INTRODUCTION Financial Statement Analysis is Important To

8/14/2019 INTRODUCTION Financial Statement Analysis is Important To

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INTRODUCTION

Financial statement analysis is important to boards, managers, payers, lenders, and others who make judgments about the financial health of organizations. One widely accepted method of assessing

financial statements is ratio analysis, which uses data from the balance sheet and income statement to produce values that have easily interpreted financial meaning. Most hospitals, health systems andother healthcare organizations routinely evaluate their financial condition by calculating variousratios and comparing the values to those for previous periods, looking for differences that couldindicate a meaningful change in financial condition. Many healthcare organizations also comparetheir own ratio values to those for similar organizations, looking for differences that could indicateweaknesses or opportunities for improvement.

INTRODUCTION

OBJECTIVE:

To understand the information contained in financial statements with aview to know the strength or weaknesses of the firm and to makeforecast about the future prospects of the firm and thereby enabling thefinancial analyst to take different decisions regarding the operations of the firm.

RATIO ANALYSIS:

Fundamental Analysis has a very broad scope. One aspect looksat the general (qualitative) factors of a company. The other sideconsiders tangible and measurable factors (quantitative). This meanscrunching and analyzing numbers from the financial statements. If usedin conjunction with other methods, quantitative analysis can produceexcellent results. Ratio analysis isn't just comparing differentnumbers from the balance sheet, income statement, and cash flow

statement. It's comparing the number against previous years, other companies, the industry, or even the economy in general. Ratios look atthe relationships between individual values and relate them to how acompany has performed in the past, and might perform in the future.

MEANING OF RATIO:


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A ratio is one figure express in terms of another figure. It is amathematical yardstick that measures the relationship two figures, whichare related to each other and mutually interdependent. Ratio is express

by dividing one figure by the other related figure. Thus a ratio is anexpression relating one number to another. It is simply the quotient of two numbers. It can be expressed as a fraction or as a decimal or as a

pure

MEANING OF RATIO ANALYSIS:

Ratio analysis is the method or process by which the relationship of items or group of items in the financial statement are computed,

determined and presented.Ratio analysis is an attempt to derivequantitative measure or guides concerning the financial health and

profitability of business enterprises. Ratio analysis can be used both intrend and static analysis. There are several ratios at the disposal of anannalist but their group of ratio he would prefer depends on the purposeand the objective of analysis. While a detailed explanation of ratioanalysis is beyond the scope of this section, we will focus on atechnique, which is easy to use. It can provide you with a valuableinvestment analysis tool.This technique is called

cross-sectional analysis

. Cross-sectional analysis compares financial ratios of several companiesfrom the same industry. Ratio analysis can provide valuable informationabout a company's financial health. A financial ratio measures acompany's performance in a specific area. For example, you could use a

ratio of a company's debt to its equity to measure a company's leverage.By comparing the leverage ratios of two companies, you can determinewhich company uses greater debt in the conduct of its business. Acompany whose leverage ratio is higher than a competitor's has moredebt per equity. You can use this information to make a judgment as towhich company is a better investment risk.However, you must be careful


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not to place too much importance on one ratio. You obtain a better indication of the direction in which a company is moving when severalratios are taken as a group.

OBJECTIVE OF RATIOSOBJECTIVE OF RATIOS

Ratio is work out to analyze the following aspects of businessorganization-A)Solvency-1)Long term 2)Shortterm3)ImmediateB)Stability

C)ProfitabilityD)Operational efficiencyE)Credit standingF)StructuralanalysisG)Effective utilization of resourcesH)Leverage or externalfinancing

FORMS OF RATIO:

Since a ratio is a mathematical relationship between to or more variables/ accounting figures, such relationship can be expressed in differentways as follows

A] As a pure ratio:

For example the equity share capital of a company is Rs. 20,00,000 &the preference share capital is Rs. 5,00,000, the ratio of equity sharecapital to preference share capital is 20,00,000: 5,00,000 or simply 4:1.

B] As a rate of times:

In the above case the equity share capital may also be described as 4times that of preference share capital. Similarly, the cash sales of a firmare Rs. 12,00,000 & credit sales are Rs. 30,00,000. sothe ratio of creditsales to cash sales can be described as 2.5 [30,00,000/12,00,000] or simply by saying that the credit sales are 2.5 times that of cash sales.

C] As a percentage:


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The analysis is called Time series analysis when the performance of afirm is evaluated over a period of time. By comparing the present

performance of a firm with the performance of the same firm over thelast few years, an assessment can be made about the trend in progress of the firm, about the direction of progress of the firm. Time series analysishelps to the firm to assess whether the firm is approaching the long-termgoals or not. The Time series analysis looks for (1) important trends infinancial performance (2) shift in trend over the years (3) significantdeviation if any from the other set of data\

3] Combined analysis:

If the cross section & time analysis, both are combined together to studythe behavior & pattern of ratio, then meaningful & comprehensiveevaluation of the performance of the firm can definitely be made. Atrend of ratio of a firm compared with the trend of the ratio of thestandard firm can give good results. For example, the ratio of operatingexpenses to net sales for firm may be higher than the industry averagehowever, over the years it has been declining for the firm, whereas theindustry average has not shown any significant changes.

the analyst cannot reach any fruitful conclusion unless the calculatedratio is compared with some predetermined standard. The importance of a correct standard is oblivious as the conclusion is going to be based onthe standard itself.

TYPES OF COMPARISONS

The ratio can be compared in three different ways

1] Cross section analysis:

One of the way of comparing the ratio or ratios of the firm is to comparethem with the ratio or ratios of some other selected firm in the sameindustry at the same point of time. So it involves the comparison of two


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or more firms financial ratio at the same point of time. The crosssection analysis helps the analyst to find out as to how a particular firmhas performed in relation to its competitors. The firms performance may

be compared with the performance of the leader in the industry in order to uncover the major operational inefficiencies. The cross sectionanalysis is easy to be undertaken as most of the data required for thismay be available in financial statement of the firm.

2] Time series analysis:

The analysis is called Time series analysis when the performance of afirm is evaluated over a period of time. By comparing the present

performance of a firm with the performance of the same firm over thelast few years, an assessment can be made about the trend in progress of the firm, about the direction of progress of the firm. Time series analysishelps to the firm to assess whether the firm is approaching the long-termgoals or not. The Time series analysis looks for (1) important trends infinancial performance (2) shift in trend over the years (3) significantdeviation if any from the other set of data\

3] Combined analysis:If the cross section & time analysis, both are combined together to studythe behavior & pattern of ratio, then meaningful & comprehensiveevaluation of the performance of the firm can definitely be made. Atrend of ratio of a firm compared with the trend of the ratio of thestandard firm can give good results. For example, the ratio of operatingexpenses to net sales for firm may be higher than the industry average

however, over the years it has been declining for the firm, whereas theindustry average has not shown any significant changes.

5)Last but not least, the analyst must find out that the two figures beingused to calculate a ratio must be related to each other, otherwise there isno purpose of calculating a ratio.


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CLASSIFICATION OF RATIO

CLASSIFICATION OF RATIO

BASED ON FINANCIAL BASED ON FUNCTIONBASED ON USERSTATEMENT1] BALANCE SHEET 1]LIQUIDITY RATIO 1] RATIOS FOR RATIO 2]LEVERAGE RATIOSHORT TERM2] REVENUE 3] ACTIVITYRATIOCREDITORS STATEMENT4] PROFITABILITY 2]RATIO FOR RATIO RATIOSHAREHOLDER3] COMPOSITE 5] COVERAGE3] RATIOS FOR RATIO RATIO

MANAGEMENT4] RATIO FOR LONG TERMCREDITORS

BASED ON FINANCIAL STATEMENT

Accounting ratios express the relationship between figures taken fromfinancial statements. Figures may be taken from Balance Sheet , P& PA/C, or both. One-way of classification of ratios is based upon thesources from which are taken.

1] Balance sheet ratio:

If the ratios are based on the figures of balance sheet, they are calledBalance Sheet Ratios. E.g. ratio of current assets to current liabilities or ratio of debt to equity. While calculating these ratios, there is no need torefer to the Revenue statement. These ratios study the relationship

between the assets & the liabilities, of the concern. These ratio help to

judge the liquidity, solvency & capital structure of the concern. Balancesheet ratios are Current ratio, Liquid ratio, and Proprietory ratio, Capitalgearing ratio, Debt equity ratio, and Stock working capital ratio.

2] Revenue ratio:


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Ratio based on the figures from the revenue statement is called revenuestatement ratios. These ratio study the relationship between the

profitability & the sales of the concern. Revenue ratios are Gross profitratio, Operating ratio, Expense ratio, Net profit ratio, Net operating

profit ratio, Stock turnover ratio.

3] Composite ratio:

These ratios indicate the relationship between two items, of which one isfound in the balance sheet & other in revenue statement.There are twotypes of composite ratios-a)Some composite ratios study the relationship

between the profits & the investments of the concern. E.g. return on

capital employed, return on proprietors fund, return on equity capitaletc.b)Other composite ratios e.g. debtors turnover ratios, creditorsturnover ratios, dividend payout ratios, & debt service ratios

BASED ON FUNCTION:

Accounting ratios can also be classified according to their functions in toliquidity ratios, leverage ratios, activity ratios, profitability ratios &turnover ratios.

1] Liquidity ratios:

It shows the relationship between the current assets & current liabilitiesof the concern e.g. liquid ratios & current ratios. 2] Leverage ratios:

It shows the relationship between proprietors funds & debts used infinancing the assets of the concern e.g. capital gearing ratios, debt equityratios, & Proprietory ratios.

3] Activity ratios:

It shows relationship between the sales & the assets. It is also known asTurnover ratios & productivity ratios e.g. stock turnover ratios, debtorsturnover ratios.


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4] Profitability ratios:

a)

It shows the relationship between profits & sales e.g. operating ratios,gross profit ratios, operating net profit ratios, expenses ratiosb)It showsthe relationship between profit & investment e.g. return on investment,return on equity capital.

5] Coverage ratios:

It shows the relationship between the profit on the one hand & theclaims of the outsiders to be paid out of such profit e.g. dividend payout

ratios & debt service ratios.BASED ON USER:

1] Ratios for short-term creditors:

Current ratios, liquid ratios, stock working capital ratios

2] Ratios for the shareholders:

Return on proprietors fund, return on equity capital3] Ratios for management:

Return on capital employed, turnover ratios, operating ratios, expensesratios

4] Ratios for long-term creditors:

Debt equity ratios, return on capital employed, proprietor ratios

WORKING CAPITAL MANAGEMENT

Introduction:Working capital is the life blood and nerve centre of a business. Just as circulation of blood is essential in thehuman body for maintaining life, working capital is very essential to maintain the smooth running of a business. Nobusiness can run successfully with out an adequate amount of working capital.


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Working capital refers to that part of firms capital which is required for financing short term or current assets suchas cash, marketable securities, debtors, and inventories. In other words working capital is the amount of fundsnecessary to cover the cost of operating the enterprise.

Meaning:

Working capital means the funds (i.e.; capital) available and used for day to day operations (i.e.; working) of anenterprise. It consists broadly of that portion of assets of a business which are used in or related to its currentoperations. It refers to funds which are used during an accounting period to generate a current income of a typewhich is consistent with major purpose of a firm existence.

Objectives of working capital:

Every business needs some amount of working capital. It is needed for following purposes-

For the purchase of raw materials, components and spares. To pay wages and salaries. To incur day to day expenses and overhead costs such as fuel, power, and office expenses etc. To provide credit facilities to customers etc.

Factors that determine working capital:

The working capital requirement of a concern depend upon a large number of factors such as? Size of business? Nature of character of business.? Seasonal variations working capital cycle? Operating efficiency? Profit level.? Other factors.

Sources of working capital:The working capital requirements should be met both from short term as well as long term sources of funds.

? Financing of working capital through short term sources of funds has the benefits of lower cost and establishingclose relationship with banks.

? Financing of working capital through long term sources provides the benefits of reduces risk and increasesliquidity

Types of working capital:


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Working capital an be divided into two categories-

Permanent working capital:

It refers to that minimum amount of investment in all current assets which is required at all times to carry outminimum level of business activities.

Temporary working capital:

The amount of such working capital keeps on fluctuating from time to time on the basis of business activities.

Advantages of working capital:

It helps the business concern in maintaining the goodwill. It can arrange loans from banks and others on easy and favorable terms. It enables a concern to face business crisis in emergencies such as depression. It creates an environment of security, confidence, and over all efficiency in a business. It helps in maintaining solvency of the business.

Disadvantages of working capital:

Rate of return on investments also fall with the shortage of working capital. Excess working capital may result into over all inefficiency in organization. Excess working capital means idle funds which earn no profits. Inadequate working capital can not pay its short term liabilities in time.

Management of working capital:

A firm must have adequate working capital, i.e.; as much as needed the firm. It should be neither excessive nor inadequate. Both situations are dangerous. Excessive working capital means the firm has idle funds which earn noprofits for the firm. Inadequate working capital means the firm does not have sufficient funds for running itsoperations. It will be interesting to understand the relationship between working capital, r isk and return. The basicobjective of working capital management is to manage firms current assets and current liabilities in such a way thatthe satisfactory level of working capital is maintained, i.e.; neither inadequate nor excessive. Working capital sometimes is referred to as circulating capital. Operating cycle can be said to be t the heart of the need for workingcapital. The flow begins with conversion of cash into raw materials which are, in turn transformed into work-in-progress and then to finished goods. With the sale finished goods turn into accounts receivable, presuming goodsare sold as credit. Collection of receivables brings back the cycle to cash.The company has been effective in carrying working capital cycle with low working capital limits. It may also beobserved that the PBT in absolute terms has been increasing as a year to year basis as could be seen from theabove table although profit percentage turnover may be lower but in absolute terms it is increasing. In order tofurther increase profit margins, SSL can increase their margins by extending credit to good customers and also bypaying the creditors in advance to get better rates.

WORKING CAPITAL AND RATIO ANALYSIS


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Ratio Analysis is one of the important techniques that can be used to check the efficiency with which workingcapital is being managed by a firm. The most important ratios for working capital management are as follows

Net Working Capital:

There are two concepts of working capital namely gross working capital and net working capital. Net working capital

is the difference between current assets and current liabilities. An analysis of the net working capital will be veryhelp full for knowing the operational efficiency of the company. The following table provides the data relating to thenet working capital of SSL.

NET WORKING CAPITAL = CURRENT ASSETS-CURRENT LIABILITIS

YEAR CURRENT ASSETS CURRENT LIABILITIES NET WORKING CAPITAL2005 246755108 184541063 622140452006 289394416 169342603 1200518132007 337982290 187602877 1503794132008 36344554 217973661 145471893

Graph

INFERENCE:

From the above table it can be inferred that the proportion of net working capital had increased from the year 2005to2007 and decreed in the year 2008 compare with 2007.

Working capital turnover ratio:

This is also known as sales to working capital ratio and usually represented in times. This establishes therelationship of sales to net working capital. This ratio indicates -heather or not working capital has been effectivelyutilized in making sales. In case if a company can achieve higher volume of sales with relatively small amount of working capital, it is an indication of the operating efficiency of the company. It is calculated as follows-

YEAR NET SALES(RS) WORKING CAPITAL(RS) RATIO2005 429128296 62214045 6.892006 622181610 120051813 5.22007 668215791 150379413 4.42008 655229319 145471893 4.5

INTERPRETATION:

From the above table we can conclude that working capital ratio is decreasing. In the year 2005 it is 6.89 times itdecreased to 4.4 times in the year 2007. And it is increasing 4.5 times in the year 2008.


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CURRENT ASSETS TO TOTAL ASSETS RATIO:

Current assets play an important role in day-to-day functioning of an organization. So, every firm should maintainadequate current assets so as to meet the daily requirements of business. If the proportion of current assets in totalassets exceeds then the required limit, there will be some idle investments on such assets. At the time, theproportion of current assets in total should not less than requirements. So, every firm should maintain the adequatequantity of current assets. But during the situations of peak demand, should employ more current assets and vice-versa. Particularly in case of production organizations, there is heavy importance to the current assets than fixedassets. This kind of analysis will enable the managers to understand the working capital position of the firm. Datarelating to the proportion of working capital in total assets is depicted as follows-

This ratio establishes the relationship between the current assets and total assets.

YEAR CURRENT ASSETS(RS) TOTAL ASSETS(RS) RATIO%2005 217973661 390012770 55.882006 187602877 327640705 57.252007 169342603 475995664 35.572008 184541063 491935181 37.51

INFERENCE:From the above table it can be inferred that the proportion of current assets to total assets had decreased 55.88 inthe year 2005. In the year 2005 it had increased to 57.25, again in the year 2007 it has decreased 35.57%, again inthe year 2008 increase in 37.51Current assets to sales ratio:The current assets are used for the purpose of generating sales. A ratio of current assets to sales reveals that howbest the assets are applied in business for turnover. As per the above said ratio, a low proportion of current assetsin relation to sales indicates better turnover of the company and vice-versa, which will show positive impact onprofitability. The data relating to this aspect is provided as follows and it is calculated as follows.

YEAR CURRENT ASSETS(RS) NET SALES(RS) RATIO%2005 246755108 429128296 57.52006 289394416 622181610 46.52007 337982290 668215791 50.52008 363445554 655229319 55.4

INFERENCE:


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From the above table it can be inferred that the proportion of current assets to sales had increased to 57.5% in theyear 2005. In the year 2006 it had decreased 46.5%. In the years 2007 it had increased to 50.5% and in the year 2008 had increased 55.4%.

Current assets to fixed assets ratio:

Total assets in any business contain both fixed and current assets. For properly functioning of the organization interms of production and marketing it is necessary to maintain a properly balance between them. If the proportion of fixed assets increases, it will be a negative impact on the firms liquidity and if current assets increase, productionincreases and which causes impact on the demand for the product. In view of effective management of funds andto invest on both fixed and current assets, it is necessary to take the decision as soon as possible. Data relating tothe ratio between current assets to fixed assets is depicted as follows.

YEAR CURRENT ASSETS(RS) FIXED ASSETS(RS) RATIO%2005 246755108 167454219 14.132006 289394416 184597059 15.672007 337982290 138013376 24.42008 363445554 202084725 18.0

INFERENCE:From the above table it can be inferred that the proportion of current assets to fixed assets had decreased 14.13%in the year 2005. In the year 2006 it had increased to 15.67%. In the year 2007 it had increased 24.4%it haddecrease in year 2008 in 18.0%.

RATIO ANALYSIS

INTRODUCTION:

Ratio Analysis is a powerful tool o financial analysis. Alexander Hall first presented it in 1991 in Federal ReserveBulletin. Ratio Analysis is a process of comparison of one figure against other, which makes a ratio and theappraisal of the ratios of the ratios to make proper analysis about the strengths and weakness of the firmsoperations. The term ratio refers to the numerical or quantitative relationship between two accounting figures. Ratioanalysis of financial statements stands for the process of determining and presenting the relationship of items andgroup of items in the statements.

Ratio analysis can be used both in trend analysis and static analysis. A creditor would like to know the ability of thecompany, to meet its current obligation and therefore would think of current and liquidity ratio and trend of receivable.


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Major tool of financial are thus ratio analysis and Funds Flow analysis.Financial analysis is the process of identifying the financial strength and weakness of the firm by properly establishing relationship between the items of the balance sheet and the profit account

The financial analyst may use ratio in two ways. First he may compare a present ratio with the ratio of the past fewyears and project ratio of the next year or so. This will indicate the trend in relation that particular financial aspect of the enterprise. Another method of using ratios for financial analysis is to compare a financial ratio for the company

with for industry as a whole, or for other, the firms ability to meet its current obligation. It measures the firmsliquidity. The greater the ratio, the greater the firms liquidity and vice-versa.

A ratio can be defined as a numerical relationship between two numbers expressed in terms of (a) proportion (b)rate (c) percentage. It is also define as a financial tool to determine an interpret numerical relationship based onfinancial statement yardstick that provides a measure of relation ship between two variable or figures.

Meaning and Importance:

Ratio analysis is concerned to be one of the important financial tools for appraisal of financial condition, efficiencyand profitability of business. Here ratio analysis id useful from following objects.1. Short term and long term planning2. Measurement and evaluation of financial performance3. Stud of financial trends4. Decision making for investment and operations

5. Diagnosis of financial ills6. providing valuable insight into firms financial position or picture

ADVANTAGES& DISADVANTAGES OF RATIO ANALYSIS

Advantages:The following are the main advantages derived of ratio analysis, which are obtained from the financial statement viaProfit & Loss Account and Balance Sheet.a) The analysis helps to grasp the relationship between various items in the financial statements.b) They are useful in pointing out the trends in important items and thus help the management to forecastc) With the help of ratios, inter firm comparison made to evolve future market strategies.d) Out of ratio analysis standard ratios are computed and comparison of actual with standards reveals thevariances. This helps the management to take corrective action.e) The communication of that has happened between two accounting the dates are revealed effective action.f) Simple assessments of liquidity, solvency profitability efficiency of the firm are indicted by ratio analysis. Ratiosmeet comparisons much more valid.

Disadvantages:

Ratio analysis is to calculate and easy to understand and such statistical calculation stimulation thinking anddevelop understanding.But there are certain drawbacks and dangers they are.i) There is a trendy to use to ratio analysis profusely.ii) Accumulation of mass data obscured rather than clarifies relationship.iii) Wrong relationship and calculation can lead to wrong conclusion.1. In case of inter firm comparison no two firm are similar in size, age and product unit.(For example :one firm maypurchase the asset at lower price with a higher return and another firm witch purchase the asset at asset at higher price will have a lower return)2. Both the inter period and inter firm comparison are affected by price level changes. A change in price level canaffect the validity of ratios calculated for different time period.3. Unless varies terms like group profit, operating profit, net profit, current asset, current liability etc., are properlydefine, comparison between two variables become meaningless.


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Inference:

The standard norm for this ratio is 2:1 the empirical analysis of the data relating to the current ratio of AnnapurnaEar canal Ltd. Has decreased from 1.71 in the year 2006 to 1.8 in the year 2007

QUICK RATIO:

This ratio establishes a relationship between quick of liquid assets and current liabilities. It is an absolute measureof liquidity management of the concern. An asset is liquid if it can be converted in to cash immediately or reasonably soon without a loss of value, if ignores totally the stocks. Because inventories normally require sometime for realizing into cash: their value also has a tendency to fluctuate. The standard quick ratio is 1:1.

Quick Ratio = Quick Assets/Current Liabilities

YEAR QUICK ASSETS CURRENT LIABILITIES QUICK RATIO(%)2005 203744623 184541063 1.12006 243039010 169342603 1.42007 296815785 187602877 1.582008 323437711 217973661 1.48

QUICK RATIO GRAPH

Inference:

The standard norm for this ratio is 1:1, means for every 1 rupee of current liability, company must have 1 rupee of quick assets.

The quick ratio of Annapurna earcanal ltd.1.1in 2005, 1.4 in 2006 and1.58 in 2007. It have more than 1 rupee of quick assets for all 4years.

Absolute quick ratio:

Since cash is the most liquid assets necessary to examine the ratio of cash and its equivalent to current liabilities.Trade investment or marketable securities are equivalent of cash. Therefore, they may be included in theconsumption of absolute quick ratio.

Absolute quick ratio = Absolute Quick Assets/Current Liabilities

YEAR CASH&EQUIVLENT CURRENT LIABILITIES ABSOLUTE QUICK RATIO


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2005 4548328 184541063 0.0242006 9272929 169342603 0.0552007 16297869 187602877 0.0872008 24336946 217973661 0.111

Absolute quick ratio graph

Inference:

The standard norms of absolute quick ratio is 0.5:1.From the above table the firm not maintain the sufficient level of

quick assets because of the day-to-day expenses .It is fluctuating betweenThe standard norm for this ratio is 1:2 means for every 2 rupees of current Liabilities, Company must have 1 rupeeof cash and bank balance and marketable securities.

Net Profit Ratio:

As every business is to earn profit, this ratio is very important because it measures the profitability of sales. Abusiness may yield high gross income but low net income because of increasing operating and non-operatingexpenses. This situation can easily be detected by calculating this ratio.

The profits used for this purpose may be profits after/before tax. To obtain this ratio, the figure of net profits after taxis divided by the figure of net profits after tax is divided by the figure of sales the ratio is also known as sales marginas we can ascertain with its help the margin which the sales leave later deducting all the expenses. The unit of expression is percentage, as is the case with profitability ratios.

YEARS NET PROFIT NET SALES RATIO %2005 70557286 429128286 1.642006 24851266 622181610 3.992007 22072724 668215791 3.312008 14235566 655229319 2.17

Graph

Inference:Higher the ratio better is the profitability. From the table the ratio is declining from 2005 to 2006 is increase. Againdecrease in the year 2008

Net Profit Ratio is not effective over the period of study. Company has not control over the cost of goods sold,selling, administrative and distribution expenses.


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So, effective steps are to be taken to increase the profits.

CASH MANAGEMENT

Introduction:Cash management is one of the key areas of working capital management. Cash is the liquid current asset. Themain duty of the finance manager is to provide adequate cash to all segments of the organization. The importantreason for maintaining cash balances is the transaction motive. A firm enters into variety of transactions toaccomplish its objectives which have to be paid for in the form of cash.

Meaning of cash:

The term cash with reference to cash management used in two senses. In a narrower sense it includes coins,

currency notes, cheques, bank drafts held by a firm. n a broader sense it also includes near-cash assets such asmarketable securities and time deposits with banks.

Objectives of cash management:

There are two basic objectives of cash management. They are-

? To meet the cash disbursement needs as per the payment schedule.? To minimize the amount locked up as cash balances.

Basic problems in Cash Management:Cash management involves the following four basic problems.

? Controlling level of cash? Controlling inflows of cash? Controlling outflows of cash and? Optimum investment of surplus cash.

Determining safety level for cash:

The finance manager has to take into account the minimum cash balance that the firm must keep to avoid risk or cost of running out of funds. Such minimum level may be termed as safety level of cash. The finance manager determines the safety level of cash separately both for normal periods and peak periods. Under both cases hedecides about two basic factors. They are-

Desired days of cash:

It means the number of days for which cash balance should be sufficient to cover payments.


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Average daily cash flows:

This means average amount of disbursements which will have to be made daily.

Criteria for investment of surplus cash:

In most of the companies there are usually no formal written instructions for investing the surplus cash. It is left to

the discretion and judgment of the finance manager. While exercising such judgment, he usually takes intoconsideration the following factors-

Security:

This can be ensured by investing money in securities whose price remains more or less stable.

Liquidity:

This can be ensured by investing money in short term securities including sha\ort term fixed deposits with banks.

Yield:

Most corporate managers give less emphasis to yield as compared to security and liquidity of investment. So theyprefer short term government securities for investing surplus cash.

Maturity:

It will be advisable to select securities according to their maturities so the finance manager can maximize the yieldas well as maintain the liquidity of investments.

Cash Management in SSL:

The cash management is carried out in seaways by CTM (Corporate Treasury Management). CTM is a commonlyfollowed procedure in most of the companies.

Ratio Analysis is one of the important techniques that can be used to check the efficiency with which cashmanagement is being managed by a firm. The most important ratios for cash management are as follows-

Cash to current assets ratio:

This ratio establishes the relationship between the cash and the current assets. It is calculated as follows

YEAR CASH (RS) CURRENT ASSETS(RS) RATIO2005 3460206 246755108 1.42006 8184807 289394416 2.822007 15209747 337982290 4.52008 23476324 363445554 6.45


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Graph

INFERENCE:

From the above table it can be inferred that the cash to current assets

Ratio is shown it is 1.4% in the year 2005 and increased till 2008.

CASH TO CURRENT LIABILITIES RATIO:

This ratio establishes the relationship between the cash and current liabilities. It is calculated as follows.

YEAR Cash (Rs) CURRENT LIABILITIES(RS) Ratio2005 3460206 184541063 1.872006 8184807 169342603 4.832007 15209747 187602877 8.12008 23476324 217973661 10.77


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Graph

INTERPRETATION:

From the above table it can be inferred that the proportion cash to current liabilities ratio is shown decreasing trend.It is 13.40% in the year 2000-01 & decreased to 0.74% in the year 2005-06.

RECEIVABLES MANAGEMENT

Introduction:Receivables constitute a significant portion of the total assets of the business. When a firm seller goods or serviceson credit, the payments are postponed to future dates and receivables are created. If they sell for cash noreceivables created.

Meaning:

Receivable are asset accounts representing amounts owed to the firm as a result of sale of goods or services in theordinary course of business.

Purpose of receivables:

Accounts receivables are created because of credit sales. The purpose of receivables is directly connected with theobjectives of making credit sales. The objectives of credit sales are as follows-? Achieving growth in sales.? Increasing profits.? Meeting competition.

Factors affecting the size of Receivables:

The main factors that affect the size of the receivables are-? Level of sales.? Credit period.? Cash discount.

Costs of maintaining receivables:

The costs with respect to maintenance of receivables are as follows-

Capital costs:


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This is because there is a time lag between the sale of goods to customers and the payment by them. The firm has,therefore to arrange for additional funds to meet its obligations.

Administrative costs:

Firm incur this cost for manufacturing accounts receivables in the form of salaries to the staff kept for maintaining

accounting records relating to customers.

Collection costs:The firm has to incur costs for collecting the payments from its credit customers.Defaulting costs:

The firm may not able to recover the over dues because of the inability of customers. Such debts treated as baddebts.

Receivables management:

Receivables are direct result of credit sale. The main objective of receivables management is to promote sales and

profits until that point is reached where the ROI in further funding of receivables is less than the cost of funds raisedto finance that additional credit (i.e.; cost of capital). Increase in receivables also increases chances of bad debts.Thus, creation of receivables is beneficial as well as dangerous. Finally management of accounts receivable meansas the process of making decisions relating to investment of funds in this asset which result in maximizing the over all return on the investment of the firm.

Receivables management and Ratio Analysis:

Ratio Analysis is one of the important techniques that can be used to check the efficiency with which receivablesmanagement is being managed by a firm. The most important ratios for receivables management are as follows-

DEBTORS TURNOVER RATIO: -

Debtors constitute an important constituent of current assets and therefore the quality of the debtors to a greatextent determines a firms liquidity. It shows how quickly receivables or debtors are converted into cash. In other words, the DTR is a test of the liquidity of the debtors of a firm. The liquidity of firms receivables can be examinedin two ways they are DTR and Average Collection Period.

YEAR CREDIT SALES (RS) AVG DEBTORS (RS) RATIO2005 429128286 69433936 6.182006 622181610 77624616 8.012007 668215791 87464986 7.632008 655229319 115088536 5.69


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INTERPRETATION:

From the above table it can be inferred that the proportion sales to average debtors is showing fluctuating trend inthe year 2005 is 6.18. It increased to 1.83 times in 2006 and increases remaining two years decries.

DEBTORS COLLECTION PERIOD:Data collection period is nothing but the period required to collect the money from the customers after the creditsales. A speed collection reduces the length of operating cycle and vice versa

YEARS AVG Debtors(in Rs) Net credit sales (in Rs) Debtors collection period (in days)2005 69433936 429128286 592006 77624616 622181610 462007 87464986 668215791 48

2008 11508856 655229319 64Source: data compiled from the annual reports of Annapurna earcanal ltd.

INFERENCES:

From the above table it can be inferred that the debtors turn over ratios showing fluctuating trend. In the year 2005it is debtors collection period is 59 days and reduced in the year 2006 to 46 days then increased slightly up to 2008.

INVENTORY MANAGEMENT

Introduction:

Inventories are stock of the product a company is manufacturing for sale and components. That makeup theproducts. The various forms in which inventories exist in a manufacturing company are: Raw-materials, work-in-process, finished goods.

? Raw-Materials: - Are those basic inputs that are converted into finished products through the manufacturingprocess. Raw-materials inventories are those units, which have been purchased and stored for future production.

? Work-In-Process inventories are semi-manufactured products. The represent products that need more workbefore they become finished products for sale.


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Inventory management techniques

In managing inventories the firm objective should be in consonance with the shareholders' wealth maximizationprinciple. To achieve this firm should determine the optimum level of inventory. Efficiently controlled inventoriesmake the firm flexible. Inefficient inventory control results in unbalanced inventory and inflexibility-the firm masometimes run out of stock and sometimes may pileup unnecessary stocks. This increases level of investment andmakes the firm unprofitable.

To manage inventories efficiency, answers should be sought to the following two questions.1)How much should be ordered?2)When should it be ordered?

The first question how much to order, relates to the problem of determining economic order quantity (EOQ), and is

answered with an analysis of costs of manufacturing certain level of inventories. The second question when toorder arise because of determining the reorder point.

EOQ

One of the major inventory problems to be resolved is how many inventories should be added when inventory isreplenished. If the firm is buying raw materials it has to decide lots in which it has to be purchased on eachreplenishment. If the firm is planning a production run, the issue is how much production to schedule or how muchto make. These problems are called order quantity problems and the task of the firm is to determine the optimum or economic order quantity (or economic lot size) determining an optimum inventory level involves two types of costs.

1)Ordering cost2) Carrying costThe economic order quantity is that inventory level which minimizes the total of ordering and carrying costs.

Ordering cost

The term ordering cost is used in case of raw materials (or supplies) and includes the entire cost of acquiring rawmaterials. The include costs incurred in following activities. Requisitioning purchase ordering, transporting,receiving, inspecting and storing (store placement).

Carrying cost

Cost incurred for maintaining a given level of inventory is called carrying cost. They include storage, taxes,insurances, deterioration and obsolescence.Economic order quantity (EOQ) =v2AC/c


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Where A = annual requirement of raw materialsC=ordering costc=carrying cost

EOQ Graphical Approach

The economic ordering quantity can also be found out graphically. The EOQ figure is as follows:

In the above figure costs-carrying, ordering and total are plotted on vertical axis is used to represent the order size.We note that total carrying costs increases as the order size increases, because, on an average a larger inventorylevel be maintained, and ordering costs decline with increase in order size because large order size means lessnumber of orders. The behavior of total costs line is noticeable since it is a sum of two types of costs, which behavedifferently with order size. The total costs decline in their first instance but they start rising when the decreases in anaverage ordering costs is more than offset by the increases in carrying costs. The economic order quantity occursat the point Q. Where the total cost is minimum. Thus the firms operating profit is maximized at point.Reorder Point (ROP)

The problem how much to order is solved determining the economic order quantity yet the answer should thesought to the second problem, when to order this is a problem of determining the reorder point is that inventorylevel at which an order should be placed to replenished the inventory. To determine the reorder point under certainty, we should knowa) Lead timeb) Average usagec) Economic order quantity

Lead time is the time normally taken is replenishing inventory after the order has been placed by certainty we meanthe usage and lead time do not fluctuate under such a situation ROP is simply that inventory level which will bemaintained for consumption during the lead time. i.e,Reorder point (under certainty) =lead time X Average usageRe-order Point (under certainty) = Lead time X Average usage.Inventory management at Annapurna Earcanal Ltd


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The Annapurna Ear canal Ltd management all the unit and corporate level every month reviews inventory. All thefunctional head are called for minutes and the inventory holdings are discussed in detail at the meeting every month.A.E.Ltd purchases the material when the customer places the order, since the product of are tailor-made tocustomers requirements. After purchasing the raw materials, which is mostly, still will be stocked at one place allother procured against production orders are stored. Depending up on the requirement in various productiondepartments the raw material is sent to the respective departments or production shops.

When the order is placed for raw material certain raw material is in transit, such raw material is called as rawmaterial in transit.Example Raw material on over seas.

The raw material can be transfer from unit to another unit or from one department to another is called transfer-in transist.It is nothing but to the transfer of raw material among the inter firm units of Annapurna Earcanal Ltd.

The raw material, which is production process, is called work-in process. The work in process becomes finishedgoods inventory. The finished should not be kept for a longer time. They should be sold off to clear off the entireinventory. However, finished goods inventory is not there for Annapurna Earcanal Limited, since production ismainly done on customer order and specifications. The raw material is purchased and the whole process isrepeated again which we call it as inventory cycle.

Inventory turnover Ratio:-Inventory turnover ratio indicates the efficiency of the firm in producing and selling its products. It is calculated by

dividing the cost of goods sold by the average inventory. The average inventory is the average of open and closingbalance of inventory.

Inventory turnover Ratio= Cost of Goods Sold / Average Inventory

Years Cost of goods sold Average inventory ITR( in Times)2005 307656311 32775024 9.382006 606604844 64752367 9.362007 399298008 67315972 5.92008 390386083 43339215 9

Source:Data compiled from the annual report of Annapurna Earcanal Ltd.

Inferences:

From the above table it can inferred that the proportion cost of good sold to average stock it is increased to9.38times in the year2005 and again decreased 5.9 times in the year 2007and again increased 9 times in the year 2008.

Inventory holding period:-

Inventory holding period is the reciprocal of inventory turn over ratio.This can be measure in terms of number of days.

Inventory holding period= Average inventory x365daysCost of goods of sold


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Years AVG INVENTORY CGS (In Rs.) INVENTORY HOLDING PERIOD(In days)2005 32775024 307656311 392006 64752367 606604844 40

2007 67315972 399298008 622008 43339215 390386083 41

Graph

Inferences:

From the above table it can infer that the proportion of average inventory to cost of goods sold had 39 days in 2005.In the year 2007 it can be increased that is 62 days and again decries.

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