A PROJECT REPORT ON “ W ORKING C APITAL M ANAGEMENT" DEVELOPED BY, M ISS. U PADHYE P RIYANKA V INAYAK FROM MAHINDRA SONA LTD. SUBMITTED IN THE FULFILMENT OF THE M. B. A. (FINANCE), TO U NIVERSITY O F P UNE (2008-2009) P. D. V. V. P. FOUNDATION’S I NSTITUTE OF B USINESS M ANAGEMENT AND R URAL D EVELOPMENT, A HEMADNAGAR 1
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A
PROJECT REPORTON
“ W ORKING C APITAL M ANAGEMENT"
DEVELOPED BY,MISS. UPADHYE PRIYANKA VINAYAK
FROM
MAHINDRA SONA LTD.
SUBMITTED IN THE FULFILMENTOF THE
M. B. A. (FINANCE),
TO
UNIVERSITY OF PUNE(2008-2009)
P. D. V. V. P. FOUNDATION’SINSTITUTE OF BUSINESS MANAGEMENT
AND RURAL DEVELOPMENT, AHEMADNAGAR
1
DECLAIRATION:
I hereby declare that, all the information in this project report is
based on my own fact-findings and experienced at “Mahindra Sona
Limited.”
And the result embodies in this project report not been submitted
to any other university or institute for the award of degree or diploma.
IBMRD, AHEMADNAGAR.
Date:
Miss. Upadhye Priyanka V.
Place:
2
ACKNOWLEDGEMENT:
To begin with, I am extremely grateful to the Mahindra Sona
Limited, Nashik for having accepted me as summer trainee and thus
making it possible for we have wonderful work experience.
I most indebted to my guide at ‘Mahindra Sona Limited, Nashik’,
Mr. D. N. Mahale (Personnel Manager) and Mr. Shirish Kale (Finance
Executive) under whose constant supervision and valuable guidance the
project was tethered his cheerful countenance and approachability
delicately enamored productivity of work place.
I also extend my gratitude to whole staff of ‘Mahindra Sona
Limited,’ for giving their valuable support and guidance in completion
of project.
I sincerely thanks to my project guide Prof. Dr. M. P. Sharma
(Faculty, Institute of Business Management and Rural Development,
Ahemadnagar.), for his unfailing and valuable guidance from time to
time.
3
OBJECT OF THE PROJECT:
For the partial fulfillment of the MBA course a student is
supposed to undergo training in an organization for 50, days which is
mandatory by PUNE UNIVERSITY. While working with the
organization, one has to undertake a small study on the field of work
and subject allotted by the firm. Based on this study one has to submit a
report to the organization, University and College.
Summer project work exposes the real-time corporate
environment to a student to experience the current .And facilitates
student to experience the scenario .The project helps in giving an insight
in the field of FINANCE. To acquire knowledge and information of
financial aspects of the organization, the topic given by the organization
was “working capital management”.
4
OBJECTIVE OF THE PROJECT
TO CALCULATE THE RATIOS IN RELATION TO WORKING
CAPITAL AND ITS TREND ANALYSIS.
TO FORECAST THE WORKING CAPITAL REQUIREMENT OF
THE YEAR 2008-2009.
5
METHODOLOGY OF THE STUDY
RESEARCH
Research is a careful inquiry or examination to discover new information or relationships and to expand and verify existing knowledge.
The various sources of information can be broadly classified in two categories namely primary and secondary.
PRIMARY DATA COLLECTION:The information and data collected is though\rough formal and informal discussion with the officers of accounts department.
SECONDARY DATA COLLECTION:During the training period, data was collected from financial reports. For analyzing working capital management, certain books were also referred.
6
INDEX:
7
CONTENT PAGE NO.
1. COMPANY PROFILE:
i. INTRODUCTIONii. HISTORYiii. PRODUCTS AND APPLICATIONSiv. MILEESTONESv. ORGANIZATIONAL CHARTvi. PLANT LAYOUT
9-17
2. PROJECT ON WORKING CAPITAL:
i. WORKING CAPITAL POLICYii. TYPES OF WORKING CAPITALiii. NEED FOR WORKING CAPITALiv. CHARACTERISTICS OF CURRENT
ASSETSv. CURRENT ASSETS CYCLEvi. FACTORS INFLUENCING WORKING
CAPITAL vii. CURRENT ASSET FINANCING POLICY
18-33
3. OPERATING CYCLE AND CASH CYCLE:
i. OPERATING CYCLE ANALYSISii. DURATION OF LIFE CYCLEiii. MATCHING OR HEDGING APPROACHiv. CONSERVATIVE APPROACHv. AGGRESSIVE APPROACHvi. RATIO ANALYSIS
34-46
4. WORKING CAPITAL FINANCING:
i. INTRODUCTIONii. TYPES OF FINANCING WORKING
CAPITAL iii. SOURCES OF FINANCING WORKING
CAPITALiv. REGULATION OF BANK FINANCEv. OTHER FORMS OF FINANCING
47-52
8
5. DATA ANALYSIS AND INTERPRETATION:
i. BALANCE SHEET DATAii. BALANCE SHEET OF MSLiii. CURRENT ASSETSiv. CURRENT LIABILITIESv. CHANGES IN WORKING CAPITALvi. FINANCIAL REPORTvii. PROFIT AND LOSS ACCOUNT
53-62
6. RATIO ANALYSIS:
i. CURRENT RATIOii. LIQUID RATIOiii. ABSOLUTE LIQUID RATIOiv. CURRENT ASSET TURN-OVER RATIOv. WORKING CAPITAL TURN-OVER
RATIOvi. INVENTORY TURN-OVER RATIOvii. GROSS PRIFIT RATIOviii. NET PROFIT RATIOix. DEBTORS TURN-OVER RATIOx. INVESTMENT IN RECEIVABLESxi. OPERATING CYCLExii. GROSS OPERATING CYCLExiii. NET OPERATING CYCLExiv. CREDITORS TURN OVER RATIOxv. DEBT-EQUITY RATIO
63-78
7. CONCLUSION 79
8. RECOMMENDATIONS 80
9
COMPANY PROFILE
i. INTRODUCTIONii. HISTORYiii. PRODUCTS AND APPLICATIONSiv. MILESTONESv. ORGANIZATIONAL CHARTvi. PLANT LAYOUT
10
COMPANY PROFILE:
‘Mahindra Sona Limited’ was formed in collaboration with Dana
Corporation of USA, over two decades ago through access to
international technology and has since emerged as a leading
independent manufacturer of Automotive Components which include
Propeller Shafts/ Carden Shafts, UJ Components and automotive
Clutches. Progressively, ‘Mahindra Sona Limited’ has expanded its
product range to meet demands of various Automotive Manufacturers.
The facilities contain more than 9300 sq. meters of manufacturing space
strategically located in western India providing easy accessibility to
various vehicle manufacturers and provide ample scope for future
expansion to almost five times the current size. ‘Mahindra Sona
Limited’ has a strong team of 380 motivated employees, of which, 50
are qualified engineers and professionals.
HISTORY: The Company has long history, which dates back to the
year 1885 when M/s Turner Hoare and company started its activity in
imports and exports of traditional Indian consumer goods.
In 1968, M/s Turner Hoare and company took over another Company,
M/s East Atlantic Company and realistic market potential entered into
execution of engineering projects like Hydro pneumatic ash handling
system, mechanical cleaning like vibroscreen, traveling water screens
and bagged Import Substitution award twice. In 1977, with equity
participation of Dana Corporation, USA, the company went into
technical collaboration to manufacturer automotive components like
11
Propeller Shaft, Axle Shafts, Universal Joint Kits, and Automotive
Clutches.
The Nashik plant commenced production in 1979, following a
technical and financial joint venture between Mahindra and Mahindra
Limited and Dana Corporation, USA, Named Mahindra Spicer limited.
In 1984, Mahindra Spicer Limited merged with its parent company,
Mahindra and Mahindra Limited and became MSL division of the
parent company. In March 1995, Mahindra and Mahindra Limited and
Sona Koyo Steering Systems Pvt. Ltd. formed a new company
‘MAHINDRA SONA LIMITED’ to take over the automotive
components business of MSL division of Mahindra and Mahindra
Limited.
The company is engaged in designing and manufacturing a wide range
of auto- ancillary products such as Propeller Shaft, Axle Shafts,
Commercial vehicles, Medium Commercial vehicles, and Heavy
Commercial vehicles.
PRODUCTS AND APPLICATIONS:
• PRODUCTS:
o Propeller Shafts
o Universal Joints
o Steering Joints
o Clutch
1. PROPRLLER SHAFTS:
• Applications:
o Heavy Duty Vehicles
o Light Commercial Vehicles
o Passenger Cars
o Three Wheelers
o Earth Moving Equipments
o Constructing Machinery
2. AXLES:
• Applications;
o Multi Utility Vehicles
3. CLUTCHES:
• Applications;
o Multi Utility Vehicles
o Passenger Cars
14
MILESTONES:
1. 1968: Collaboration agreement between
Mahindra group and Dana Corporation, US for manufacturing the
clutches
2. 1976: Formation of a joint venture
company Mahindra Spicer Ltd.
3. 1979: Inauguration of Nashik work.
4. 1984: Merging of Mahindra Spicer Ltd
with Mahindra and Mahindra Ltd, the division of Mahindra and
Mahindra Ltd.
5. 1986: Dana Collaboration ends.
6. 1989: Modernization plan, redesigning
of entire clutch range.
7. 1994: Formation of Mahindra Sona Ltd.
restructure of Mahindra AND MAHINDAR MSL Division as Mahindra
Sona Ltd.
15
8. 1995: ISO-9001 certification by TUV-
CERT, Germany.
9. 1999: QS-9000 certification by TUV-
CERT, Germany.
10. 1999: Exports to USA begins.
16
BOARD OF DIRECTORS
Mr. J. V. PrabhuManaging Director
Mr. B. S. PatwardhanManagement
Representative
Mr. J. S. Chaudhary
Sr. Vice President(Marketing)
Mr. U. D. PhatakVice President
(A & F)Company Secretary
Mr. S. R. KundajeGeneral Manager(Technical Series)
Mr. R. V. Vadhavkar
General Manager(Materials)
Marketing (OEM after Marketing
Customers)Branch Offices, New Business Opportunities,
Customer Satisfaction,
Publicity, Brand Management
A/C, Finance, Costing, MIS
Production- Universal
Joints, Clutch, Tool
Room, Maintenance
and Shop Scheduling
Product engineering, UJ
and Clutch process, Product Testing, R and D, CAD, QA, Quality
System, CIP, Industries
Engineering, Capital
Expenditure, Info systems, HR,
Administration
Purchase, SOA, Suppliers, QS Development,
Customer Schedule Liaison,
Material Scheduling, OSP Schedule, Plant Job Ordering,
Packing, Dispatch, Sales
Administration, RM Stores,
Material Documentation.
17
18
19
Finance Department
Mr. A. D. KaleD. G. M.
Accounting and
Finance
Mr. R. M. Sawai
D. G. M.Costing and
MIS
Cash and Bank
Purchase Receivables
Purchase and Sales
ExportsSales
Accounts
Sales and accounts costing
activities
INTRODUCTION:
The topic was provided by the project guide in the organization. The
organization wanted to know how efficiently the working capital management
is working. The various ratios relating to the working capital shows the
efficient management of current asset and current liabilities is done.
OBJECTIVE OF PROJECT:
Main object is to match theoretical aspect with practical experience. The
project forms a vital element in the curriculum of M.B.A. Under M.B.A.
curriculum, University of Pune each student has to carry out the project in an
organization and submit the project in the University.
20
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PLANT LAYOUT
During the past decade there has been a burst in each and every business in
India. Competition has increased considerable within this decade. This has
forced the organization to reduce the cost rather than increasing its market
price for its product. Cost reduction can be achieved by various method like,
proper inventory management, managing debtors and creditors and other
current assets and liabilities, value engineering etc. To achieve all the things
effective and efficient working of capital is necessary.
21
EX
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WORKING CAPITAL POLICY
i. WORKING CAPITAL POLICYii. TYPES OF WORKING CAPITALiii. NEED FOR WORKING CAPITALiv. CHARACTERISTICS OF CURRENT ASSETSv. CURRENT ASSETS CYCLEvi. FACTORS INFLUENCING WORKING CAPITALvii. CURRENT ASSET FINANCING POLICYviii. THEORY OF RATIO ANALYSIS
PROJECT ON WORKING CAPITAL
WORKING CAPITAL POLICY:
Working capital management provides a summarized view of the
position of the current assets and current liabilities and how to manage
them and have an efficient and effective and optimum working capital.
For day to day working of the concern is known as working capital and
to fulfill this need, working capital management is necessary.
This introduces working capital management or short term
financial management which is concerned with decisions relating to
current assets and current liabilities.
The key difference between long term financial management and
working capital management is in terms of the timing of cash. While
long term financial decisions like buying capital equipment or issuing
debentures involve cash flows over an extended period of time( 5 to 15
years or even more), short term financial decisions typically involves
cash flows within a year or within the operating cycle of the firm.
There are two concepts of working capital: gross working capital
and net working capital. Gross working capital is the total of all current
assets. Net working capital is difference between current assets and
current liabilities. Management of working capital refers to the
management of current assets as well as current liabilities. The major
thrust, of course, is on the management of current assets. This is
22
understandable because current liabilities arise in the context of current
assets.
Working capital management is a significant facet of financial
management. Its importance stems from two reasons;
An investment in current assets represents a substantial portion of the
total investment.
Investment in current assets and the level of current liabilities
have to be geared quickly to change in sales. To be sure, fixed asset
investment and long term financing are also responsive to variation in
sales. However, this relationship is not as close and direct as it is in the
working capital components.
The importance of working capital management is reflected in
the fact that financial managers spend a great deal of time in managing
current assets and current liabilities. Arranging short term financing,
negotiating favorable credit terms, controlling the movement of cash,
administering accounts receivable, and investing short term surplus
funds consume a great deal of time of financial managers.
TYPES OF WORKING CAPITAL:
There are two types of working capital:
o Fixed working capital
o Variable working capital
23
o Fixed working capital :
To carry on business a certain minimum level of working capital is
necessary on a continuous and uninterrupted basis and for all practical
purpose this requirement will have to be met with long term sources.
This requirement is referred to as permanent or fixed working capital.
Variable working capital :
Any amount over and above the permanent level of working capital is
known as temporary, fluctuating or variable working capital. This
portion of the working capital is needed to meet fluctuations in demand
consequent upon changes in production as a result of seasonal changes.
24
KINDS OF WORKING CAPITAL
ON THE BASIS OF CONCEPT
ON THEBASIS OF
TIME
GROSS WORKINGCAPITAL
NET WORKING CAPITAL
FIXED WORKING CAPITAL
VARIABLE WORKING CAPITAL
REGULAR WORKING CAPITAL
RESERVE WORKING CAPITAL
SEASONAL WORKING
CAPITAL
SPECIAL WORKING CAPITAL
25
NEED FOR WORKING CAPITAL:
The objective of financial decision making to maximize the
shareholder’s wealth, it is necessary to generate sufficient profit. The
extent to which profits can be earned will naturally depend upon sales.
However, sales can not be easily converted into cash. Therefore, a need
for working capital in the form of current assets to deal with the
problem arising out the lack of immediate realization of cash again good
sold.
Of technically, this is referred to as the operating or cash cycle. This
cycle consists three phases;
PHASE 1-
Conversion of cash into inventory i.e. purchase of raw material,
conversion of raw material, conversion of raw material into work-in-
progress and finished goods.
PHASE 2-
Conversion of inventory in to receivables i.e. allowing customers credit
sales.
PHASE 3-
Conversion of receivables into cash i.e. receivables are collected.
26
Working capital policy is divided into seven sections;
Characteristics of current assets: There are mainly two characteristics
of current assets;
o Short life span and
o Swift transformation into other asset forms.
Factors influencing working capital requirements: The working
capital needs of a firm are influenced by numerous factors. The
important ones are;
o Nature of business
o Seasonality of operations
o Production policy
o Market conditions
o Condition of supply
Level of current assets: An important working capital
policy decision is concerned with the level of investment in current
assets. Under the flexible policy (also referred to as a ‘conservative
policy’), the investment in current assets is high. This means that the
firm maintains a huge balance of cash and marketable securities, carries
large amount of inventories, and grants generous terms of credit to
customers which leads to a high level of debtors. Under a restrictive
policy (also referred to as an ‘aggressive policy’), the investment in
current assets is low. This means a firm keeps a small balance of cash
and marketable securities, manages with small amount of inventories,
and offers stiff terms of credit which leads to low level of debtors.
27
Current assets financing policy: The investment in
current assets may be broken into two parts: Permanent Current Assets
and Temporary Current Assets. The former represents what the firm
requires even at the bottom of its
Cycle; the latter reflects the variable component that moves in line with
seasonal fluctuations.
Profit criterion for current assets: Current assets can be easily
liquidated and the value realized on liquidation would be more or less
equal to the amount invested initially. Put differently, investment in
current assets is reversible. For reversible investments, the criterion for
net profit per period (which here means residual income) is equivalent
to the criterion of net present value.
Operating cycle analysis: The investment in working capital is
influenced by four keys events in the production and sales cycle of the
firm:
o Purchase of raw materials
o Payment for raw materials
o Sale of finished goods
o Collection if cash for sales
Cash requirement for working capital: A financial manager is always
interested in figuring out how much cash he/she should be arrange to
28
meet the working capital needs of his/her firm. There is a two step
procedure for this:
o Estimate the cash cost of various current assets required by firm.
o Deduct the spontaneous current liabilities from the cash cost of
current assets.
A. CONSTITUENTS OF CURRENT ASSETS:
Inventories
o Raw materials and components
o Work-in-progress
o Finished goods
o Others
Trade debtors
Loans and advances
Cash and bank balances
B. CONSTITUENTS OF CURRENT LIABILITIES:
Sundry creditors
Trade advances
Borrowings (short-term)
o Commercial banks
o Others
Provisions
29
CHARACTORISTICS OF CURRENT ASSETS:
While managing working capital, bear in mind two
characteristics of current assets;
i) Short life span
ii) Swift transformation into other asset forms.
Current assets have a short life span. Cash balances may be held idle for
a week or two, accounts receivables may have a lifespan of 30 to 60 days, and
inventories may be held for 2 to 60 days. The lifespan of current assets
depends upon the time required in the activities of procurement, production,
sales and collection and the degree of synchronization among them.
Each current asset is swiftly transformed into other asset forms: cash is
used for acquiring raw materials; raw materials are transformed into finished
goods (this transformation may involve several stages of work in process);
finished goods, generally sold on credit, are converted into accounts receivable
(bank debt); and finally, accounts receivable, on realization, generate cash.
The short lifespan of working capital components and their swift
transformation from one form into another has certain implications;
• Decisions relating to working capital management
are repetitive of frequent.
30
Finished Goods
Accounts Receivable
Work in Process
Wages, salaries, Factory overheads
Cash Suppliers
Raw materials
• The difference between profit and present value is
insignificant,
• The close interaction among working capital
components implies that efficient management of other
components. For example, if the firm has a large accumulation of
the finished good inventory, it may have to provide more liberal
credit terms or show laxity in credit collection. Another example;
if the firm has a crunch it may have to offer generous discounts.
CURRENT ASSET CYCLE
31
FACTORS INFLUENCING WORKING CAPITAL REQUIREMENTS:
The working capital needs of a firm are influenced by numerous
factors. The important ones are;
Nature of business
Seasonality of operations
Production policy
Market conditions
Conditions of supply
Credit Policy
Inventory Policy
Abnormal Factors
Business Cycle
Growth And Expansion
Level Of Taxes
Dividend Policy
Price Level Changes
Operating Efficiency
Few of them are given bellow;
a. Nature of business: The working capital requirement of a 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 sales prominently on cash basis, has a modest
working capital requirement. On the other hand, a manufacturing
concern likes a machine tools unit, which has a long operating cycle and
32
which sales largely on credit have a very substantial working capital
requirement.
b. Seasonality of operations: Firms which have marked seasonality in
their operations usually have highly fluctuating working capital
requirements. To illustrate, consider a firm manufacturing ceiling fans.
The sale of ceiling fan reaches a peak during summer months and drops
sharply during winter period. The working capital requirements of such
a firm are likely to increase considerably in summer months and
decrease significantly during winter period. On the other hand, a firm
manufacturing product like lamps, which have fairly even sales round
the year, tends to have stable working capital
c. 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. For
example, a manufacturer of ceiling fans may maintain a steady
production throughout the year, rather than intensify the production
activity during the peak business season. Such a production policy may
dampen the fluctuations in working capital requirements.
d. Market Conditions: The degree of competition prevailing in the
market place has an important bearing on working capital needs. When
competition is keen, a larger inventory of finished goods is required to
promptly serve customers who may not be inclined to wait because
other manufacturers are ready to meet their needs. Further, general
credit terms may have to be offered to attract customers in a highly
competitive market. Thus, working capital requirements tend to be high
33
because of greater investments in finished goods, inventory and
accounts receivable.
If the market is strong and the competition is weak, a firm can
manage with a smaller inventory of finished goods because customers
can be served with some delay. Further, in such a situation the firm can
insist on cash payment and avoid lock-up of funds in accounts
receivable- it can even ask for advance payment, partial or total.
e. Conditions of Supply: The inventory of raw materials, spares and
stores depends on the conditions of supply. If the supply is prompt and
adequate, the firm can manage with small inventory. However, if the
supply is unpredictable and scant, then the firm, to ensure continuity of
production, would have to acquire stocks as and when they are available
and carry larger inventory, on an average. A similar policy may have to
be followed when the raw material is available seasonally and
production operations are carried out round the year.
CURRENT ASSETS FINANCING POLICY:
After establishing the level of current assets, the firm must determine
how these should be financed. What mix of long term capital and short
term debt should the firm employ to support its current assets?
For the sake of simplicity, assets are divided into two classes, viz. fixed
assets and current assets. Fixed assets are assumed to grow at a
constant rate which reflects the secular growth in sales. Current assets,
too, are expected to display the same long-term rate of growth; however,
they exhibit substantial variations around the trend line, thanks to
seasonal (or even cyclical) patterns in sales and/or purchases.
34
The investment in current assets may be broken into two parts:
Permanent Current Assets and Temporary Current Assets. The former
represents what the firm requires even at the bottom of its sales cycle;
the latter reflects the variable component that moves in line with
seasonal fluctuations.
Several strategies are available to a firm for financing its capital
requirements. These strategies are illustrated by lines A, B and C in
following diagram.
STRATAGY A: Long-term financing is used to meet fixed asset as
well as peak working capital requirements. When the working capital
requirements are less than its peak level, the surplus is invested in liquid
assets (cash and marketable securities).
STRATEGY B: Long-term financing is used to meet fixed asset
requirements, permanent working capital requirements, and a portion of
fluctuating working capital requirements. During seasonal upswings,
short-term financing is used; during seasonal downswings, surplus is
invested in liquid assets.
STRATEGY C: Long-term financing is used to meet fixed asset
requirements and permanent working capital requirements. Short-term
financing is used meet fluctuating working capital requirements.
35
Fluctuating Current Asset fluctuating requirement
A
B
C
Fixed Asset Requirement
36
Fluctuating CurrentAsset Requirements
Permanent CurrentAsset Requirements
Ca
pita
l R
equ
ire
me n
ts
CAPITAL REQUIREMENTS AND THEIR FINANCING
37
Time
OPERATING CYCLE
AND CASH CYCLE
i. OPERATING CYCLE ANALYSISii. DURATION OF LIFE CYCLEiii. MATCHING OR HEDGING APPROACHiv. CONSERVATIVE APPROACHv. AGGRESSIVE APPROACH
OPERATING CYCLE AND CASH CYCLE:
The investment in working capital is influenced by four keys events in
the production and sales cycle of the firm:
• Purchase of raw materials
• Payment for raw materials
• Sale of finished goods
• Collection if cash for sales
The firm begins with the purchase of raw materials which are
paid for after a delay which represents the accounts payable period. The
firms convert the raw material into finished goods and then sell the
same. The time lag between the purchase of raw materials and the sell
of finished goods is the inventory period. Customers pay their bills
sometimes after the sales. The period that elapses between the date of
38
sale and the date of collection of receivables is the accounts receivable
period (debtor’s period).
The time that elapses between the purchase of raw materials and
the collection of cash for sales is referred to as the operating cycle,
whereas the time length between the payments for raw material
purchases and the collection of cash for sales is referred to as the cash
cycle. The operating cycle is the sum of inventory period and the
accounts receivable period, whereas the cash cycle is equal to the
operating cycle less the accounts receivable period.
From the financial statement of the firm, we can estimate the
inventory period, the accounts receivable period, and the accounts
payable period.
39
Stock arrives
Inventory Period
Accounts Receivable Period
Cash Cycle
OPERATING AND CASH CYCLE
Cash ReceivedOrder placed
Accounts Payable Period
Firm Receives invoice
Cash Paid For Materials
Operating Cycle
OPERATING CYCLE ANALYSIS:
The Concept of Operating Cycle:
The net working capital is the difference between current assets
and current liabilities. A firm acquires current assets to convert them
into cash so that the current liabilities can be satisfied. On the other
hand, fixed assets such as land and building, plant and machinery etc.
are acquired with long term objective. The amount of capital invested in
fixed assets is recovered after a long period of time. On the other hand,
amount blocked in current assets is expected to recover as early as
possible. The concept of operating cycle is based on this aspect.
Operating cycle:
The concept of operating cycle implies the time period that is
required from the time cash is put on the business along with other
inputs to the time it is recovered from the amount of sales made by the
firm. A firm puts cash on as an input and the inputs like raw materials
are purchased with the cash. The raw materials are converted into
finished product and for this additional cash may be required. The
finished product is converted into sale and if the sale is made for cash,
the operating cycle is complete as cash is recovered back. On the other
hand, if sales are on credit, sales are converted into debtors and debtors
are converted into cash.
The length of operating cycle depends upon several factors.
These factors are as follows;
40
(i) Length of the manufacturing process: If the manufacturing
process is quite lengthy, the operating cycle will be prolonged. On the
other hand, if the manufacturing process is of shorter duration, the
length of the operating cycle will also be of a shorter duration. For
example, in case of hotels and restaurants, the manufacturing process is
relatively short which reduces the duration of the operating cycle. In
case of heavy engineering industries, since the manufacturing process
itself is very lengthy, the operating cycle also becomes very long.
(ii) Holding period of inventories: On an average for how long firm
holds inventory is also one of the factors affecting operating cycle. If the
firm holds inventory of raw material for a longer duration due to safety
precautions, operating cycle is prolonged. Firms following hand to
mouth policies regarding inventories of raw materials will have a
shorter operating cycle. Similarly in case of work-in-process, if the time
duration is long before being converted into finished product, operating
cycle will be of longer period. In case of finished goods inventory also,
the same principle exists. If finished goods are quickly converted into
sales, operating cycle will be shorter. But if finished goods inventory is
not converted into sales quickly and liberal credit is extended to the
customers, operating cycle becomes lengthy.
The operating cycle of a firm begins with the acquisition of raw material
and ends with the collection of receivables. It may be divided into four
stages.
o Raw material and stores storage stage
o Work in progress stage
o Finished goods inventory stage
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o Debtor’s collection stage
DURATION OF LIFE CYCLE:
The duration of life cycle is equal to the sum of duration of each of
these stages less the credit period allowed by the suppliers of the firm.
O = R + W + F + D - C
Where O = duration of operating cycle
R = raw material and stores storage period
W= work - in - progress period
F = finished goods storage period
D = debtors collection period
C = creditors payment
The components of operating cycle may be calculated as follows;
Average stock of Raw material
R = ---------------------------------------------------------------------------
Average raw material and stores consumption per day
Average work-in-progress inventory
W = ---------------------------------------------------------------------------
Average cost of production per day
Average finished goods inventory
F = -----------------------------------------------------------------------------
Average cost of goods sold per day
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Average book debts
D = -----------------------------------------------------------------------------
Average credit sales per day
Average trade creditors
C = -----------------------------------------------------------------------------
Average credit purchase per day
MATCHING APPROACH OR HEDGING APPROACH:
In matching approach or hedging approach for financing in which the
expected life of assets is matched with the sources of funds rose to
finance assets. The more explanation of the exact matching approach is
the purpose of financing is to make payments of assets, the financing
should be relinquished when the asset is expected to be relinquished,
and long term finance for the short term is expensive or costly because
funds will not be utilized for full period.
Similarly financing long term assets with a short term financing will
have to be made on a continuing basis. In this way, when a company
follows matching approach, long term financing will be used to finance
fixed assets and permanent current assets. Short term financing is used
to finance temporary current assets.
CONSERVATIVE APPROACH:
The financing policy of a company is conservative when it depends
more on long term funds for financing needs.
In this approach, company finances permanent assets with long term
financing. In this way company has no temporary assets, company
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stores liquidity by investing surplus funds into marketable securities.
This plan mainly depends upon long term financing and so less risky.
AGGRESSIVE APPROACH:
While financing assets, company may select aggressive approach when
a company uses more short term financing than warranted by matching
approach. In this policy, company finances a part of its permanent
current assets are also financed by short term finance. The relatively
more used of short term financing makes this aggressive approach more
risky.
RATIO ANALYSIS:
A ratio is simple arithmetical expression of the relationship of one
number to another. It may be defined as the indicated quotient of the
two mathematical expressions.
A ratio is defined as, “The indicated quotient of two
mathematical expressions.” And as, “The relationship between two or
more things.” Ratio analysis is powerful tool of financial analysis.
Ratio analysis is a technique of analysis and interpretation of
financial statements. It is a process of establishing and interpreting
various ratios for helping in making certain decisions.
CLASSIFICATION OF RATIOS (ACCORDING TO TEST):
Various ratios have been classified as bellow;
a) LIQUIDITY RATIO: These are the ratios which measure short
term solvency for financial position of a firm.
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b) LONG TERM SOLVANCY AND LIQUIDITY RATIO: Long
term solvency ratios convey the firm’s ability to meet the
interest costs and repayment schedules of its long term
obligations. E.g. Debt-equity ratio and Interest coverage ratio.
c) ACTIVITY RATIO: These are calculated to measure the
efficiency with which the resources of a firm have been
employed.
d) PROFITABILITY RATIOS: These ratios measure the results
of business operations or overall performance and effectiveness
of a firm.
LIQUIDITY RATIO:
Liquidity refers to the ability of a concern to meet its current obligations
as and when it becomes due. These should be convertible into cash for
paying obligations of short term nature. If current assets can pay off
current liabilities, then liquidity position will be satisfactory. On the
other hand, if current liabilities may not be easily met out of current
assets then liquidity position will be bad. To measure liquidity of a firm,
the following ratios can be calculated;
i. Current Ratio
ii. Quick or Acid Test or Liquid Ratio
iii. Absolute Liquid Ratio or Cash Position ratio
A. CURRENT RATIO:
Current ratio may be defined as the relationship between current assets
and current liabilities. This ratio is also known as the Working Capital
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Ratio, which is a measure of general liquidity and is most widely used
to make the analysis of short term financial position or liquidity of a
firm.
Current Assets
Current Ratio = --------------------------------------
Current liabilities
OR
Current Assets: Current Liabilities
B. LIQUID RATIO:
Liquid ratio or quick or acid test ratio may be defined as the relationship
between liquid assets and current or liquid liabilities. An asset is said to
be liquid if it can be converted into cash within a short period without
loss of value. In that sense, cash in hand and cash at bank are the most
liquid assets.
Liquid Assets
Liquid Ratio = --------------------------------
Liquid Liabilities
C. ABSOLUTE LIQUID RATIO:
The ratio should be calculated together with current ratio and acid test
ratio so as to exclude even receivables from the current assets and find
out the absolute liquid assets.
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Absolute Liquid Assets
Absolute Liquid Ratio = -----------------------------------
Current Liabilities
D. CURRENT ASSET TURNOVER RATIO:
Funds are invested in various assets in business to make sales and earn
profit. The efficiency with which assets are managed directly affects the
volume of sales. The better the management of assets, the larger is the
amount of sales or profits. Activity ratios measure the efficiency or
effectiveness with which a firm manages its resources or assets. These
ratios are called as “Turn-over ratios” because they indicate speed with
which assets are converted into sales.
Current Assets SalesTurnover Ratio = ----------------------
Current Assets
E. WORKING CAPITAL TURNOVER RATIO:
Working capital turnover ratio indicates the velocity of the utilization of
net working capital. This ratio indicates the number of times the
working capital is turned over in the course of a year.
A higher ratio indicates efficient utilization of working capital and a low
ratio indicates otherwise.
Working Capital Cost of SalesTurnover Ratio = ---------------------------------
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Average Working Capital
F. INVENTORY TURNOVER RATIO:
This is also known as Stock Velocity. It indicates whether inventory has
been efficiently used or not. The purpose is to see whether only required
minimum funds have been locked up in inventory. The ratio indicates
number of times the stock has been turned over during the period and
evaluates the efficiency with which a firm is able to manage its
inventory.
Inventory SalesTurnover Ratio = ----------------------
Inventory
G. GROSS PROFIT RATIO:
Gross profit ratio measures the relationship of gross profit and net sales
and is usually represented as a percentage.
Gross Profit
Gross Profit Ratio = ---------------------- Î 100
Net Sales
H. NET PROFIT RATIO:
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Net profit ratio establishes a relationship between net profit (after taxes)
and sales, and indicates the efficiency of the management in
manufacturing, selling, administrative and other activities of the firm.
Net Profit after Tax
Net Profit Ratio = -------------------------- Î 100
Net Sales
I. DEBTORS TURNOVER RATIO:
Debtor’s velocity indicates the velocity of debt collection of firm. In
simple words, it indicates the number of times average debtors
(Receivables) are turned over during the year.
Net Credit Sales
Debtors Turnover Ratio = -------------------------------
Average Trade Debtors
= No. of Times
J. CREDITORS TURNOVER RATIO:
A firm has to make credit purchases and incur short term liabilities. A
supplier of goods, i.e., creditor, is naturally interested in finding out how
much time the firm is likely to take in repaying its trade creditors.
Net Purchases
Creditors Turnover Ratio = -------------------------------
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Average Trade Creditors
K. DEBT-EQUITY RATIO:
Debt-equity ratio, also known as “External- Internal Equity Ratio” is
calculated to measure the relative claims of outsiders and the owners (i.
e. shareholders) against the firm’s asset. The ratio indicates the
relationship between the outsider’s funds and the shareholders funds.
Outsider’s funds
Debt-Equity Ratio = ---------------------------
Shareholders funds
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WORKING capital financing
i. INTRODUCTIONii. TYPES OF FINANCING WORKING CAPITALiii. SOURCES OF FINANCING WORKING CAPITALiv. REGULATION OF BANK FINANCEv. OTHER FORMS OF FINANCING
WORKING CAPITAL FINANCING:
INTRODUCTION:
The investment in raw materials, stock-in-progress, finished goods, and
receivables (the principal constituents of current assets) often varies a great
deal during the course of the year. Hence, the financial manager generally
spends a good chunk of his time in finding money to finance current assets.
TYPES OF FINANCING WORKING CAPITAL:
The firm must find out the sources of finds to finance its working capital.
There are three different financial policies which are as follows;
• Long Term Financing: The sources of long term
financing
Are;
o Shares (Equity shares and preference shares)
o Debentures
o Retained earnings and
o Long term loan from financial institution
• Short Term Financing: The sources of short-term financing are short
term credit, which the firm arranges. These sources include.
o Short term bank credit or loans
o Commercial papers
o Factoring receivable and
o Public deposit
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• Spontaneous Financing: Spontaneous financing refers to the automatic
sources of short term funds.
E.g. Trade credit and outstanding expenses. The main features of these
sources are that they are cost free.
Normally permanent working capital is financed by long term sources where
as temporary working capital is financed by short term sources.
While taking the decision of financing working capital requirement, certain
factors are to be taken into consideration;
i. cost of financing
ii. flexibility
o Cost of Financing: The interest rates increased with the time.
Longer the maturity of debit greater the interest rate. The decision of the
company is guided by risk-return trade off.
o Flexibility: Short term funds are more flexible. Short term funds can
be easily refunded as compared to long term funds, because long term
funds can not be refunded before its maturity period. Financing for the
domestic order is majority met by letter of credit. In case of any shortage
company uses the surplus into various activities such as;
a) short term investments
b) Inter corporate deposit – In case any sister factory is in need of
funds, the surplus fund is used as given to the sister concern.
c) Paying for Overdrafts
Typically, current assets are supported by a combination of long-term and
short-term sources of finance. Long-term sources of finance primarily support
fixed assets and secondarily provide the margin money for working capital.
Short-term sources of finance, more or less exclusively support the current
assets.
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CASH FLOW STATEMENT:
Cash flow statements indicate movement of cash only. The preparation
of cash flow statement is important to understand the paradoxical
situation in which the firm finds difficulty in honoring its short period
business
Indicated by the funds flow statement (working capital basis).
FUNDS FLOW STATEMENT:
The funds flow statement reveals the sources from which the funds are
made available and how they are utilized or applied. Difference between
cash flow and funds flow statement is given bellow;
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DIFFERENCE BETWEEN FUNDS FLOW AND CASH
FLOW STATEMENT:
FUND FLOW STATEMENT CASH FLOW STATEMENTThe term fund refers to working
capital and it shows changes in
working capital.
The term cash refers to only cash
and it shows change in cash
position of the business.This analysis is more useful in long
term planning.
This is more useful in short term
planning.This considers changes in all current
assets and current liabilities.
This indicates simply cash receipt
and cash payments and does not
take into consideration other current
assets.
Improvement in working capital
does not mean improvement in cash
position.
Improvement in cash position
results in improvement in working
capital.This is a test of effective use of
working capital by the management
in a particular period of time.
This is the test of effective control
of flow of cash by the management
in a particular period of time.This explains in brief the changes
occurred in the items in two balance
sheets.
This explains the movement of cash
and all those dealings which affects
the cash position of the concern.
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INVENTORY MANAGEMENT:
INTRODUCTION:
There are three types of inventories: raw materials, work in progress,
and finished goods.
a. Raw materials are materials and components that are inputs in
making the final product.
b. Work-in-process also called stock-in-process refers to goods in
the intermediate stages of production.
c. Finished goods consist of final products that are ready for sale.
While manufacturing firms generally hold all the three types of
inventories, distribution firms hold mostly finished goods.
Inventories represent the second largest asset category for
manufacturing companies, next only to plant and equipment. The
proportion of inventories to total assets generally varies between 15 and
30 percent. Given substantial investment in inventories, the importance
of inventory management can not be emphasized.
o
REGULATION OF BANK FINANCE:
The regulation of bank finance by central bank of India to our company is
CMA data (Current Monitoring Analysis) bank before giving finance to the
company sees and analyze the earning capacity of the company. The money
that the bank will be giving where the company is going to invest and for what
purpose. Whether the money is put into the manufacture process or not bank
needs to know the financial condition of a firm and its credit worthiness.
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57
DATA ANALYSIS AND
INTERPRETATIONi. BALANCE SHEET OF MSLii. CURRENT ASSETSiii. CURRENT LIABILITIESiv. CHANGES IN WORKING CAPITALv.FINANCIAL REPORT
DATA ANALYSIS AND INTERPRETATION:
BALANCE SHEET OF MAHINDRA SONA LTD.Schedule 2003-2004` 2004-2005 2005-2006 2006-2007
Sources of funds :-Share Capital I 39600000 39600000 39600000 39600000Reserve & Surplus II 130763392.2 189700080.3 265042678.5 363683646
Loan Funds:-Secured Loan III 68886274.5 81342342.9 96630797.7 67521776.4Unsecured Loan IV 15262110 15262110 15262110 15262110
Deferred tax liability(Net) V 3394386
Total 257906162.7 325904533.2 416535586.2 486067532.4
Application of funds :-Fixed AssetGross Block VI 235246054.5 276634041.3 326875086 342719935.2Less: Depreciation/ Amortization VII 147383485.2 167001049.8 182503653.3 197105247Net Block VIII 87862569.3 109632991.5 144371432.7 145614688.2Capital WIP & Capital advance IX 9909356.4 17384400 234702 1606675.5
Investment 1021410 1021410Deferred tax Asset(Net) X 1257219 7207127.1 12316295.7
Current Asset loans & advancesInventories XI 96845011.2 152829979.2 116907812.1 122664522.6Sundry debtors XII 222813224.1 324030586.5 320144611.5 360091789.2Cash & Bank balance XIII 35200474.2 10243058.4 50582646 73017614.7Loans & Advances XIV 23957856.9 41913249.3 38010249 34831211.4
Less:-Current liabilities XV 175436987.4 254001050.1 185920966.8 184014939.6Provisions XVI 43245342 77385900.6 76023437.4 81081735.3
Net current asset XVII 160134237 197629922.7 263700914.4 325508463
Total 257906162.7 325904533.2 416535586.2 486067532.4
Net Current Asset 378816566.4 529016873.4 526666728.6 591626547.9
Working capital leverage 1.111135256 1.271572286 1.073679094
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CURRENT ASSET2003-2004 2004-2005 2005-2006 2006-2007
ii]total outstanding dues of creditorsother than small scale industrial undertaking 106150972.5 202512098.7 145110034.8 135508625.1Total 153880852.5 235319454.9 163748168.1 158919694.2advances from customers 7059273.3 8093942.1 8353999.8 7266978
VAT payable 5227652.7 6718377.6
Other liabilities 5673644.1 6832030.5 8231236.2 10780084.8
Interest accrued but not due on lone 513666 252911.7 359910 329805
Total 175436987.4 254001050.1 185920966.8 184014939.6
Provisions2003-2004 2004-2005 2005-2006 2006-2007
Provision for warranties [note 7] 4714534.8 4569586.2 4242493.8 3882312
Provision for income tax [net of payment] 8228560.5 22597056.9 14907864.6 14643873
Provision for fringe benefit tax 57600
Provision for wealth tax 27000 29700 37800
Provision for encashable leave on separation 4616100 6066900
Provision for gratuity 3322271.7 12780000
Provision for employee benefit 18396864 16225530.3
The Working Capital has Shown an increasing trend in the year 2005-2006 as
compared to 2004-2005.whereas in the year 2006-2007 there has been a
negligible decrease in Working Capital.
Changes in Working Capital
Year
0
1
2
3
4
5
6
7
2004 2005 2006 2007
Working Capital
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Financial Reportyear ended 31st march2004
year ended 31st march2005
year ended 31st march2006
year ended 31st march2007
Income 934.03 1427.9 1430.92 1715.15Profit before depreciation 132.38 197.87 209.64 265.03Less:-Depreciation 21.71 22.67 17.54 19.05Profit before tax 110.67 175.2 192.1 245.98Less:-Provision for taxCurrent year 43 80 70 82.5Earlier year 1.34 6.61 1.52Deferred tax (Net) 5.88 5.17 2.06 3.47Profit after tax for current year 72.21 100.37 126.65 165.43Profit for earlier year brought forward 45.7 85.2 139.69 210.4Profit available for appropriation 118.01 185.57 266.04 375.83Propose Dividend 22 30.8 37.4 44Income tax on Dividend 2.82 4.03 5.52 7.47
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RATIO ANALYSISi.CURRENT RATIOii. LIQUID RATIOiii. ABSOLUTE LIQUID RATIOiv. CURRENT ASSET TURN-OVER RATIOv. WORKING CAPITAL TURN-OVER RATIOvi. INVENTORY TURN-OVER RATIOvii. GROSS PRIFIT RATIOviii. NET PROFIT RATIOix. DEBTORS TURN-OVER RATIOx. INVESTMENT IN RECEIVABLESxi. OPERATING CYCLExii. ROSS OPERATING CYCLExiii. NET OPERATING CYCLExiv. CREDITORS TURN OVER RATIOxv. DEBT-EQUITY RATIO
NET BENEFIT 95660475.17 238207763.9 241977473.5 328735253.8
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INVESTMENT IN RECEIVABLES
050
100150200250300350
2003-2004 2004-2005 2005-2006 2006-2007
YEAR
NET BENEFIT (AMOUNT IN MILLION RS.)
INTERPRETATION:
The Investment in Receivables of a company shows deep
increase from the year 2004-2005. And then it shows very slight
increase. But later on it goes on increasing till 2006-2007.
OPERATING CYCLE2004 2005 2006 2007
1) RAW MATERIAL CONVERSION PERIODA) Raw material consumption 460469385 742734765 654570475 782073011B) Raw material consumption per day 1438966 2321046 2045532 2443978C) Raw material Inventory 18819824 27509949 29815432 33502496D) Raw material holding day's 13 11 14 13
2) WIP CONVERSION PERIOD
A) Cost of production 720265120 1111670321 10785384051261947491
B) Cost of production per day 2073703 3473969 3370432 3943585C) WIP Inventory 56680064 89319083 66041937 64072076D) Work in progress inventory holding day's 25 24 20 17
3) FINISHED GOOD CONVERSION PERIOD
A) Cost of good's sold 675026762 1045956816 10209444421211154678
B) Cost of good's sold per day 2109458 3268615 3190451 3784858C) Finished good's inventory 11441706 23605578 8447974 13279263D) FG inventory holding day's 5 7 3 4
4) COLLECTION DAY'S
A) Credit sales 739404639 1141814417 11489012031384830506