Working Capital Management

PART-I
CHAPTER:1
Introduction of the Asarwa Mills Limited.

1.1 About the Mill

Asarwa Mills, is a textile division of Bengal Tea and Fabrics Limited,

it is located in Ahmedabad, 315 miles, North of Mumbai, one of the
global cities. At its zenith in the last half of the 20th century
Ahmedabad as India’s textile hub was known as Manchester of India.
This Unit was originally incorporated in the year 1900.

In 1972 Bengal Tea took over Asarwa Mills and begun operation with
the goal of developing a latest technology textile mill and to foster
global market in the field of cotton yarn. In order to improve the
quality of its products as also the productivity of its plant to be
competitive in the industry, the company has been modernizing its
plants by replacing old, obsolete and worn out equipment with the
state-of-the art high speed equipment.

During last decade, the company has invested in its textile unit about
Rs. 67 crores for modernizing its spinning section including installation
of power plants of 4.1 MW.

Asarwa Mills, a technology savvy vintage unit has the most modern
equipment for spinning. It produces quality cotton yarn, synthetic and
blended yarn. It has a strong presence in both domestic and global
markets. Now Asarwa Mills has quality management system as per ISO
9001:2000.

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Working Capital Management

Valued customers perceive a producer of consistent quality at

competitive prices, always striving to exceed their expectations.

It is a one of the leading manufacturer and exporter of Cotton Yarn &

Fabric. Our unit is located above 315 miles, north of Mumbai, and has
an installed capacity of 47,616 spindles and 94 looms of most
sophisticated technology and it is exporting more than 50% of its yarn
to Europe, Canada, Hong Kong, Malaysia, Taiwan, Korea, Dubai, Egypt
and many other countries.

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Chapter-2 Departmental Study

2.1 Marketing Department

The company has appointed agents throughout the country who help
the company in procuring orders from various customers. The
Company has been successful in satisfying its customers by providing
superior quality at competitive prices and this enables the company to
bag repeat orders from its client base.

2.2 Human Resource Department

PERSONNEL
The Company operates in labor intensive business and the relations
with the personnel generally remained cordial throughout the year.

The Board expresses its appreciation for the contribution of the

employees at all levels.

2.3 Finance Department

System of Accounting

i) The Company generally follows the mercantile system of accounting

and recognizes income and expenditure on accrual basis except those
with significant uncertainties.
ii) Financial statements are based on historical cost convention
modified by revaluation of certain fixed assets.

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These costs are not adjusted to reflect the impact of the changing value
in the purchasing power of money.

2.4 Research and development Department

TECHNOLOGY ABSORPTION, & INNOVATION

(a) High speed Air jet Eurotec looms of wider width installed.
(b) One Air Compressor of 4000 CFM installed.
(c) Electronic Jiggers equipped with inverter installed.
Innovations
(a) Manufacturing of value added fabrics.
(b) Power savings by 3000 units per day.
(c) Increase in production capacity of bleaching

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Working Capital Management

PART-2 RESEARCH REPORT

WORKING CAPITAL MANAGEMENT

Chapter-1 Introduction

The main aim of my summer project “to study the Working Capital
Management of “Asarwa mills Ltd.”

We know that working capital is a very important aspect for any

organization. We can also say that, “It is like Oxygen for an
organization”. The objective of working capital management is
balancing the “Liquidity” and “Profitability” standard of an organization
while taking into consideration the attitude of management towards
risk.

My summer project is on working capital management because of the

previously mentioned the importance of working capital. Working
capital management involves not only managing the different
components of the current assets but also the current liabilities on the
financing of the current assets.

Working capital is said to be the amounts of capital required for the

smooth and uninterrupted functioning of the normal business operation
of a company ranging from the procurement of raw material converting
the same thing to finished products for the sale and realizing cash
along with profit.

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Working Capital Management
1.1 Meaning

According to Hogland:

“Working Capital is descriptive of that capital which is not fixed but

more common use is to consider Current Assets – Current Liabilities.”

All assets are converted into cash with in a short period of time & the
cash received is again invested into these assets. Hence it is known as
“Circulating Capital” or “Floating Capital.”

Working Capital means part of capital, which is required to keep the

flow of production smooth and continuous. The main difference
between Fixed and Working Capital is fixed assets are of long term
finance fund while working capital is short term finance fund.

Howere, such cash may more appropriately be “invested” in other

assets or in reducing other liabilities.

1.2 Working capital management takes place on two levels:

Ratio analysis can be used to monitor overall trends in working capital

and to identify areas requiring closer management. The individual
components of working capital can be effectively managed by using
various techniques and strategies. When considering these techniques
and strategies, departments need to recognize that needs to be placed
on each component varies to department.

For example, some departments have significant inventory levels;

others have little if any inventory.

Furthermore, working capital management is not an end in it self. It is

an integral part of the department’s overall management. The needs of
efficient working capital management must be considered in relation to
other aspects of the department’s financial performance.

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Working Capital Management

1.3 CONCEPTS OF WORKING CAPITALS

There are two concepts of Working Capital:

Gross Working Capital (GWC): It refers to the organization’s

investment in Current Assets which can be converted into cash within
an accounting year (or Operating Cycle) and includes Cash, bills
receivables and Stock (Inventory). The Gross Working Capital focuses
more attention on two aspect of Current Assets Management:

 Optimum investment in Current Assets

 Financing to Current Assets-Working Capital.

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Net Working Capital (NWC): It refers to the difference between
Current Assets and Current Liabilities are those outsiders, which are
expects to mature for payment within an accounting year and include
creditors (accounts payable), bills payable and outstanding expenses.
Te Net Working Capital indicates:

 Liquidity Position
Advice up to what extent funds are required for working capital.

Current Assets are those assets that in the ordinary course of business
can be converted into cash within a brief period, i.e. during the
operating cycle of business and normally not exceeding one year
without undergoing diminution in value and without disrupting the
operations.

Current Liabilities are those liabilities intended, at their inception, to be

paid in the ordinary course of business within a reasonably short-time,
normally within a year out of the current assets or the income of the
business.

Networking Capital can be “positive” or “negative”. A positive

networking capital will arise when Current Assets exceeds Current
liabilities. A negative networking capital occurs when Current Liabilities
are in excess of Current Assets.

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Working Capital Management

1.4 SCOPES OF WORKING CAPITAL

a. Maintain an adequate level of Working Capital, always, to meet

the rising turnover. This way, peak levels need can be taken care
of.

b. Sufficient liquidity to meet-term obligations as and when they

arise, also to avail market opportunities.

c. Avoid holding surplus Current Assets of any king by closely

monitoring their usage and turnover.

d. Efficient policy making with reference to important current assets

component such as inventory, debtors or cash.

e. Proper inter-departmental co-ordination to minimize working

capital investments regarding goods, inventory etc.

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Working Capital Management
f. Selection of appropriate sources of financing working capital viz.
Trade Credit, Bank Finance or other Short-term sources as well
as long term sources of funds.

1.5 DETERMINATION OF WORKING CAPITAL

There are no set rules or formulate to dermine the the working capital
requirements of organizations. The following are the factors, which
generally influence the working capital requirements of organizations:

Nature of Business: The shorter the manufacturing process, the

lower is the requirements for the working capital. This is because: in
such a case inventories have to be maintained at a low level
.

Credit Policy: A Company, which allows liberal credit to its customers,

may have higher sales but consequently will have lager amounts of
funds tied up in Sundry Debtors.

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Working Capital Management
1. Inventory Policy: The inventory policy of a company also has
an impact on the working capital requirements since larger
amounts of funds tied up in Sundry Debtors.

2. Abnormal Factors: Abnormal conditions like strikes and

lockouts also require additional working capital.

3. Market Conditions: Working Capital requirements are also

affected by market conditions like degree of competition.

4. Conditions of supply: If prompt and adequate supply of raw-

material, spares, stores, etc. is available it is possible to manage
with small investment in inventory or work on Just In Time (JIT)
inventory principles.

5. Price level changes: Inflationary trends in the economy

necessitate more working capital to maintain the same level of
activity.

6. Operating efficiency: Efficient and co-coordinated utization of

capital reduces the amount invested in working capital.

1.6 Classification of Working capital

Permanent or fix working capital: As is apparent form the ‘permant

“is that part of the capital, which is permanently, locked up in the
circulation of the current assets and keeping it moving .

Variable working capital: the variable working capital changes with

the volume of the business it may sub –divide into;

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Working Capital Management
(a) Seasonal working capital ;the capital riquried to meet the seasonal
needs of the industry is termed as seasonal working capital
(b) Special working capital; the capital required for financing special
operation such as carrying out of special operation such as carrying out
of special jobs

The key events of an operating cycle of any organization are as

follows

 Purchase of raw materials

 Payment for raw materials
 Sale of finished goods
 Collection of cash for sales

The cycle begins with purchase of raw materials which are paid for
after a deal which represents the Account payable period. The
organization converts the raw materials into finished goods and then
sells it.
The lag between the purchase of raw materials and the sale of finished
goods is called Inventory period, the customers pay for the sale of
the goods after some time, the time lag between sale n the collection
of the amount is receivable period.

1.7 CURRENT ASSETS FINANCIAL POLICY

 Current assets classification in managing working capital

policy:

1. Fluctuation of current assets.

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Working Capital Management

There are many factors affecting a organization’s working

capital policy:

Level of production

Level of sales

Seasonal

Credit policy, etc.

2. Permanent and temporary current assets.

Temporary current assets represent the level of inventory,

cash and accounts receivable that fluctuate seasonally.
Through a organization’s business cycle. Permanent current
assets represent the base of level of inventory, cash, and
accounts receivable, which tends to be maintained. It tends to
build on an organization’s balance sheet yearly.

Cash collections increase as the business grows. Accounts

receivable grow as the list of credit customer lengthens.
Inventory on hand rises as new facilities are opened, etc.

CHAPTER-2 RESEARCH DESIGN

1.8 OPERATING CYCLE

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Working Capital Management
DIAGRAM SHOWING THE OPERATING CYCLE

Cash Purchase
of raw materials

Receivables Work in progress

Finished Goods

In Asarwa Mills Ltd. Where the manufacturing activity is involved,

has much shorter span of operating cycle as it is exclusive of the raw
materials and work in process stage and partly by the bank and other
creditors. Company also gets raw materials from the suppliers on
credit.

Thus, the funds are required only to finance all the items contained in
the operating cycle but excluding the quantum of raw materials
obtained on credit, as these will be payable at a later date. As we may
see from the above figure, the process starts with the investment of
cash for the bills receivable of cash.

Thus Asarwa is able to complete one full circle ,i.e one singal oprating
cycle, during the period of four month means in one year company is
able to complete three cycles.

CURRENT ASSETS FINANCING POLICY

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Working Capital Management
> Current asset classification in managing working capital
policy

1. Fluctuation of current assets.

There are many factors affecting a organization's working

capital policy: Level of production Level of sales Seasonal
redit policy, etc

2. Permanent and temporary current assets.

Temporary current assets represent the level of inventory, cash,

and accounts receivable that fluctuate seasonally. Through a
organization's business cycle. Permanent current assets represent
the base of level of inventory, cash, and accounts receivable,
which tends to be maintained. It tends to build on an
organization's balance sheet yearly.

Cash collections increase as the business grows. Accounts

receivable grow as the list of credit customer lengthens.
Inventory on hand rises as new facilities are opened, etc.

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Working Capital Management
> Optimal level of current assts ^

1. Liquidity versus profitability

Lenders prefer a company having a large excess of current assets over
current liabilities whereas the owners prefer a high return. Current
assets have the advantage of being liquid, but holding them is not very
profitable. Cash account is paid no interest. Accounts receivable earns
no return. Inventory earns no return until it is sold. Non current assets
can be profitable, but they are usually not very liquid. Organizations
are usually faced with a trade-off in their working capital management
policy. They seek a balance between liquidity and profitability that
reflects their desire for profit and their need for liquidity.

2. Risk and return of current liabilities

A organization's working capital is financed from short-term borrowing,
long-term borrowing,- equity financing, or some mixture of all three. The
choice of the organization's working capital financing depends on
manager's desire for profit versus their degree of risk aversion.
The balance between the risk and return of financing options depends
on the organization, its financial managers, and its financing
approaches.

3. Establishing the optimal level of current assets

A organization's optimal level of current assets is reached when the
optimal level supply, of inventory, of accounts receivable, and other
current assets is achieved. Cash: organizations try to keep just enough
cash on hand to conduct day-to-day business, while investing extra
amounts in short-term marketable securities. Inventory organizations
seek the level that reduces lost sales due to lack of inventory, while at
the same time holding down bad debt and collection expenses through
sound credit policies.
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Working Capital Management

>" Working capital finance approaches

The quantum of working capital requirement is directly dependent on the

policy of the company regarding the level of current assets, as to how much
stocks of inventories of raw material and finished goods may be considered
to be sufficiently and reasonably safe, so as to fairly avoid the possible risk
of stock cuts and losses of business and the resultant losses.
Based upon this criterion, the working capital policy may broadly be
divided into three categories.

The aggressive approach

More short-term financing is used to finance current assets. Borrowing

short-term is considered more risky than borrowing long-term.
Organization risk increases/ due to the risk of fluctuating interest rates,
but the potential for higher returns increases because of the generally
low-cost financing. This approach involves the use of short-term debt
to finance at least- the organization's temporary assets, some or all of
its permanent current assets, and possibly some of its long-term fixed
assets. The organization has very little net working capital. It is more
risky or may be a negative net working capital. It is very risky.

The conservative approach

Avoid short-term financing to reduce risk, but decreases the potential

for maximum value creation because of the high cost of long-term debt
and equity financing. Borrowing long-term is considered less risky than
borrowings short-term. This approach involves the use of long-term
debt and equity to finance all long-term fixed assets and permanent
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Working Capital Management
assets, in addition to some part of temporary current assets. The
organization has a large amount of net working capital. It is a relatively
low-risk position. The safety of conservative approach has a cost.
Long-term financing is generally more expensive than short-term
financing.

The moderate approach:

This approach tries to balance risk and return concerns. Temporary

current assets that are only going to be on the balance sheet for a short
time should be financed with short-term debt, current liabilities. And,
permanent current assets and long-term fixed assets that are going to
be on the balance sheet for a long time should be financed from long-
term debt and equity sources. The organization has a moderate amount
of net working capital. It is a relatively amount of risk balanced by a
relatively moderate amount of expected return.

In the real world, each organization must decide on its balance of

financing sources and its approach to working capital management
based on its particular industry and the organization's risk and return
strategy.

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Working Capital Management

MANAGEMENT OF ACCOUNTING RECEIVABLE

Accounts receivables of a organization are created for both sides of the

productive system. On one side of this system, the organization may
make advance payments to the Suppliers of inventories to ensure
timely supply. On the other side accounts receivables are created by a
organization when it sells its outputs on credit. These are popularly
termed as Sundry Debtors.

Effective debtor control policy requires careful consideration of

the following:

1. Credit period.

2. Credit standards.

3. Cost of Cash discounts.

4. Collection policy.

Credit Period
The main factors influencing the period of credit granted to customers
arc as
follows:
1. The normal terms of trade for the industry.

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Working Capital Management
2 The importance of trade credit as a market tool.
3. The individual credit ratings of Customer.

Asarwa Limited is in trading business and dealing with more

than

Credit Limits
Credit limits should then be set for each customer based on their
credit worthiness. The organization should consider in this regard:
1. Customer payment record: is the customer a prompt payer?
2. Financial signals: is there evidence of the customer running up
losses or having liquidity problems.
Credit Standards
The five determinants of credit worthiness of a customer are as follows:
(a) Capacity
Capacity is defined as the ability of the enterprises to honor payment
commitments, which depends upon its ability to generate cash-flows with
which the bills are to be paid. Capacity to pay is measured by debt-
services coverage ratio.
(b) Capital
Capital is defined as the net worth which provides that important
cushion to the business to absorb shocks corning front both internal
and external environment when regular cash flows arc adversely
affected.
(c) Condition
Condition refers to economic and other factors that are beyond the
control of the
organization and that may affect its ability to pay debts.

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Working Capital Management

(d) Character
Character of a business (and that of the entrepreneur) rest on such
traits as honor. Trust worthiness and commitment. A business may
have all the good ratios, regular cash flows and solid capital base, but
may still turn out to be a bad customer because ii doesn't keep
commitments. How a business will react when all other C's have turned
worse, determines its character.

(e) Collateral
Collateral refers to assets that are pledged for security m a credit
transaction At Aasarwa mill all the above five determinants of credit
worthiness are taken into consideration while granting credit. Credit
Period depends on the credit ratings of the customer and credit limits
depend on the past dealing with the customer. The cash discount
varies from customer to customer.

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Working Capital Management

LIQUIDITY MANAGEMENT

Cash is the life-blood of an organization. A sustained growth' at an

organization
depends on the cash ability of the profit, not the profit as reflected in
the income
statement.

Liquidity
Liquidity is the ability of the organization to meet its cash obligation
when theyare due and to exploit sudden opportunities in the market.
The ultimate result of
illiquidity is bankruptcy. A measure of liquidity should indicate the
level at
solvency and the financial flexibility of the organization the following
are the
measures of liquidity.
• Current Ratio
Quick/Acid Test Ratio.

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Working Capital Management
• Net Working Capital Ratio - a superior Liquidity
measure Net Liquidity Ratio (NLR) Sales Cash
Conversion Cycle (SCCC)

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Working Capital Management
MANAGEMENT OF ACCOUNTS PAYABLE

Accounts payable includes trade credit and accrued expenses, which

provide spontaneous, self-adjusting source of Finance. Accounts payable
policy of an enterprise depends mostly on the accounts receivables policies
of the supplier.

Terms of Purchaser includes:

• Credit period,

• Cash discount for early payment and

• Penalty for delayed payment

Organizations often stretch accounts payable to enjoy additional float,

But it involves the economic costs of loss of goodwill. Other accruals
include outstanding salaries and wages, overheads taxes, dividend
payments etc. They do provide spontaneous short- term financing, but
the organization has limited flexibility on these sources due to severe
organizational and legal implications.

A good information system for accounts payable is necessary not only to

protect the organization against over-trading and missed out discount
opportunities, but also for cash forecasting and budgeting.

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Working Capital Management

ABC INVENTORY CONTROL SYSTEM :-

The organization should be selective in its approach to control
investment in various types of inventories. This analysis approach is called
ABC analysis and tends to measure the significance of each item of
inventories in terms of its value. The value items are classified as 'A
items' and would be under the tightest control. 'C items' represent
relatively least value and would be under simple control. 'B items' fall in
between these two category and require attention of management.
The ABC analysis concentrates on important items and is also known as
control
by importance and exception. The following steps are
involved in
implementing the ABC analysis:
> Classify the items of inventories, determining the expected use in
units
and the price per unit for each item.
> Determine the total value of each item by multiplying the expected
units by its unit's price.
Rank the items in accordance with the total value, giving first rank to
the
item with highest total value and so on. Compute the ratios of number of
units of each item to total units of all items and the ratio of total value of
each item to total value of all items. Combine items on the basis of their
relative value to form three categories- A, B and C.

In AML the entire stocks, of the items in category "A" must be closely
monitored and controlled, the monitoring and control say, 10% of the items
of category "C" could be considered enough to serve the purpose. And in
the case of "B" category of items, the monitoring and control of say 25%
of the item alone may be taken as sufficient.

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Working Capital Management

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 SOURCES OF WORKING CAPITAL FINANCE
FUND BASED LIMITS
CASH CREDIT:-
The cash credit facility is similar to the overdraft arrangement. It is the most
popular method of bank finance for working capital in India. Under the cash
credit facility, a borrower is allowed to withdraw funds from the bank up to the
sanctioned credit limit. Cash credit limits are sanctioned against the securities of
current assets. Though funds borrowed are repayable on demand, banks usually
do not recall such advances unless they are compelled by adverse circumstances.
It is the most flexible arrangement from the borrower's point of view.

A short-term cash loan to a company, Bank provides this type of funding,

but only after the required security is given to secure the loan. Once a security for
repayment has been given, the business that receives the loan can continuously
draw from the bank up to a certain specified amount. This type of financing is
similar to a line of credit. Cash credit components in the ratio of 75% of the
maximum Permissible Bank Finance.
WORKING CAPITAL DEMAND LOAN:
Sometimes a borrower may require ad hoc sanctioned credit limit to
meet unforeseen contingencies. Banks provide such accommodation
through a demand loan account or a separate non-operable cash credit
account. The borrower is requiring paying a higher rate of interest above
the normal rate of interest on such additional credit. Working capital
demand Loan in the ratio of 25% of the Maximum Permissible Bank
Finance.

PACKING CREDIT (PRE-SHIPMENT FINANCE):

On disbursement of the loan under packing credit, the exporting unit
starts the manufacturing process, after the purchase of stocks of raw
materials and consumable stores. The goods in process as also the
stocks of finished goods, as and when these keep getting ready, are
stored and stacked separately, segregated from the stocks of such
inventories meant for domestic sales. After the stocks of finished goods
get finally ready for the purpose of export, these are first securely
packed such that packing may withstand the stress .

WORKING CAPITAL DEMAND LOAN:

Sometimes a borrower may require ad hoc sanctioned credit limit to
meet unforeseen contingencies. Banks provide such accommodation
through a demand loan account or a separate non-operable cash credit
account. The borrower is requiring paying a higher rate of interest above
the normal rate of interest on such additional credit. Working capital
demand Loan in the ratio of 25% of the Maximum Permissible Bank
Finance.
PACKING CREDIT (PRE-SHIPMENT FINANCE):
On disbursement of the loan under packing credit, the exporting unit
starts the manufacturing process, after the purchase of stocks of raw
materials and consumable stores.
The goods in process as also the stocks of finished goods, as and when
these keep getting ready, are stored and stacked separately, segregated
from the stocks of such inventories meant for domestic sales.
After the stocks of finished goods get finally ready for the purpose of
export, these are first securely packed such that packing may withstand
the stress and strain of the long journey abroad, by the ship or by air,
may be even by road, depending upon the destination country and
approach and the route.
If the stock are to be exported by ship, the goods have first to be
transported by trucks or train, up to the port town, where after these
are put on board the ship. On receipt of such goods, the exporter is first
issued a 'Mate's Receipt', which is "kachcha" acknowledgement of goods
on board, pending issuance of a proper Bill of Landing, duly signed by the
Captain of the ship.

And, after the consignment is thoroughly inspected and checked by the

officials of the ship, and are found to be in proper order, free of any
apparent packing defects, etc, a document, known as the Bill of Landing, is
issued under the signature of the Captain of the Ship.

PROCEDURE:-
• Availability of limits.
• Drawing power to be taken in to account before availing PC.
• Contracts to be furnished with validity period. •
• Request letter along with contract for disbursal of PC.
• Contract is duly endorsed and returned n=by the bank.
• Disbursement of PC and conorganizationing due date.
• Bank commission, charges and interest against PC.

• Extension of due date in specific case.

• Liquidation of PC against export bills.

• Overdue charges or Penal interest.

 FOREIGN BILL PURCHASE/DISCOUNT:

Under this finance the borrower can obtain credit from a bank against
its bill. The banks purchase or discount the borrower's bills. The
amount provided under this agreement is covered within the overall
cash credit or overdraft limit. Before purchasing the bills, the bank
satisfies itself as to the creditworthiness of the drawer. Though the
term bill purchased implies that the bank becomes owner of the bills.
When a bill is discounted, the borrower is paid the discounted amount
of the bill. The banks collect the full amount on maturity.

PROCEDURE:-
• Formal application to Bank which contains :

• Purpose of Loan
• Required Loan amount

Sanction / Approval which contains :

• Sanctioned Loan amount

• Tenure & Rate of Interest

• Security to be offered —

• Repayment modes - Principal & interest payment terms

• Other compliances of documentation.

Documents Execution Disbursement Principal &

interest serving on due-dates.

 NON-FUND BASED FINANCE

LETTER OF CREDIT:-
Suppliers, insist that the buyer should ensure that his bank will make
payment if he fails to honor its obligation. This ensured through a
letter of credit arrangement. A bank opens a letter of credit in favor of
a customer to facilitate his purchase of goods. If the customer does
not make the pay to the supplier within the credit period, the bank
makes the payment under the letter of credit arrangement. Bank
charges the customers for opening the letter of credit. The letter from
the bank guaranteeing that the buyer's payment to the seller will be
received on time and for the correct amount. In the event that the
buyer is unable to make payment on the purchase, the bank will be
required to cover the full or remaining amount of the purchase.

Procedure of Letter of Credit regarding to AEL:

Seller (S) Buyer (B)

Seller's bank ^—————————————————— Buyer's

Bank

Step 1:- Seller draws the bill of exchange and submits the same,
along with all the required documents.
Step 2:- Seller's bank thereupon scrutinized all documents, carefully

and meticulously, so as to satisfy that all the terms and conditions,

stipulated in the

letter of credit has been fully and perfectly compiled with. On being
fully satisfied to this effect, seller's bank releases the fully payment of
the bill to seller by crediting the amount to the documents for
reimbursement of the entire amount of seller's bank.

Step 3:- Buyer's bank again meticulously scrutinized all the

documents and on being fully satisfied to the effect that all the terms
and conditions, stipulated in the letter of credit has been strictly
compiled with, debits the account of buyer and remits the account to
seller's bank. Thus buyer's bank and seller's bank too, come out of the
picture.
•
Step 4:- The relative documents are then sent by buyer's bank to
buyer, along with the advice that the account of buyer's has been
debited with the relative amount. Thus, buyer's bank has also been
able to realize the full payment from buyer and ultimately, buyer has
made the payment for goods purchased and all the relative documents
received.
PROCEDURE:-
• Request from the respective desk along with receipt of contract/
Invoice / sales agreement from respective desk availability of LC limits
for the above.

• LC liability to incorporate into our LC Limits margin to be provided.

• Account to be funded towards LC commission and charges.

• LC application as per bank's format duly stamped as per

stamping Act.

• Covering Letter for LC.

• Bank commission and charges debited to our account.

• Memo presentation along with draft from Bank on receipt of

Documents as per LC by them organization's due date.

« Acceptance & drafts against the Memo of the organization's

payment on due date.

» Submission of stamp duty if documents carry USANCE.

BANK GUARANTEE:

A bank guarantee is a guarantee made by a bank on behalf of a customer (usually an

established corporate customer) should it fail to deliver the payment, essentially
making the bank a co-signer for one of its customer's purchases. Should the bank
accept that its customer has sufficient funds or credit to authorize the guarantee, it
will approve it. A guarantee is a written contract stating that in the event of the
borrower being unable or unwilling to pay the debt with a merchant, the bank will
act as a guarantor and pay its client's debt to the merchant.

A guarantee from a lending institution ensuring that the liabilities of the debtor
will be met. In other words, if the debtor fails to settle a debt, the bank will cover
it. A bank guarantee enables the customer (debtor) to acquire goods, buy
equipment, or draw down loans, and thereby expand business activity.

Restrictions imposed by the RBI on the issuance of Performance Bank Guarantee

• Banks would do well to avoid issuance of Performance Bank Guarantee.
• Further such bank guarantee should be issued on behalf of very valuable
constituents only, whose credit worthiness, honesty and integrity are of
very high order.
• Such bank guarantee must be issued only as per the Performa bank
guarantee circulated by the RBI to all the banks.
• Moreover such amendments must be duly approved by the bank's
controlling authorities concerned, as the branches have not been entrusted
with any discretionary powers to allow such changes in the bank
guarantee performs.

PROCEDURE:-

• Request from the respective desk along with receipt of contract.

• Availability of limits opening BG against the above.

• Type of Guarantee: Financial or performance.

• BG liability to be provided for against our existing BG limit.

• Margin to be provided for BG.

• Account to be funded towards BG commission and charges.

• BG format and contract copy to be submitted along with covering letter

request to issue BG.

• Issuance of BG duly stamped and signed by Banker.

• Amendment if required from either side.

• Renewal of BG on expiry if required.

• Reversal of BG Liability as soon as the BG expired, cancelled or revoked.

 7. FINANCIAL RATIO

The relationship of one item to another expressed in a simple

mathematical form is known as the “RATIO”. A ratio is a quotient to
two numbers. It must be interpreted against some standard. In
assessing the financial stability of a firm, a management should, part
form profitability, be interested in relative figures. A ratio is of major
importance for financial analysis; it engages qualitative measurement
& shows precisely how adequate is one key item in relation to another.
To evaluate the financial condition & the purpose of the firm the
financial analyst needs certain yardsticks. The yardsticks frequently
used in ratio or an index relating two pieces of financial data to each
other’s.

UTILITY OF RATIO ANALYSIS:

1. Probability.
2. Liquidity.
3. Efficiency.
4. Inter – Firm Comparison.
5. Indicates Trend.
6. Useful of Budgetary Controls.
7. Useful for Decision Making.

Ratio Analysis is widely used tool of financial analysis. It can be used

to compare the risk and return relationships of firms of different sizes.
It is defined as the systematic use of ratio to interpret the financial
statements so that the strengths and weaknesses of a firm as well as
its historical performance and current financial condition can be
determined.

This ratio analysis contains five types of ratio as below:

1. Profitability Ratios.
2. Liquidity Ratios.
3. Assets Turnover Ratios.
4. Finance Structure Ratios.
5. Valuation Ratios.
1. Liquidity Ratios:

Liquidity is the ability of a company to meet its short-term obligations

when fall due. A company should have enough cash % other current
assets, which can be converted in to cash so that it can pay its
suppliers & lenders on time.

In evaluating Jay Chemical Industries Ltd’s liquidity four ratios are

presented.

 Current Ratio.
 Quick Ratio or Acid-test Ratio.
 Net Working Capital.
 Bank Finance Gap Ratio.
1.1. Current ratio

 Current ratio indicates the firm’s ability to pay its current liabilities, i.e.
day-to-day financial obligations.
 It shows the strength of credit, strength of working capital
& capacity to carry on effective operations.
 High ratio i.e. more than 2:1 indicates sound solvency
position.

Current Ratio = Current Assets

Current Liabilities

1.1 CURRENT RATIO (Rs. In Lacs)

Particular 2007-08 2006-07 2005-06

Current Assets.* 3578.76 4789.71 5067.19

Current 872.26 1348.97 1566.55
Liabilities.**
Current Ratio. 4.10 3.55 3.23

Graph: 1.1

 In the Year2005-06, Current Ration is 3.23 and it is

increased to 3.55in the Next year i.e.2006-07. This ratio is
continuous increase over the three years that is due to
increased in current Assets at a faster rate than Current
Liabilities.
 In the current year, i.e. in 2007-08this ratio shows favorable
position for the company and also viable to fulfill its
obligation
*Current Assets = Inventories + Debtors + Cash & Bank Balance + Loans & Advances
**Current Liability = Liabilities + Provision for Taxation

1.2. Quick Ratio or Acid Test Ratio

 Quick ratio is a measurement of a firm’s ability to convert

its convert assets quickly into cash in order to meet its
current liabilities.
 No standard norm is available for this ratio. However it is
believed that liquid assets should at least cover the
liquidity liabilities i.e. the ratio should be 1:1.

Quick Ratio = Quick Assets

Quick Liabilities

1.2 QUICK RATIO (Rs in Lacs)

Particular 2007-08 2006-07 2005-06
Quick Asset* 2706.6 3440.74 3500.64
Quick
Liability** 872.26 1348.97 1566.55
Ratio 3.10 2.55 2.23

Graph: 1.2

 In 2004-05, Quick Ratio is 1.24 which is higher than 1. It is

increasing year by year. The main reason for higher ratio is
company’s Assets are increasing faster than the Liability in
Current year Liability is increased more compare to
previous year but Assets are increased up to double
compare to last year so the Ratio is gone higher in the
Current Year.
 Higher Ratio will help company to meet any of the
unwanted Liability.

*Quick Assets = Current Assets – Inventories.

** Quick Liability = Current Liabilities

1.3. Net Working Capital

  Working capital refers to the funds locked up in materials,
work-in-progress, finished goods, receivables and cash etc.
 In very simple terms, “working capital may be defined has
capital invested in current assets”.

Net Working Capital = Current Assets – Current Liabilities

1.3 NET WORKING CAPITAL (Rs. In Lacs)

Particular 2007-06 2006-07 2005-06

Current Assets. 5067.19 4789.71 3578.76

Current Liabilities. 1566.55 1948.97 872.26
Net Working Capital 3500.64 3440.74 2706.50
Graph: 1.3


In 2004-05, Working Capital is Rs. 1159.84 Lacs and in
2005-06 is Rs. 3745.09 Lacs and it is further increased in
2006-07 is Rs. 6446.72 which shows increasing trend in
Working Capital.
 This ratio implies favorable position for the firm in which
company can work more efficiently and utilized working
Capital.
 Company should try to control the Receivable level that will
help in controlling the Bad debt as well as credibility of the
company.
1.4. Bank Finance Gap Ratio

 Bank Finance Gap Ratio = Total Current Assets – MPBF

Under Tendon Committee
 MPBF indicates maximum permissible bank finance under
tendon committee recommendations of 1975.
 The maximum permissible bank finance was restricted to
75% of the working capital gap under three successive
method of bank leading.

 Method 1:
 75% (Current Assets – Current Liabilities)
2004 – 2005: 75% (7033.42 – 3822.08) = 2408.51
2005 – 2006: 75% (7259.35 – 3514.26) = 2808.82
2006 – 2007: 75% (11719.07 – 5272.35) = 4835.04

 Method 2:
75% (Current Assets) – Current Liabilities.
2003 – 2004: 75% (7033.42) – 3822.08 = 1452.99
2004 – 2005: 75% (7259.35) – 3514.26 = 1930.25
2005 – 2006: 75% (11719.07) – 5272.35 = 3516.95

 Method 3:
75% (Current Assets – Core Current Assets*) – Current
Liabilities.
2003 – 2004: 75% ( 7033.42 – 4246.82) – 3822.08 = -1732.13
2004 – 2005: 75% (7259.35 – 4130.11) – 3514.26 = -1167.33
2005 – 2006: 75% (11719.07 – 8781.35) – 5272.35 = -3069.06

2. Profitability Ratios:

Profitability ratio measures the degree of operating success of a

company in an accounting period. Two types of profitability ratios are
there.

1. Profit Margin Ratios.

2. Rate of Return Ratios.

A profit margin ratio shows the relationship between profit & sales.
Three popular profits margin ratios are:

 Gross Profit Margin Ratios. Net Profit Margin Ratios.

2.1 Gross Profit Ratio

  Gross profit ratio is the basic measure of profitability of
business.
 It expresses relationship between gross profits earned to
net sales.

Gross Profit Ratio = Gross Profit x 100

Sales

2.1 GROSS PROFIT RATIO (Rs. In Lacs)

Particular 2006-07 2005-06 2004-05

Gross Profit 3162.26 2708.6 2612.84

Sales 17069.53 12291.17 11487.25
Gross Profit 18.53 22.04 22.75
(%)

Graph: 2.1

 There is a slight fluctuation in the Gross Profit Margin over

the last two years. But in the Current Year Gross Margin is
decreased by 3.51%.
 The main reason behind the decreasing in Gross Margin is
company’s Cost of Sales is increased in the Current year.

2.2 Net Profits Ratio

 The Net profit Margin indicative management’s ability to

operate the business with sufficient success not only to
recover from the incomes of the period, the cost of goods
and services, the expenses of operating the business
(including depreciation) and the cost of borrowed funds,
but also leave a margin of reasonable compensation to the
owners for providing their capital at risk.
 The ratio of Net profit to sales expresses the cost price of
effectiveness of the operation

Net Profit Ratio = Net Profit x 100

. Net Sales
 2.2 NET PROFIT RATIO (Rs. In Lacs)
Particular 2006-07 2005-06 2004-05

Net Profit. 464.87 294.16 205.55

Net Sales. 18309.42 12115.22 11337.36
Net Profit Ratio. 2.53 2.43 1.81
Graph: 2.2

 Net Profit Margin of Jay Chemical shows increasing trend

during the three years.
 In the Current Year Ratio is 2.53% because of increase in
the Sales near by 50%.
 This shows favorable condition for the Company.

3. Assets Turnover Ratios

Assets Turnover Ratios are basically Production ratios which measures

the output produced from the given input deployed. The relationship of
productivity is equal to output divided by input & assets turnover is
equal to sales divided by Assets.

Assets Turnover Ratios are as follows:

 Total Assets Turnover.

 Net Working Capital Turnover.
 Inventory Turnover.
 Debtor’s Ratio.

3.1 Total Assets Turnover Ratio

 The funds used in business are employed in both fixed

assets and current assets, and profit is earned with the
help of both. Hence it would be useful to know the
proportion of total assets to sales.
 The higher the turnover ratio, the more efficient is the
utilization of assets.
Total assets Turnover Ratio = Sales
Total Assets

3.1 TOTAL ASSETS TURNOVER RATIO (Rs. In Lacs)

 Particular 2006-07 2005-06 2004-05
Net Sales 18309.42 12115.22 11337.36
Total Assets* 13275.78 8736.65 4681.80
Ratio 1.38 1.38 2.42
Graph:3.1

 Total Assets Turnover Ratio shows the Decreasing trend in

the year 2004-05 it was highest i.e. 2.42. but in Current and
previous years it is decreased and stand at 1.38.
 In the year 2004-05 the total assets of rupee 1, the sale is
2.42, but in current year it is 1.38.
 So company should try to maintain the ratio which was in
past.

3.2 Net Working Capital Turnover

 This ratio indicates who efficiently the working capital is

utilized.
 The more the ratio the more is the efficiency.

Net Working Capital Turnover = Sales

Net Working Capital

3.2 NET WORKING CAPITAL TURNOVER (Rs. In Lacs)

Particular
2006-07 2005-06 2004-05
Sales 17069.53 12291.17 11487.25
Net Working Capital* 6446.72 3745.09 3211.34
Ratio 2.65 3.28 3.58
Graph: 3.2

 Company’s Sales and Net Working Capital both are

increasing in the given period but in different proportion
because of which ratio is decreasing year by year.
 It shows that company is not utilizing its net working
capital efficiently.

*Net Working Capital = Current Assets – Current Liabilities.

3.3 Inventory Turnover Ratio

  The Ratio signifying the efficiency of sales is the stock
turnover.
 It shows the number of times the average stock is turned
over during the year.

Inventory Turnover Ratio = Cost of Goods Sold

Average Inventories

3.3 INVENTORY TURNOVER RATIO (Rs. In Lacs)

Particular 2006-07 2005-06 2004-05

Cost of goods Sold 13753.28 9039.98 8874.41

Average Inventory* 4502.34 4522.54 3607.13
Ratio 3.05 2.00 2.46

Graph: 3.3

 The ratio is fluctuating over the three years. In 2006-07 it is

highest i.e. 3.05. that means company is using its inventory
efficiently.
 The overall ratio of the three years is more than 2.00 which shows the
satisfactory condition

4. Finance Structure Ratio

It indicates the relative mix or blending of owner’s funds and outsider’s

debt funds in the total capital employed in the business. Financial
leverage refers to the use of debt finance. While debt capital is a
cheater source of finance, it is also a riskier source of finance.

Two types of ratio are commonly used to analyze financial leverage

1. Structural Ratios.
2. Converge

Structure ratio is base on the proportion of debt and equity in the

financial structure of the firm. Important structural ratios are: -

 Debt equity Ratio

 Debt Ratio
 Rs. In lacs
Debt Equity Ratio

D/E ratio = Total Long Term Debt / Net Worth

2006-07 2005-06 2004-05

Debt 3820.21 5542.36 5669.01
Net Worth 3503.98 4507.25 111.26
Ratio 1.09 1.23 50.95

Debt = Secured + Unsecured Loans

Net Worth = Share Capital + Res. & Surplus - Misc. Exp

Interest Coverage Ratio

Interest Coverage Ratio = EBIT / Interest

2006-07 2005-06 2004-05

EBIT 471.57 679.65 501.59
Interest 379.87 306.32 214.86
Ratio 1.24 2.22 2.33

Interest = Int.on term loan +Int. on Bank Borrowings

Inventory Turnover Ratio

Inventory Turnover Ratio = Cost of Goods Sold / Avg. Inventory

4.1 Debt Ratio

 The Ratio shows the proportion of Long Term Debt to Total

Capital Employed.
 The sum of equity ratio and debt ratio should be 1.

Debt Ratio = Long-term Debt

Total Capital Employed

4.1 DEBT RATIO (Rs.In Lacs)

Particular 2006-07 2005-06 2004-05

Long Term Debt* 4664.19 2348.01 2101.59

Total Capital 8003.44 5222.39 4681.80
Employed**
Ratio 0.58 0.45 0.45
 Graph: 4.1

 The ratio shows the increasing trend, which means that total
long-term debt is increasing year by year compare, to Capital
Employed.

4.2 Debt Equity Ratio


This ratio establishes relationship between Long-term Debt
and Net Worth.
 A higher ratio means that outside creditors have a larger
claim than the owners of the business.
 In India, the general norm of debt-equity ratio is 2 for 1
rupee of equity.
Debt Equity Ratio = Total Long-term Debt
Net Worth

4.2 DEBT EQUITY RATIO (Rs. In Lacs)

Particular 2006-07 2005-06 2004-05

Total Long Term Debt 4664.19 2348.01 2101.59

Net Worth 3339.25 2874.38 2580.22
Ratio 1.40 0.82 0.81
Graph: 4.2

 This shows increasing trend during the year. It is lowest in

2004-05 i.e. 0.81.
 During the Current year ratio is going up because company
is expanding its capacity of production for meeting the
future demand prevailing in the market. So company had
borrowed large amount from the bank. But company should
have to improve the ratio during the next year.

4.3 Interest Coverage Ratio

  The ratio indicates as to how many times the profit covers
the payments of interest on debentures and other long-
term loans. It measures the debt service capacity of the
firm in respect of fixed interest on long-term debts.
 The higher the ratio, the more sound is the financial
strength of the company, as it indicates greater ability of
the firm to handle fixed charges.

Interest Coverage Ratio = EBIT

Interest

4.3 INTEREST COVERAGE RATIO (Rs. In Lacs)

Particular 2006-07 2005-06 2004-05

EBIT 471.57 679.65 501.59

Interest 379.87 306.32 214.86
Ratio 1.24 2.22 2.33

Graph: 4.3

 In the Current Year Interest Coverage ratio is go down the

reason for that is expansion of plant capacity so company
had taken more long term funds from the bank.
 Comparison of the Ratio of Last three Years of Jay Chemical
Industries Ltd.

Ratio Formula 2006-07 2005-06 2004-05

LIQUIDITY
Current Asset/Current 2.22 2.07 1.84
Current Ratio Liabilities
Quick Asset/Quick
Quick Ratio Liabilities 1.85 1.33 1.24

PROFITABILITY
Gross Profit (%) Gross Profit/Sales 18.53 22.04 22.75
Net Profit (%) Net Profit/Sales 2.53 2.43 1.81

ASSET TURNOVER
Total Assets Sales/Total Assets 1.38 1.38 2.42
Net Working Capital Sale/Net working Capital 2.65 3.28 3.58
Inventory COGS/Average Inventories 3.05 2.00 2.46
Credit Sales/Average
Debtors Debtors 2.67 3.05 3.28

FINANCE STRUCTURE
LongTerm Debt/Total
Debt Capital Employed 0.58 0.45 0.45
Total Longterm Debt/Net
Debt Equity worth 1.40 0.82 0.81
Interest Coverage EBIT/Interest 1.24 2.22 2.33