Working capital management requires much of the financial

manager’s time.
• Investment. Working capital represents a large portion of the total
investment in assets. Actions should be taken to curtail unnecessary
investment in current assets.
• Criticality. Working capital management has great significance for all
firms but it is very critical for small firms. Small firms in India face a
severe problem of collecting their dues debtors. Further, the role of
current liabilities is more significant in case of small firms, as, unlike
large firms, they face difficulties in raising long-term finances.
• Growth. The need for working capital is directly related to the firm’s
growth. As sales grow, the firm needs to invest more in inventories and
debtors. Continuous growth in sales may also require additional
investment in fixed assets.

Liquidity vs. Profitability: Risk-Return Trade-off

A large investment in current assets under certainty would mean a low rate
of return on investment for the firm, as excess investment in current assets
will not earn enough return. A smaller investment in current assets, on the
other hand, would mea interrupted production and sales, because of
frequent stock-outs and inability to pay creditors in time due to restrictive
policy.

Given a firm’s technology and production policy, sales and demand

conditions, operating efficiency etc., its current assets holdings will depend
upon its working capital policy. These policies involve risk-return trade-offs. A
conservative policy means lower return and risk, while an aggressive policy
produces higher return and risk.

15
The two important aims of the working capital management are: profitability
and solvency. Solvency, used in the technical sense, refers to the firm’s
continuous ability to meet maturing obligations. If the fir maintains a
relatively large investment in current assets, it will have no difficulty in
paying claims of creditors when they become due and will be able to fill all
sales orders and ensure smooth production. Thus, a liquid firm has less risk
of insolvency; that is, it will hardly experience a cash shortage or a stock-out
situation. However, there is a cost associated with maintaining a sound
liquidity position. A considerable amount of the firm’s will be tied up in
current assets, and to the extent this investment is idle, the firm’s
profitability will suffer.

To have higher profitability, the firm may sacrifice solvency and maintain a
relatively low level of current assets. When the firm does so, its profitability
will improve as fewer funds are tied up in idle current assets, but its solvency
would be threatened and would be exposed to greater risk of cash shortage
and stock-out.

2.2.1 ESTIMATING WORKING CAPITAL NEEDS

• Current Assets Holding Period. To estimate working capital
requirement on the basis of average holding period of current assets
and relating them to costs based on the company’s experience in the
previous years. This method is essentially based on the operating cycle
concept.

• Ratio of Sales. To estimate working capital requirements as a ratio of

sales on the assumption that current change with sales

• Ratio of Fixed Investment. To estimate working capital

requirements as a percentage of fixed investment.

POLICIES FOR FINANCING FIXED ASSETS

A firm can adopt different financing policies vis-à-vis current assets. Three
types of financing may be distinguished:

16
 • Long-term Financing. The sources of long-term financing include
ordinary share capital, preference share capital, debentures, long-term
borrowings from financial institutions and reserves and surplus
(retained earnings).

• Short-Term Financing. The short-term financing is obtained for a

period less than one year. It is arranged in advance from banks and
other surplus of short-term finance in the money market. It includes
working capital funds from banks, public deposits, commercial paper,
factoring of receivables etc

• Spontaneous Financing. It refers to the automatic sources of short-

term funds arising in the normal course of a business. Trade
(supplier’s) credit and outstanding expenses are examples of
spontaneous financing.

The real choice of financing current assets, once the spontaneous sources of
financing have been fully utilized, is between the long-term and short-term
sources of finance.

Depending on the mix of short-term and long-term financing, the approach

followed by a company may be refereed to as:

• Matching approach
• Conservative approach
• Aggressive approach

Matching Approach

The firm following matching approach (also known as hedging approach)

adopts a financial plan which matches the expected life of the sources of
funds raised to finance assets. For e.g., a ten-year loan may be raised to
finance a plant with an expected life of ten years. The justification for the
exact matching is that, since the purpose of financing is to pay for the
assets, the source of financing for short-term assets is expensive, as funds
will not be utilized for the full period. Similarly, financing the long-term assets
17
with short-term financing is costly as well as inconvenient as arrangement for
the new short-term financing will have to be made on a continuing basis.

Conservative approach

Under a conservative plan, the firm finances its permanent assets and also a
part of temporary currents assets with long-term financing. In the periods
when the firm has no need for temporary current assets, the idle long-term
funds can be invested in the tradable securities to conserve liquidity. The
conservative plan relies heavily on long-term financing and, therefore, the
firm has less risk of facing the problem of shortage of funds.

Aggressive approach

An aggressive approach policy is said to be followed by the firm when it uses

more short-term financing than warranted by the matching plan. The firm
finances a part of its permanent current assets with short term financing. The
relatively more use of short-term financing makes the firm more risky.

INVENTORY MANAGEMENT
 INTRODUCTION: Inventories constitute the most significant part of
current assets of a; large number majority of companies in India. On an
average, inventories are approximately 60 % of current assets in public
limited companies in India. Because of the large size of the inventories
maintained by the firm, a considerable amount of funds is required to
be committed to them. It is, therefore, absolutely imperative to
manage inventories efficiently and effectively in order to avoid
unnecessary investment.
Inventories are stock of the product a company is manufacturing for sale and
components that make up the product. The various forms in which
inventories exist in a manufacturing company are:

 Raw materials are those basis inputs that re converted into finished
product through the manufacturing process. Raw materials inventories
are those units, which have been purchased and stored for future
productions.

18
  Work-in-progress inventories are semi-manufactured products. They
represent those products that need more work before they become
finished products for sale.
 Finished goods inventories are those completely manufactured
products, which are ready for sale. Stocks of the raw materials and
work-in-process facilitate production, while stock of finished goods is
required for smooth marketing operations. Thus the inventories serve
as a link between the production and the consumption of goods.

The levels of the three kinds of inventories for the firm depend on the nature
of the business. A manufacturing firm will have substantially high level of
finished goods inventories and no raw material and work-in progress
inventories within manufacturing firm, there will be differences.

THE OPERATING CYCLE AND WORKING CAPITAL

The working capital requirement of a firm depends, to a great extent up on

operating cycle of the firm. The operating cycle may be defined as the time
duration starting from the procurement of goods or raw material and ending
with the sales realization the length and nature of the operating cycle may
differ from one firm to another depending on the size and nature of the firm.

The investment in working capital is influenced by four key events in the

production and sales cycle form:

 Purchase of raw materials

 payment of raw materials
 sale of finished goods
 collection of cash for sales

Operating cycle period: the firm begins with the purchase of raw material,
which are paid for after a delay, which represents the accounts payable
period. The firm converts raw material into finished goods and then sell the
same. The time that, elapses between the purchase of raw material and the
collection of cash for the sales is referred to as the operating cycle. The
length or time duration of the operating cycle of any firm can be defined as

19
the sum of its inventory conversion period and the receivables conversion
period.

A) Inventory Conversion period (ICP): The time lag between the

purchase of raw material and the sale of finished goods is the
inventory conversion period. In the manufacturing firm ICP
consists of raw materials conversion period (RPCP), work-in-
progress conversion period (WPCP), and the finished goods
conversion period (FGCP).
RMCP refers to the period for which the raw material is generally
kept in stores before it is used by the production department. The
WPCP refers to the period for which the raw material remains in the
production process before it is taken out s a finished product. The
FGCP refers to the period for which finished goods remain in stores
before being sold to a customer.

B) Receivables conversion period (RCP): It is the time required to convert

the credit sales into cash realization. It refers to the period between the occurrence
of credit sales and collection from debtors.

The total of ICP and RCP is also known as Total Operating Cycle period (TOCP). The
firm might be getting some credit facilities from the supplier o a material, wage
earners, etc. this period for which the payment of these parties are deferred or
delayed is known as Deferral Period (DP). The Net Operating Cycle (NOC) of the firm
is arrived at by deducting the DP fro the TOCP. NOC is also known as cash cycle.

RMCP = (AVG. raw material stock/ Total raw materials stock)*365

WPCP = (avg. work-in process/ Total work-in-process)*365

FGCP = (Avg. finished goods/ Total cost of goods sold)*365

RCP = (Avg. receivables / Total credit purchase)*365

DP = (Avg. creditors / Total credit purchase)*365

In respect of these formulations, the following points are note worthy:

20
 a) The “Average” value in the numerator is the average of opening balance and
closing balance of the respective item. However, if only the closing balance is
available, then even the closing balance may be taken as the “Average”.
b) The figure “365” represents number of days in a year. It may also be taken as
“360” for the ease of calculation.
c) The “total” figure in the denominator refers to the total value of the item in a
particular year.
d) In the calculation of RMCP, WPCP, ad FGCP. The denominator is calculated at
cost-basis and the profit margin has been excluded. The reason big that there
is no investment of funds in profit as such.

2.2.2 WORKING CAPITAL LIMITS

FUND BASED CREDIT LIMITS
1. CASH CREDIT/PACKING CREDIT:
The cash credit facility is similar to the overdraft arrangement. It is the most poplar
method of bank finance for working capital in India. Under the cash credit facility, a
borrower is allowed to withdraw funs from the bank up to the cash credit limit. He is
not required to borrow the entire sanctioned credit once, rather, he can draw
periodically to the extent of his requirement and repay by depositing surplus funds
in his cash credit account. Cash credit is sanctioned against the security of current
assets. Cash credit is the most flexible arrangement from the borrower’s point of
view.

2. DISCOUNTING OF BILLS
Under the purchase or discounting of bills, a borrower can obtain credit from a bank
against its bills. The bank purchase or discounts the borrower’s bills. He amount
provided under this agreement is covered within the overall cash credit or overdraft
limit

Before purchasing or discounting the bills, the bank satisfies itself as credit
worthiness of the drawer. Though, the item “bills purchased” implies that the bank
becomes owner of the bill. In practice, bank hold bills as security for the credit.
When a bill is discounted, the borrower is paid he discounted amount of the bills,
(visa, full amount of bill minus the discount charged by the bank). The bank collects
full amount on maturity. The major part of bank borrowings comes through
Discounting Bills. On this firm has to pay interest of 12%.

NON-FUND BASED

21
 1. LETTER OF CREDIT
Commonly used in international trade, the letter o credit is now used in domestic
trade as well. A letter of credit, or L/C, is used by a bank on behalf of its
customers (buyer) to the seller. As per this document, the bank agrees to honor
drafts on it for the supplies made to the customer if the seller fulfills the
conditions laid down in the L/C.

The L/C serves several useful functions:

(i) It virtually eliminates credit risk, if the bank has a good standing.
(ii) It reduces uncertainty, as the seller knows the conditions that should be
fulfilled receive payment.
.

2. BANK GUARANTEE
Bank Guarantee is very similar to Letter of Credit but it is provided for much
longer period compared to letter of credit. Very small portion of working capital
is funded by Bank Guarantee.

 The firm is having low credit holding period it can try to increase is so
that, those funds can remain with it for a longer period n can be utilized
for fulfilling the working capital requirements. For this purpose firm can be
little strict credit standards it can also adopt discount policy.

LOAN ASSESSMENT
Steps in loan processing :
Submission of Project Report along with the Request Letter.

Carrying out due diligence

Preparing Credit Report

Determining Interest Rate

Preparing and submission of Loan Sheet

If not approved if approved

Preparation of proposal

Submission of Proposal to designated authority

22
If No queries raised If queries raised

Project Rejected Sanction of proposal on Solve the queries

various on Terms & condition

Communication of Sanction

Acknowledgement of Sanction
on various Terms & Condition

Application to comply with Sanction Terms &

Condition & execution of Loan Documents

Disbursement
Credit Report and Credit Rating
The credit report is an important determinant of an individual's financial credibility. They are
used by lenders to judge a person's creditworthiness. They also help the person concerned to
narrow down on the financial problem areas.

Credit report is a document, which comprises detailed information about the credit payment
history of an applicant. It is mostly used by the lenders to determine the credit worthiness of an
applicant. The business credit reports provide information on the background of a company. This
assists one to take crucial business related decisions. People can also assess the amount of
business risk associated with a company and then decide whether they would be comfortable in
providing them with credit facilities. The degree of interest that would be shown by investors in
their company can also be gauged from the business credit reports as they can get an idea of the
conception of their customers regarding themselves. Since these records are updated at regular
intervals of time they enable people to identify the risk levels associated with a business as well
as its future. These reports also allow businesses to get detailed information about the financial
status of business partners and suppliers.

23
2.3 METHODOLOGY
The methodology to be adopted for the project is explained as under:

1. The initial step of the project was studying about the company and
then evaluating the financial position of the company on the basis of
ratio analysis.
2. Comparing the firm’s financial position with the help of following
ratios-
• Liquidity ratios
• Solvency/Leveraging ratios
• Coverage ratios
• Activity/turnover ratios
• Profitability ratios
• Investors ratios
3. The project will focus on the study of overall working capital
management at the organizations, for which the following study and
analysis will be undertaken:
• This project is aimed to estimate the operating plan for the year 2010-
2011
• This will also include the calculations and analysis of the operating
cycle for the company.
• Study of CMA form and to prepare for the current year.
• It will also include the ratio analysis of the financial statement so that
the profitability and liquidity trade off can be analyzed.

2.4 SCHEDULE
The complete project will be for duration of 8 weeks. The study of company’s
financial position by doing ratio analysis of the financial statement so that
the profitability and liquidity condition of the organization can be studied
.Here the operating plan will be prepared and the study and analysis of the C
M A form will be done. This will include the estimation of working capital
requirement for 2008-2009, forecasting for 2009-2010 .

24
 2.5 SCOPE OF THE STUDY
Studying working capital management of the Penguin Industries ltd and
deciding its credibility.

2.6 LIMITATIONS
In spite of my continued efforts to make the project as accurate and wide in
scope as possible, certain limitations are becoming evident while
implementing the project. These limitations cannot be removed and have to
be accepted as permanent constraints in implementing the project.

Some limitations, which have been identified, by me are:

1. Generalizations and calculated assumptions had to be made in

some areas while analyzing the financial statements, ratios etc.
due to non-availability of complete information and not all the
information are provided as per the rules of the ban

CHAPTER 3 – PROPOSAL

3.1 PENGUIN INDUSTRIES

BORROWER PROFILE

NAME OF THE ACCOUNT M/SPENGUIN ELECTRONICS LIMITED(PEL)-(SME A/C)

UNLISTED PRIVATE LIMITED
CONSTITUTION COMPANY

MANUFACTER OF CONSUMER ELECTRONICS PRODUCTS

BUSINESS ACTIVITY ,DOMESTIC APPLIANCES

ESTABLISHED IN 1983
ADVANCE SINCE 1 1987
PRESENT PROPOSED
RISK RATING LC1 LC1
PRICING RATING LC1 LC1
25
EXTERNAL CREDIT RTING
ASSET CODE 11(STANDARD)

NO MAJOR GROUP
GROUP AFFILIATION

MR RAKESH N
KEY PERSON .GARODIA
CONSORTIUM NO
FINANCIALS BELOW
POSITION OF ACCOUNTS ANNEXURE 1
LAST SANCTION AUTHORITY: DY GM.LIMIT FBL -6 CRORES.NFBL: 0.40 CROR
NO CPA RELATED TO LAST SANCTION OF 31.03.09 IS

CPA APPLICABLE AS THERE IS NO ENHANCEMENT IN THE LIMIT

LAST INSPECTION 09.01.2010,SATISFACTORY

CORPORATE OFFICE
4, Piramal Industrial Estate

S. V ROAD, GOREGOAN (WEST), MUMBAI

MANAGEMENT

26
 MANAGEMEN
T

MR.ASHOK
MR RAKESH MR. ARUN MR. V G. KUSUM GAYATRI
N
N. N. DESHPAND A DEVI
.GARODIA
GARODIA GARODIA E .GARODIA N.GARODIA
CHIEF
DIRECTOR DIRECTOR DIRECTOR DIRECTOR DIRECTOR
EXECUTIVE

Crisil Rating for bank facilities of

Penguin Electronics ltd

Rated
sl no Facility Amount Rating
1 Cash credit 45 BBB/stable
2 Long term loan 11 BBB/stable
3 Bills discounting 15 P3+
4 Letter of credit 3.5 P3+
5 Bank guarantee 0.5 P3+

2007 -2008 2008- 2009

FINANCIALS AUDITED AUDITED
PAID UP CAPITAL 1 1
NET WORTH(EXCLD REVALUATION
RESERVE) 14.85 14.87
NET SALES 46.01 34.86
OTHER INCOME 1.43 1.17
GROSS PROFIT/LOSS 1.57 0.86
NET PROFIT/LOSS 1.37 0.14

RATIOS
27
CURRENT RATIO 1.28 1.35
DEBT /EQUITY 0.8 0.6
PROFITABILITY 2.98 0.4
DSCR - -
INTEREST COVERAGE 2.85 1.28

FINANCIAL INDICATORS
Audited31.03 Est.31.03 Audited Estd.31.03 Proj
Finnancial indicators .07 .07 31.03.08 .09 31.03.10
Paid up capital
a)Equity 1 1 1 1 1
b)Preference share
Tangible net worth 13.62 14.26 14.85 15.45 16.13
Investment in companies 3.42 6 5.72 6.18 6.18
Adjusted TNW -
Capital employed 16.83 15.45 16.26 16.13 16.53
Net block 6.22 5.05 7.22 5.54 5.17
Net sales 59.03 40 46.01 33 34.65
Total sales 59.03 40 46.01
Other income 0.59 0.35 1.43 0.61 0.61
EBITA/PBITA 2.9 2.89 2.97 2.35 2.45
Interest 0.57 0.96 0.55 0.7 0.7
Gross profit/loss 2.33 1.93 2.42 1.65 1.75
Taxes 0.28 0.28 0.31 0.18 0.2
Cash Accruals 2.05 1.65 2.11 1.47 1.55
Depreciation 0.69 0.9 0.74 0.75 0.75
Net profit/Loss 1.36 0.75 1.37 0.72 0.8
Net profit/Capital
employed% 8.08 4.85 8.43 4.46 4.84
Current assets 16.55 14.13 16.6 14.01 14.37
Currrent liabilities 9.36 9.73 13.28 9.6 9.19
Ratios
Current Ratios 1.77 1.45 1.25 1.46 1.56
Debt /Equity
a) Term LIAB/TNW 0.24 0.08 0.09 0.04 0.02
b)Tol/TNW 0.92 0.77 0.99 0.67 0.59
(Profitability- PAT) /Net
sales 2.3 1.88 2.98 2.18 2.31
DSCR-Company as a
whole Avg 2.51 Avg 2.51 Avg 2.51 Avg 2.51 Avg 2.51

28
 Interest coverage 4.6 2.72 4.84 3.1 3.21
(Inventory+Receivables)/
sales% 30 27 19 33 17

COMMENTS IN BRIEF

The company has submitted audited balance sheet for 2008-2009.The selected financial
indicator above reveals satisfactory financial position except Low profitability and decline
in sales and ISCR during 08-09.Net worth shown a increased trend with retension of profits
and is Rs 14.87 cr as on 31.03.10. ISCR is at 1.28 and is not above the acceptable level of 1.5.

3.2 COMPANY REQUEST- PENGUIN

ELECTRONICS LIMITED
SALES

Hitherto our business module mainly compromised of

manufacture of audio Products for Philips India Ltd. keeping in
view the market trends and the likely orders to be placed by
our buyers we have concentrated on production of domestic
home appliances. In the current year 09 -10 sales of 2790.07
lacs have been achieved. The expected sales are expected to
29
be 3150 lacs for the current year sales in the next financial
year is projected to be 3250 lacs on conservative basis.

PROFITABILITY

EBITA has been estimated at around 5 % with PAT estimated

at 2 %

CURRENT RATIO

Has been estimated at benchmark level keeping in view of

stipulated working capital continued towards Working capital.

TRADERS CREDITORS RATIO

Creditors level would be endeavored to be kept at minimum of

upto 8 days level so far.

DEBT EQUITY RATIO

Debt/ Equity ratio is kept at 1:1.

INTEREST

Request for interest at 9.5 % on Bills Discounting Limit.

3.3 COMMENTS IN BRIEF ON FINANCIAL POSITION OF PENGUIN

ELECTRONICS LIMITED.

PAID UP CAPITAL / TNW

Paid Up Capital of the company is maintained at Rs 1 crore and is estimated to
remain at the same level during the current and ensuing year. The Net Worth of
the company has gone up from 13.62 crores as at 14.85. Company has paid
interim dividend of Rs 10 lakhs during 2007-08.

NET SALES

30
 Company has achieved the sale of Rs 46.01 crores as on 31.03.08 as the
estimates of Rs 40 crores. Hence company is considered doing well.

OTHER INCOME
Company has other income of Rs 1.43 crores which comprises of profit of
sale of investments of Rs 0.74 crore, rent from its leased property at
Daman of Rs 0.41 crores. Interest of deposits and MF of Rs 0.20 crores.

PROFITS/PROFITABILITY
Company has earned profits of Rs 1.37 crores during 2007-08.As they
have closed their audit unit at Daman and are operating from their new
unit set up at Baddi, Himachal Pradesh. Profitabilty at 2.18% for the year
ended 31.03.09 would be slightly lower than as compared to 2.98% for
the year 31.03.08.the lower profitability was explained due to thin
margins in electronics industry due to stiff competition.

INVESTMENTS
Company has invested in some Blue Chip Companies to the tune of Rs 4.76
crores and in MF of Rs 0.76 crores as on 31.03.08.

CURRENT RATIO
Current Ratio was at 1.25 as on 31.03.08 and is estimated to improve to 1.46
as on 31.03.09. Current ratio is above the benchmark level and hence
acceptable.

DEBT-EQUITY RATIO
THE DER was 0.99 as on 31.03.08 and is slated to improve to 0.67 and to
0.59 during next two years. The same is acceptable levels.

INTEREST SERVICE COVERAGE RATIO

31
ISCR as on 31.03.08 was at 4.84 .The estimated ISCR at 3.10 and projected
at 3.21 as on 31.03.09 and 31.03.10 respectively.

NET BLOCK
Company net block was Rs 7.22 crores as on 31.03.08. As the company has
shifted to Baddi, they have sold their plant and machinery. There was an
adjustment in depreciation on account of sale of plant and machinery which
has amounted to reduction in net block to Rs 5.54 crores as on 31.03.09.

CONTINGENT LIABILITY

Company has no contingent liability.

STATUTORY AUDITORS REMARKS

Company audited financials as on 31.03.08 are unqualified.

INTER COMPANY COMPARISION

NAME OF PBT/SA TOL/TN
COMPANY YEAR SALES LES W CR
PENGUIN 2207-
ELECTRONICS 08 46.01 3.6 0.99 1.67
PACIFIC 2007-
ELECTRONICS 08 29.23 6.32 3.06 1.13

FAVOURABLE CONDITIONS

The products manufactured by the company are supplied to MNCs

like Philips India limited and Legrand private ltd. The company
enjoys brand equity of these MNCs without any additional costs.

3.4 ASSESMENT / JUSTIFICATION OF PROPOSED LIMITS

TERM LOAN ASSESMENT

Company was granted TERM LOAN of Rs 2.50 crores for part

funding of this project cost of Rs 3.85 crore for setting up

32
 manufacturing unit at Baddi. The average DSCR for the balance
repayment period works out to be 2.51 which is very comfortable.

WORKING CAPITAL ASSESMENT

Company has estimated sales of 40 crores for 07-08 against

which they achieved 46.01 crores. Comapny has been enjoying
star Channel Credit of Rs 6 crores within the WC limit.

JUSTIFICATION

Companys WC has been reduced from 10 crores to 6 crores at

their request as they have closed their unit at Daman.

Company has been granted term loan of rs 2.5 cr towards part

funding for setting up unit at Baddi. The Term Loan is repayed in
20 equvalent quarterly repayments.

NON FUND BASED LIMITS

Compant has been granted LC-DP OF Rs 0.35 crore nad LC DA 90

days limit of RS 0.10 crores subject to maximaum of rs 0.35 crore
and Bank guarantee limit of Rs 0.05 crore.

ANNEXURE

A ) BENCHMARK RATIOS FOR PERFORMANCE OF COMPANY:

RATIO ANALYSIS USUAL NORM

EFFICIENCY RATIOS:
33
Net Sales / Total Tangible Assets (Times) >1.50

PBT / TTA (%) >5.00%

Operating Cost / Net Sales (%) <75.00%

Bank Finance / Current Assets (%) <50.00%

Inventory + Receivables / Net Sales (Days) <60 Days

LIQUIDITY RATIOS:

Current Ratio >1.33

Acid Test Ratio >1.00

Bank Finance to WCG Ratio <0.75

LEVERAGE RATIOS:

Debt Equity Ratio <2.00

TOL / TNW <3.00

Debt-Assets Ratio <0.60

Fixed Assets Coverage <0.60

TURNOVER RATIOS:

Inventory Turnover Period (Days) <30 Days

Average Collection Period (Days) <30 Days

Total Assets Turnover (Times) >1.00

Capital Turnover Ratio (Times)

Average Credit Period (Days) – Creditors <30 Days

34
Bank Finance Turnover (Times) >5.00

Current Assets Turnover (Times) >3.00

PROFITABILITY RATIOS:

Net Profit Margin after tax (%) >5.00%

Net Income to Assets Ratio (%) >10.00%

Return on Investment (%) [PBDIT/TTA] >20.00%

Return on Equity (%) >18.00%

Operating Profitability (%) >20.00%

Pre-Tax Profitability (%) >15.00%

PBT / TTA (%) >10.00%

STRUCTURAL RATIOS:

Retained Profit (%) >20.00%

Raw Material Content (%) <50.00%

Operating Cost / Sales (%) <75.00%

B) FINANCIAL ANALYSIS
LIQUIDITY RATIOS (SHORT- TERM LIQUIDITY)

Liquidity ratios measure the short term solvency, i.e., the firm’s ability to pay
its current dues and also indicate the efficiency with which working capital is
being used.

Commercial banks and short-term creditors may be basically interested in

the ratios under this group. They comprise of following ratios:

• CURRENT RATIO OR WORKING CAPITAL RATIO

Current ratio is a relationship of current assets to current liabilities.

35
‘Current assets’ means the assets that are either in the form of cash or
cash equivalents or can be converted into cash or cash equivalents in short
time(say within a year) like cash, bank balances, marketable securities,
sundry debtors, stock, bills receivables, prepaid expenses.

‘Current liabilities’ means liabilities repayable in as short time like sundry

creditors, bills payable, outstanding expenses, bank overdraft.

Computation. The ratio is calculated as follows:

Current ratio = Current Assets

Current Liabilities

Objective.

• The ratio is mainly used to give an idea of the company's ability to pay
back its short-term liabilities with its short-term assets.

• The higher the current ratio, the more capable the company is of
paying its obligations. A ratio under 1 suggests that the
company would be unable to pay off its obligations if they came due at
that point.

• While this shows the company is not in good financial health, it does
not necessarily mean that it will go bankrupt - as there are many ways
to access financing - but it is definitely not a good sign.

• The current ratio can give a sense of the efficiency of a company's

operating cycle or its ability to turn its product into cash.

• An acceptable current ratio varies by industry. For most industrial

companies 1.5 is an acceptable CR. A standard CR for a healthy
business is close to 2.

• However, a blind comparison of actual current ratio with the standard

current ratio may lead to unrealistic conclusions. A very high ratio
indicates idleness of funds, poor investment policies of the
management and poor inventory control, while a lower ratio indicates
lack of liquidity and shortage of working capital.
36
• Liquid ratio or Quick ratio or Acid test ratio
Liquid ratio is a relationship of liquid assets with current liabilities. It is fairly
stringent measure of liquidity.

Liquid assets are those assets which are either in the form of cash or cash
equivalents or can be converted into cash within a short period. Liquid assets
are computed by deducting stock and prepaid expenses from the current
assets. Stock is excluded from liquid assets because it may take some time
before it is converted into cash. Similarly, prepaid expenses do not provide
cash at all and are thus, excluded from liquid assets.

Computation. The ratio is calculated is as under:

Liquid ratio= Liquid assets

Current liabilities

Objective.

• The ratio of current assets less inventories to total current liabilities.

This ratio is the most stringent measure of how well the company is
covering its short-term obligations, since the ratio only considers that
part of current assets which can be turned into cash immediately (thus
the exclusion of inventories).

• The ratio tells creditors how much of the company's short term debt
can be met by selling all the company's liquid assets at very short
notice. also called acid-test ratio.

• The current ratio does not indicate adequately the ability of the
enterprise to discharge the current liabilities as and when they fall due.
Liquid ratio is considered as a refinement of current ratio as non-liquid
portion of current assets is eliminated to calculate the liquid assets.
Thus it is a better indicator of liquidity.

37
 • A quick ratio of 1:1 is considered standard and ideal, since for every rupee of
current liabilities, there is a rupee of quick assets. A decline in the liquid ratio
indicates over-trading, which, if serious, may land the company in difficulties.

SOLVENCY/LEVERAGE RATIOS (LONG-TERM SOLVENCY)

The term ‘solvency’ implies ability of an enterprise to meet its long term
indebt ness and thus, solvency ratios convey the long term financial
prospects of the company. The shareholders, debenture holders and other
lenders of the long-term finance/term loans may be basically interested in
the ratios falling under this group.

Following are the different solvency ratios:

• Debt-equity Ratio
The debt-equity ratio is worked out to ascertain soundness of the long term
financial policies of the firm. This ratio expresses a relationship between debt
(external equities) and the equity (internal equities).

Debt means long-term loans, i.e., debentures, public deposits, loans (long
term) from financial institutions. Equity means shareholder’s funds, i.e.,
preference share capital, equity share capital, reserves less losses and
fictitious assets like preliminary expenses.

Computation. Te ratio is calculated as under:

Debt-Equity Ratio = Debt (Long-term Loans)

Equity (shareholder’s funds)

Objective.

• The objective of this ratio is to arrive at an idea of the amount of

capital supplied to the concern by the proprietors and of asset
‘cushion’ or cover available to its creditors on liquidation of the
organization equity.
• It also indicates the extent to which the firm depends upon outsiders
for its existence. In other words, it portrays the proportion of total
funds acquired by a firm by way of loans.
• A high debt-equity ratio may indicate that the financial stake of the
creditors is more than that of the owners. A very high debt-equity ratio
38
 may make the proposition of investment in the organization a risky
one.
• While a low ratio indicates safer financial position, a very low ratio may
mean that the borrowing capacity of the organization is being
underutilized.
• The debt/equity ratio also depends on the industry in which the
company operates. For example, capital-intensive industries such as
auto manufacturing tend to have a debt/equity ratio above 2, while
personal computer companies have a debt/equity of under 0.5.
• The readers of financial management may remember that to borrow
the funds from outsiders is one of the best possible ways to increase
the earnings available to the equity shareholders, basically due to two
reasons:
a) The expectations of the creditors in the form of return on their investment
are comparatively less as compared to the returns expected by the equity
shareholders.

b) The return on investment paid to the creditors is a tax-deductible

expenditure.

• Total Assets to Debts Ratio

The total asset to debt ratio establishes a relationship between total assets
and the total long-term debts.

Total assets include fixed as well as current assets. However, fictitious

assets like preliminary expenses, underwriting commission, share issue
expenses, discount on issue of shares/debentures, etc., and debit balance of
profit and loss account are not included. Long-term debts refer to debts
that will mature after one year. It includes debentures, bonds, and loans from
financial institutions.

Computation. This ratio is computed as under:

39
Total Assets to Debt Ratio = Total Assets

Long-term debts

Objective.

• This ratio is computed to measure the safety margin available to the

providers of long-term debts. It measures the extent of coverage
provided to long term debts by the assets o the firm.
• A higher ratio represents higher security to lenders for extending the long-
term loans to the business. On the other hand, a low ratio represents a risky
financial position as it means that the business depends on outside loans for
its existence.

• Total Debt Ratio

Total debt ratio is a relationship of Total Debt of a firm to its Capital
Employed.

Computation. This ratio is calculated as under.

Total Debt Ratio = Debt

Capital Employed

Objective.

• A ratio that indicates what proportion of debt a company has relative to

its assets. The measure gives an idea to the leverage of the company
along with the potential risks the company faces in terms of its debt-
load.

• A debt ratio of greater than 1 indicates that a company has more debt
than assets, meanwhile, a debt ratio of less than 1 indicates that a
company has more assets than debt. Used in conjunction with other
measures of financial health, the debt ratio can help investors
determine a company's level of risk.

Fixed Assets to Capital Employed Ratio

Fixed assets to Capital employed ratio gives the amount of fixed assets as a
percentage of the capital employed of the company.

40
Computation. This ratio is calculated as follows:

Fixed Assets to Capital Employed = Net Fixed assets x 100

Capital Employed

Objective.

• This ratio indicates the extent to which the long term funds are sunk
into fixed assets.
• It has been an accepted principle of financial management that not
only fixed assets should be financed by way of long-term loans but also
a part of current assets or working capital should be financed by way of
long-term funds, and this part may be in the form of permanent
working capital.
• A very high trend of this ratio may indicate that a major portion of long
term funds is utilized for the purpose of fixed assets leaving a small
proportion for the investment in the current assets or working capital.
• A very low trend of this ratio coupled with a constant declining trend of
current ratio may indicate an urgent for the introduction of long-term
funds for financing the working capital in the business.

• Inventory to Net Working Capital Ratio

Inventory to Net working Capital Ratio tells how much of a company’s funds
are tied up in inventory.

Computation. The formula is as under:

Inventory to Net Working Capital = Inventory

Net Working Capital

Objective.

• Keeping track of inventory levels is crucial to determine the financial

health of a business.

41
 • It is preferable to run a business as little inventory as possible on hand,
while not affecting potential sales opportunities.
• If this ratio is high compared to the average for the industry, it could
mean that the business is carrying too much inventory.

• Proprietary Ratio
The proprietary ratio establishes a relationship between proprietor’s fund and
total assets.

Proprietor’s fund means share capital plus reserves and surplus both of
capital and revenue nature. Loss, if any, should be deducted. Funds payable
to others should not be added.

Computation. This ratio is worked out as follows:

Proprietor’s Ratio = Proprietor’s Fund or Shareholders Fund

Total Assets

Objective.

 This ratio throws a light on the general financial position of the

concern. It shows the extent to which shareholders own the business.
This ratio is of particular importance to the creditors as it helps them
to ascertain the proportion of shareholder’s funds in the total assets
employed in the firm.
 The higher this Proprietary ratio denotes that the shareholders have
provided the funds to purchase the assets of the concern instead of
relying on other sources of funds like bank borrowings, trade creditors
and others.
 However, too high a proprietary ratio say 100%Â means that
management has not effectively utilize cheaper sources of finance
like trade and long term creditors. As these sources of funds are
cheaper, the inability to make use of it might lead to lower earnings
and hence a lower rate of dividend payout.

42
PROFITABILITY RATIOS
Profit as compared to the capital employed indicated profitability of the
concern. A measure of ‘profitability’ is the overall measure of efficiency. The
different profitability ratios are as follows:

• Net Profit ratio

The Net profit ratio establishes the relationship between net profit and net
sales, expressed in percentage form.

Net Profit is derived by deducting administratitive and marketing expenses,

finance charges and making adjustments for non-operating expenses and
incomes.

Computation. This ratio is calculated as follows:

Net Profit ratio = Net Profit after taxes x 100

Net Sales

Objective.

• The net profit ratio determines the overall efficiency of the business.It
indicates that proportion of sales available to the owners after the
consideration of all types of expenses and costs – either operating or
non-operating or normal or abnormal.
• A high net profit indicates profitability of the business. Hence, higher
the ratio, the better the business is.

COVERAGE RATIOS
• Interest Coverage Ratio
The interest coverage Ratio establishes the relationship between PBIT (Profits
before interest and taxes) and Debt interest.

Computation. It is calculated as:

Interest Coverage Ratio = Profit before Interest and Taxes

43
 Debt Interest

The numerator considers the profit before income tax and interest on both
term and working capital borrowings.

The denominator considers the interest charges, which are in the form of
interest on long-term borrowings and not the interest on working capital
facilities.

Objective.

 Interest coverage is a financial ratio that provides a quick picture of a

company’s ability to pay the interest charges on its debt.

 The 'coverage' aspect of the ratio indicates how many times the
interest could be paid from available earnings, thereby providing a
sense of the safety margin a company has for paying its interest for
any period.

 A company that sustains earnings well above its interest requirements

is in an excellent position to weather possible financial storms.

 As a general rule of thumb, investors should not own a stock that has
an interest coverage ratio under 1.5. An interest coverage ratio below
1.0 indicates the business is having difficulties generating the cash
necessary to pay its interest obligations.

 The ratio suffers from the following limitations:

a) The fixed obligations in the form of preference dividend or installments

of long-term borrowings are not considered.
b) The funds available for meeting the obligations of interest payments
may not be necessarily in the form of p[profits before interest and
taxes only, as the amount of [profits so calculated may consider the
amount of depreciation debited to Profit and Loss Account which does
not involve any outflow of funds.

ACTIVITY (TURNOVER OR PERFORMANCE) RATIOS

44
Turnover indicates the speed with which capital employed is rotated in the
process of doing business. Activity ratios measure the effectiveness with
which a concern uses resources at its disposal. The following are the
important activity (turnover or performance) ratios:

• Capital Turnover Ratio

Capital Turnover ratio establishes between the Net Sales and the Capital
Employed of a firm. Capital turnover ratio indicates that the firm’s capital
employed is being efficiently used. This ratio indicates that the organization
is able to achieve maximum sales with minimum amount of capital
employed.

Computation. This ratio is computed with the help of the following formula:

Capital turnover ratio = Net sales

Capital Employed

Objective.

 This ratio indicates the effectives of the organization with which the
capital employed is being utilized.
 A high capital turnover ratio indicates the capability of the organization
to achieve maximum sales with minimum amount of capital employed.
It indicates that the capital turnover ratio better will be the situation.

• Working Capital Turnover Ratio

The working capital turnover ratio indicates the number of times a unit
invested in working capital produces sale. In other words, this ratio shows the
efficiency in the use of short-term funds for achieving sales.

Working capital is computed by deducting current liabilities from current

assets. A careful handling of the short-term assets and funds will mean a
reduction in the amount of capital employed thereby improving turnover.

Computation. The ratio is calculated as follows:

Working capital turnover ratio = Net sales

45
 Working capital

Objective.

 A company uses working capital (current assets - current liabilities) to

fund operations and purchase inventory. These operations and
inventory are then converted into sales revenue for the company.

 The working capital turnover ratio is used to analyze the relationship

between the money used to fund operations and the sales generated
from these operations.

 In a general sense, the higher the working capital turnover, the

better because it means that the company is generating a lot of sales
compared to the money it uses to fund the sales.

 A high, or increasing Working Capital Turnover is usually a positive

sign, showing the company is better able to generate sales from its
Working Capital. Either the company has been able to gain more Net
Sales with the same or smaller amount of Working Capital, or it has
been able to reduce its Working Capital while being able to maintain its
sales.

 As such, higher this ratio, the better will be the situation. However, a
very high ratio may indicate overtrading – the working capital being
meager for the scale

• Inventory Turnover ratios

a) Raw Material Inventory Turnover
Computation. This ratio is calculated as follows:

Raw Material Inventory Turnover Ratio = Raw Material

Consumed

Average Raw Material

Inventory

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 b) Finished goods Inventory Turnover
Computation. This ratio is calculated as follows:

FGIT= Net sales

Average Finished Goods Inventory

Objective.

• A high inventory turnover ratio indicates that maximum sales turnover is

achieved with the minimum investment in inventory. As such, as a
general rule, high inventory turnover ratio is desirable.
• However, the high inventory turnover ratio should be viewed from some
more angles. Firstly, it may indicate that there is under investment in
inventory whereby the organization may loose customer patronage f it is
unable to maintain the delivery schedule. Secondly, high inventory
turnover ratio may not necessarily indicate profitable situation.
• An organization, in order to achieve a large sales volume, may
sometimes sacrifice on profits, whereby a high inventory turnover ratio
may not result into high amount of profits.
On the other hand, a low inventory turnover ratio may indicate over
investment in inventory, existence of excessive or obsolete/non-moving
inventory, improper inventory management, accumulation of inventories
at the year end in anticipation of increased prices or sales volume in near
future and so on.

There can be no standard inventory turnover ratio which may be

considered ideal. It may depend on nature of industry and marketing
strategies followed by the organization.

• Assets Turnover Ratios

 Asset turnover measures a firm's efficiency at using its assets in
generating sales or revenue - the higher the number the better.

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 It also indicates pricing strategy: companies with low profit margins
tend to have high asset turnover, while those with high profit margins
have low asset turnover.
 A high Assets turnover ratio indicates the capability of the organization
to achieve maximum sales with the minimum investment in assets. It
indicates that the assets are turned over in the form of sales more
number of times. S such, higher the ratio, better will be the situation.
a) Total Assets Turnover

Computation. This ratio is computed using the following formula:

Total Assets Turnover Ratio = Net Sales

Total Assets

b) Fixed Assets Turnover

Computation. This ratio is calculated as follows:

Fixed Assets Turnover Ratio = Net Sales

Fixed Assets

Fixed assets include net fixed assets, i.e., fixed assets after providing for
depreciation.

c) Current Assets Turnover

Computation. This ratio is calculated s follows:

Current Assets turnover Ratio = Net Sales

Current Assets

Objective.

• A high Assets turnover ratio indicates the capability of the organization

to achieve maximum sales with the minimum investment in assets.
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 • It indicates that the assets are turned over in the form of sales more
number of times. S such, higher the ratio, better will be the situation.

• Debtors Turnover Ratio

Computation. The ratio will be computed as:

Debtors Turnover ratio = Net credit sales

Average sundry debtors

Objective.

• This ratio indicates the speed at which the sundry debtors are
converted in the form of cash. However this intention is not correctly
achieved by making the calculations in this way.

As such this ratio is normally supported by the calculations of Average

Collection Period which is calculated as under:

a) Calculation of Daily Sales

daily sales= Net credit Sales

No of Working Day

Inference
It is highest in case of ITC followed by HUL and DS Group respectively.

b) Calculation of Average Collection Period:

ACP= Average Sundry Debtors

Daily Sales

The average collection period as computed above should be compared with

the normal credit period extended to the customers. If the average collection
period is more than normal credit period allowed to the customers, it may
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indicate over investment in debtors which may be the result of over-
extension of credit period, liberalization of credit terms and ineffective
collection procedures.

RETURN ON INVESTMENT
The ratios computed in this group indicate the relationship between the
profits of a firm and investment in the firm. There can be three ways in which
the term ‘investment’ may be interpreted, i.e., Assets, Capital Employed and
Shareholder’s Funds. As such, there can be three broad classifications of ROI:

Return on Assets (ROA)

Computation. This ratio is calculated as:

ROA = EBIT

Average Total Assets

Objective.

 An indicator of how profitable a company is relative to its total

assets. ROA gives an idea as to how efficient management is at using
its assets to generate earnings.

 The assets of the company are comprised of both debt and equity.
Both of these types of financing are used to fund the operations of the
company. The ROA figure gives investors an idea of how effectively the
company is converting the money it has to invest into net income.

 The higher the ROA number, the better, because the company is
earning more money on less investment.

• Return on Capital Employed (ROCE)

Computation. The ratio is calculated as:

ROCE= Profit Before Interest & Taxes x 100

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 Average Capital employed

Objective.

 It is used in finance as a measure of the returns that a company is

realising from its capital employed.
 It is commonly used as a measure for comparing the performance
between businesses and for assessing whether a business generates
enough returns to pay for its cost of capital.
 ROCE measures the profitability of the capital employed in the
business. A high ROCE indicates a better and profitable use of long-
term funds of owners and creditors. As such, a high ROCE will always
be preferred.
• Return on Shareholder’s Funds
It is calculated as:

RSF= Profit After Tax x 100

Shareholder’s funds

• This is the most popular ratio to measure whether the firm has earned
sufficient returns for its shareholders or not. As such, this ratio is the
most crucial one from the owners/shareholders point of view. Higher
the ratio better will be the situation.

INVESTOR RATIOS
• Earnings per Share (EPS)
Computation. The ratio is calculated as:

EPS= Net Profit after Taxes – preference Dividend

Number of Equity shares Outstanding

Objective.

• It is widely used ratio to measure the profits available to the equity

shareholders on a per share basis. EPS is calculated on the basis of
current profits and not on the basis of retained profits.

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 • As such, increasing EPS may indicate the increasing trend of current
[profits per equity share. However, EPS does not indicate how much of
the earnings are paid to the owners by way of dividend and how much
of the earnings are retained in the business.

CONCEPTS OF WORKING CAPITAL

There are two concepts of working capital – Gross and Net

• Gross Working Capital refers to the firm’s investment in current

assets. Current assets are the assets which can be converted into
cash within an accounting year and include cash, short term
securities, debtors, bills receivable (accounts receivables or book
debts) and stock.

• Net Working Capital refers to the difference between current

assets and current liabilities. Current liabilities are those claims of
outsiders, which are expected to mature for payment within an
accounting year, and include creditors (accounts payable), bills
payable and outstanding expenses. Net working capital can be
positive or negative. A positive net working capital will arise when
current asset exceed current liabilities. A negative net working
capital occurs when current liabilities are in excess of current
assets.

Focusing on management of current assets

The gross working capital concept focuses attention on two aspects of

current assets management:

a) How to optimize investment in current assets?

b) How should current assets be financed?

The considerations of the level of investment in current assets should avoid

two danger points- excessive or inadequate investment in current assets.
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Investment in current assets should be just adequate to the needs of the
business firm. Excessive investment in current assets should be avoided
because it impairs the firm’s profitability, as idle investment earns nothing.
On the other hand, inadequate amount of working capital can threaten
solvency of the firm because of its inability to meet its current obligations. It
should e realized that the working capital needs of the firm may be
fluctuating with changing business activity. The management should be
prompt to initiate an action and correct imbalances.

Another aspect of the gross working capital points to the need of arranging
funds to finance current assets. Whenever a need for working capital funds
arises due to the increasing level of business activity or for nay other reason,
financing arrangement should be made quickly. Similarly, if suddenly, some
surplus funds arise they should not be allowed to remain idle, but should be
invested in short term securities. Thus, the financial manager should have
knowledge of the sources of working capital funds as well as investment
avenues where idle funds may temporarily are invested.

Focusing on Liquidity management

Net working capital is a qualitative concept. It indicates the liquidity position

of the firm and suggests the extent to which working capital needs may be
financed by permanent sources of funds. Current assets should be
sufficiently in excess of current liabilities to constitute margin or buffer for
maturing obligations within the ordinary operating cycle of business. In order
to protect their interests, short- term creditors always like a company to
maintain current assets at a higher level than current liabilities. However, the
quality of current assets should be considered in determining level of current
assets vis-à-vis current liabilities. A weak liquidity position possesses a threat
to the solvency of the company and makes it unsafe and unsound. A
negative working capital means a negative liquidity, and may prove to be
harmful for the company’s reputation. Excessive liquidity is also bad. It may
be due to mismanagement of current assets. Therefore, prompt and timely
action should be taken by management to improve and correct the
imbalances in the liquidity position of the firm.

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For every firm, there is a minimum amount of net working capital, which is
permanent. Therefore, a portion of working capital should be financed with
permanent sources of funds such as equity share capital, debentures, long-
term debt, preference share capital or retained earnings. Management must,
therefore, decide the extent to which the current assets should be financed
with equity capital or borrowed capital.

It may be emphasized that both gross and net concepts of working capital
are equally important for the efficient management of working capital. There
is no precise way to determine the exact amount of gross or net working
capital of a firm. A judicious mix of long and short term finances should be
invested in current assets. Since current assets involve cost of funds, they
should be put to productive use.

OPERATING AND CASH CONVERSION CYCLE

A firm should aim at maximizing the wealth of its shareholders, so the firm
should earn sufficient returns from its operations. Earning a steady amount
of profit requires successful sales activity. The firm has to invest enough
funds in current assets for generating sales. Current assets are needed
because sales do not convert into cash instantaneously. There is always an
Operating cycle involved in the conversion of sales into cash.

There is difference between current and fixed assets in terms of their

liquidity. A firm requires many years to recover the initial investment in fixed
assets such as plant and machinery or land and building. On the contrary,
investment in current assets is turned over many times in a year. Investment
in current assets such as inventories and debtors (accounts receivable) is
realized during the firm’s operating cycle that is usually less than a year.

OPERATING CYCLE is the time duration required to convert sales,

after the conversion of resources into inventories, into cash.

The operating cycle of manufacturing company involves three phases:

• Acquisition of resources such as raw material, labor power and fuel

etc.
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 • Manufacture of the product which includes conversion of raw
materials into work-in-progress into finished goods.
• Sale of the product either for cash or on credit. Credit sales create
account receivable for collection.

These phases affect cash flows, which most of the time, are neither
synchronized nor certain. They are not synchronized because cash flows
usually occur before cash inflows.

Cash inflows are uncertain because sales and collections which give rise to
cash inflows are difficult to forecast accurately, on the other hand, are
relatively certain. The firm is, therefore, required to invest in current assets
for a smooth, uninterrupted functioning. It needs to maintain liquidity to
purchase raw materials and pay expenses such as wages and salaries, other
manufacturing, administrative and selling expenses and taxes as there is
hardly a matching between cash inflows and outflows. Cash is also held to
meet any future exigencies. Stocks of raw materials and work-in-progress are
kept to ensure smooth production and to guard against non-availability of
raw material and other components. The firm holds stock of finished goods to
meet the demand of customers on continuous basis and sudden demand
from some customers. Debtors are created because goods are sold on credit
for marketing and competitive reasons. Thus, a firm makes adequate
investment in inventories, and debtors, for smooth, uninterrupted production
and sale.

Length of Operating Cycle

The length of the operating cycle can be calculated in two ways:

b) Gross Operating Cycle

c) Net Operating Cycle

a) Gross Operating Cycle

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The grass operating cycle of a manufacturing concern is the sum of Inventory
Conversion Period and debtors (receivable) conversion period. Thus, Gross
Operating Cycle is gives as follows:

Inventory conversion Period + Debtors Conversion Period

Inventory Conversion Period:

The inventory conversion period is the total time needed for producing and
selling the product. It is the sum of (1) raw material conversion period, (2)
work-in-progress conversion period, and (3) finished goods conversion
period.

• Raw material conversion period

The raw material conversion period is the average time period taken to
convert material into work-in-progress. Raw material conversion period
depends on: (a) Raw material consumption per day, and (b) Raw material
inventory. Raw material consumption par day is given by the total raw
material consumption divided by the number of days in the year (say 360).
The raw material conversion period is obtained when raw material inventory
is divided by raw material consumption per day.

Raw material conversion period = Raw material inventory

[Raw material consumption]/360

• Work-in-progress conversion period

Work-in-progress conversion period is the average time taken to complete
the semi-finished or work-in-progress. It is given by the following formula:

Work-in-progress conversion period = work-in-progress inventory

[Cost of production]/360

• Finished goods conversion period

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Finished goods conversion period is the average time taken to sell the
finished goods. It can be calculated as follows-

FGCP= Finished goods inventory

[Cost of goods sold]/360

Debtor’s conversion period:

Debtor’s conversion period is the average time taken to convert debtors into
cash. It represents the average collection period. It is calculated as
follows:

DCP= Debtors

[Credit sales]/360

b) cash conversion or Net operating cycle

Net operating cycle is the difference between Gross operating cycle and
creditors (payables) Deferral period.

Creditor’s deferral period:

Creditor’s deferral period is the average time taken by the firm in paying its
suppliers. It is calculated as follows:

CDP= Creditors

[Credit purchases]/360

In practice, a firm may acquire resources (such as raw materials) on credit

and temporarily postpone payment of certain expenses. Payables, which a
firm can defer, are spontaneous sources of capital to finance investment in
current assets. The creditor’s deferral period is the length of time the firm is
able to defer payments on various resource purchases.

Net operating cycle is also referred to as cash conversion cycle. It is the

net time interval between cash collections from sale of the product and cash
payments for resources acquired by the firm. It also represents the time
interval over which additional funds, called working capital, should be

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obtained in order to carry out the firm’s operations. The firm has to negotiate
working capital from sources such as commercial banks. The negotiated
sources of working capital financing are called non-spontaneous sources.
If net operating cycle of a firm increases, it means further need for
negotiated working capital.

There are two ways of calculations of cash conversion cycle. One is that
depreciation and profit should be excluded in the computation of cash
conversion cycle since the firm’s concern is with cash flows associated with
conversion at cost; depreciation is a non-cash item and profits re not costs.

A contrary view air that a firm has to ultimately recover total costs and make
profits; therefore the calculation of operating cycle should include
depreciation, and even the profits.

The above operating cycle concept relates to a manufacturing firm. Non-

manufacturing firms such as wholesalers and retailers will not have the
manufacturing phase. They will acquire stock of finished goods and convert
them into debtors and debtors into cash. Further, service and financial
enterprises will not have inventory of goods
(cash will be their inventory). Their operating cycles will be the shortest.
They need to acquire cash, then lend (create debtors) and again convert
lending into cash.

BIBLIOGRAPHY

 I.M PANDEY
 Financial management using Financial modeling by Ruzbeh J.
Bodhanwala
 M.Y KHAN
 R.P Rustogi
 Finance and Financial Reporting (IAI), CT-2
 Westerfield Jaffe
 www.bankofindia.com
 www.worldbank.org.in
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  www.rbi.org.in
 www.mospi.nic.in
 www.moneycontrol.com
 www.indiainfoline.com
 www.bankinginfo.com

 Bank Of India Documents

AUTHOR’s PROFILE

NAME : ABHINAV KUMAR

INSTITUTE : NARSEE MONJEE INSTITUTE OF
MANAGEMENT STUDIES
COMPANY : BANK OF INDIA , MALAD WEST
E MAIL : abhinav.dreams05@gmail.com
MOBILE : 9833737734

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