PREFACE

As we all know that the world is changing vary fast, within no time new

technology emerges and so the speed with which it is updated is increasing

consequently.

The practical training in an organization is the great opportunity to apply

class room study in to practical scenario. It has enabled me to learn how

most of the theory concepts are implemented in the organization.

I have visited the company so that as a management student I can get a

clear picture of the real world of the business & operations of industry in

the training age.

I have prepared this report so far as my knowledge is concerned. This

report is carried out to have a real & practical experience being the student

of the MBA with finance as a specialization. Thus the report is prepared as

per our syllabus and the necessary guidance & instruction given by our

professor.

The report is prepared as per the requirement of the MBA(post graduation)

degree.

ACKNOWLEDGEMENT

First and foremost I would like to thank almighty for anything and

everything.

It give me a great pleasure & satisfaction in presenting this report as a part

of the partial fulfillment for the internship program @ Indu Management

Institute (IMI), Vadodara. Affiliated by Gujarat Technological University

(GTU). I would like to take this opportunity to express my sincere gratitude

to several people without whose help and encouragement it would have

been impossible for me to carry out the desired work.

My special thanks to our director DR. Manish Vyase, my project guide

Miss. Harshita Samrani & Mr. Divyesh Patel who helped me in listing

of good thoughts & ideas to make this project profile.

I would like to thank Mr. Naresh Prajapati, the CMA officer & head of the

finance dept of the Kemrock industries and export limited who allows me to

take training in this dept and giving me this great opportunity.

I would like to thank my parents, all my teachers, friends and colleagues

who had directly or indirectly struggled to my glory of work.

Thank you

Krunal modi

Company Profile - Kemrock Industries and Export limited

INTRODUCTION

Kemrock Industries & Exports Ltd. manufactures and exports FRP/GRP

(Composite) Products for major industrial sectors such as aerospace,

defense, renewable energy, wind energy, railways, chemical processing, oil

and gas, water and waste water management, infrastructure, construction,

electrical and electronics, marine, telecommunications and many more...

A leader in the field of composites in India, the company delivers standard

as well as customized solutions that are ideal replacements for conventional

materials. The State-of the-Art facility, located close to Vadodara in the

western part of India, provides high-quality engineered advanced composite

solutions and reliable services, complying with customer specifications as

well as national and international standards. The company operates using

principles of Total Integrated Management (TIM), ensuring complete

customer satisfaction. An end-to-end solution provider, it encompasses

conceptual design, prototype development, testing, manufacturing, logistic

support, installation and comprehensive after sales service. 

Kemrock has the unique distinction of commissioning India's first Carbon

Fibre Manufacturing facility to cater to Defence, Aerospace &

Infrastructure Sectors.

Kemrock has established a reputation as a major supplier to key industries

by manufacturing first quality material, consistently. In order to do that, a

full and wide ranging Quality Assurance Team oversees the manufacture of

products at Kemrock, ensuring complete traceability. The Integrated

management system is certified under ISO 9001:2008, ISO 14001: 2004 and

OSHAS 18001:2007. Kemrock is also proud to be India’s First and only IRIS

Certified Company (IRIS - International Railway Industry Standard).

Kemrock's state-of-the-art design studio for design and development is

endowed with the most talented and experienced team of design engineers

who are proficient in the application of advanced software packages for

industrial design. Kemrock also boasts of a fully equipped test center,

supporting the needs of its customers and associates. Mechanical Testing

and Product Performance Testing Capabilities are supplemented with the

most sophisticated material analysis equipment.

Kemrock is listed on Bombay Stock Exchange (Scrip Code 526015 and Scrip

ID KEMIE) and National Stock Exchange of India (ISIN Code INE99B01012)

and has been the proud recipient of many awards along with the prestigious

Export Award from The Plastic Export Promotion Council for the years

2003-04 to 2008-09.

BOARD OF DIRECTORS

Mr. Kalpesh Patel (Chairman & Managing Director)

Mr. Kaushik Bhatt

Mr. Mukund Bakshi (ceased w.e.f. 28.08.2010)

Mr. Navin Patel

Mr. Tushar Patel

Mr. K. K. Rai

Mr. S. M. Hegde (ceased w.e.f. 15.01.2010)

Mr. Mahendra R. Patel (appointed w.e.f. 03.06.2010)

CFO

Ms. Usha Moraes

COMPANY SECRETARY

Mr. Dinesh Patel

AUDITORS

H. K. Shah & Co.,Ahmedabad

BANKERS

Allahbad Bank ICICI BankAndhra Bank Indian BankAxis Bank Punjab National BankExim Bank State Bank of India

HISTORY

2011

Kemrock & DSM sign MOU for Manufacturing of Specialty Resins in India

2010

Former President of India Dr APJ Abdul Kalam inaugurated, India's first Carbon Fiber Plant, on 9th May 2010.

SAERTEX-KEMROCK India Limited is established as a JV with SAERTEX, GERMANY to serve the Aerospace Market.

2009

Kemrock establishes a GLOBAL COMPOSITE VILLAGE at its Vadodara facility

New Mass Transportation Division Plant established

2008

Continuing expansion to establish one of the largest and most integrated GRP composite manufacturing facilities in the World.

Kemrock signs an MOU to Purchase the majority stock in Top Glass SpA

Kemrock establishes the Wind Energy Division Resin Plant expansion.

2007

Commercial production of filament wound pipe, up to 1.5 metres in diameter.

In April 2007, in the face of severe competition from Indian based multi-nationals, KIEL was awarded by the Indian Government, a contract to manufacture carbon fibre under license, and in collaboration with the National Aerospace Laboratory (NAL).

2006

Georgia Pacific & KIEL formed Georgia Pacific Kemrock international private limited to manufacture & supply thermosetting resins to the Indian sub-continent & the GCC countries of the Middle East.

KIEL signed a license agreement with Top Glass s.p.a in Italy to manufacture centrifugally cast composite poles.

KIEL bought a state of the art machine for the manufacture of Sheet Moulding Compounds (SMC).

National Aerospace Laboratories (NAL), a constituent of Council of Scientific and Industrial Research (CSIR), is India's pre-eminent civil R&D establishment in aeronautics and allied disciplines

2005

KIEL began Production of Unsaturated Polyester and Vinylesters

Commenced Production and Sale of all types of resins Established a joint venture with Top Glass s.p.a. for

manufacture of high end pultruded products and lighting Poles.

200 Obtained ISO 9000-2001 certification

4 KIEL licensed the Production of Phenolic Resins from Georgia Pacific Resins, Inc. This enabled KIEL to become the first manufacturer outside of North America to gain US Coast Guard approval for its grating products.

2003

Kemrock Industries and Exports Ltd moved from its limiting city location to a new site at Asoj village, north east of Baroda.

KIEL entered into a strategic alliance with Stoncor Group, Inc for the licensed manufacture and supply of moulded & pultruded grating along with pultruded standard structural shapes to Fibergrate, Inc.

2002

KIEL manufactured the cable racking on behalf of Fibergrate Inc., thereby beginning their relationship.

1996

Kemrock signs a license agreement with Creative Pultrusions, Inc to produce pultruded structural shapes under license.

1995

Manufactured Wind Mill Nacelle Covers for Suzlon Energy Ltd.

1981

Kemrock Industries and Exports Limited established.

PRODUCT DESCRIPTION

Carbon fibre:- Kemrock’s carbon fibre manufacturing facility is fully

integrated, including polymerisation, wet spinning, oxidation and

carbonisation of the fibre as well as all utilities for effluent and waste

management.

Mass transportation products

1 Rail coach solutions :- Kemrock’s Mass Transportation

Division was India’s first IRIS Certified facility..

2 Bus interiors :- Kemrock’s experience in the use and application of

composites is bringing new and innovative ideas to the mass transportation

market.

3 Metro frontends :- Kemrock follow an integrated approach from

concept to engineering design and manufacturing followed by installation

services as well as after sales for the manufacture of Metro Front ends.

Wind Energy

1 Rotor blades :- Rotor blade production is by resin infusion,

manufactured to the highest international standards in moulds equipped

with sophisticated in-built heating, a dedicated vacuum system and

pneumatic controls for accurate mould profile alignment.

2 Nacelle covers and Nose cone :- The production of rotor blades

is complemented with nose cone and nacelle cover mouldings, thereby

providing a complete composites package for wind energy applications.

Gratings and Pultrusion

1 Moulded gratings 2 Handrails & Ladder systems 3 Access systems 4 Cooling Towers 1 Telecom Towers 2 Car park systems 3 Modular houses & shelters 4 Cable management system

Thermosetting Resins

1 Phenolic Resins:- Under the license of Georgia-Pacific Chemicals

LLC, USA, GPK offers a range of Fire Safe Phenolic Resins for specialized

high-temperature and fire safe application. 

2 Epoxy Resins:- GPK offers a range of versatile Epoxy resins and

Hardner systems for application in industry segments like wind energy,

construction/civil engineering, industrial floorings, electrical insulators,

adhesives and coatings. Specialty Epoxy resin and Hardner system for

manufacture of windmill blades are "Germanischer Lloyd (GL)" approved.

3 Unsaturated polyester Resins :- These are highly effective resins

for FRP composites because they have excellent mechanical and corrosion

resistance properties. 

Piping system

1 GRP pipes :- Kemrock Corrosion resistant Fibre Glass Reinforced

Polymer Composite Pipes meet the demanding needs of industry to

transport corrosive and non-corrosive fluids for various applications

including Oil and Gas, Petrochemical, Power Generation, Desalination,

Potable Water, Municipal and General Industries. 

2 Flanges & Fittings :- Kemrock also manufactures a complete range

of composite fittings, using a variety of connections such as Reka ring, bell

and spigot, butt wrap and bolted flange fittings.

AWARDS & RECOGNITION

‘ICERP-JEC INOVATION AWARD’

Kemrock bags 'ICERP-JEC INNOVATION AWARD' for

Outstanding Innovation in Composites under Telecom & Electronics Category at ICERP 2011, Mumbai.

‘2008’

INDUSTRY 2.0 for “Top Indian SMB in plastic & plastic products”

‘2008’

ICERP-JEC Innovation Award for “Building & Civil Engineering”

‘2007’

FGI Award for excellence “Outstanding Entrepreneur”

from Federation of Gujarat Industries Vadodara.

‘PLEXCONCIL’ PLEXCONCIL - Export Award, first

position (FRP / GRP products) for two consecutive years

(2004-2005 and 2005-2006).

Project Title :- ‘Financial Performance Analysis’

INTRODUCTION

A financial performance engagement is an analysis of a company’s past and current financial performance and compares such performance to similar sized companies within its industry providing insight into a company’s historical growth, profitability, debt capacity and overall liquidity.

All such factors can be important indicators of a company’s ultimate value. We analyze the past five-year history of financial statements as well as financial information relative to your industry.

We calculate financial ratios (liquidity, coverage, leverage and operating) for the company, prepare common size financial statements, and analyze the information on a trended and composite basis.

A financial performance analysis may provide the following benefits:

Identify financial strengths and weaknesses and evaluate financial performance in relation to the industry performance as a whole, and acquire useful information concerning competitors.

Historical financial ratio analysis can be used as an effective preliminary step in preparing a budget or in making a forecast.

Evaluate past performance and set objectives for future performance. Also provides an ongoing means to evaluate a company’s performance financially.

Evaluate a proposed sale, merger or acquisition. Determine the financial strengths and weaknesses of the company and ultimately the transaction.

A greater awareness of financial statements and their interrelationship can lead to improved profitability or cash flow.

An 8-10 page report (without financial statement exhibits) is generated. The basis of the comparative analysis may be affected by the nature of the business, its size, geographic location, business practices, and other factors that may introduce differences between the client company and the comparable companies.

This means we need to not only be able to read the financials and see

trends, but we also must be able to understand the underlying causes of

those trends.

We must be able to compare their cooperative financials to industry

benchmarks, peer performance, and company projections. We will then use

this information to build strategic plans and financial projections for the

coming year. Much of this analysis is “common sense” analysis.

We should be able to scan the cooperative’s financial statement and identify

factors that impact each statement. The factors that impact long-term

growth are most important. The cooperative should pay particular attention

to the local savings (loss) of the cooperative. This means that the

cooperative only looks at ratios calculated from the earnings and expenses

of the main cooperative, not the patronage received from regional

investments.

Once this “common sense” analysis is complete, the board can move on to a

more in depth study of the cooperative, utilizing “common size” analysis,

peer analysis, an in-depth ratio analysis, working capital analysis, and

cash flow analysis.

Common Size Analysis

A common size analysis scales the financials into a percentage of sales for

the income statement and a percentage of total assets on the balance sheet.

The scaling effect highlights the most important expense areas and can

reveal problem areas that may not have been noticed before. It also

provides a way to compare year-to-year variations in financials.

Peer Analysis

A peer analysis involves comparing the cooperative’s performance with the

performance of other cooperatives of a comparable size, industry, and

primary business type.

This is an excellent tool for highlighting the strengths and weaknesses of

cooperatives. The peer data to compare to can be obtained from

universities, state statistic services, or the company’s banker will have some

of the data.

RATIO ANALYSIS

Ratio basics

Ratio Analysis compares one figure in one financial statement (say P&L account or Balance Sheet) with another figure in the same financial statement or in another financial statement of the company.A ratio is expressed in the numerator denominator format. Thus the numerator and denominator can be either from the P&L account or the Balance sheet of the same company. Ratios give colour to absolute figures. For example a profit of Rs.100 lakhs means very little to an analyst because he needs to know what the sales was or what the net worth was against which the Rs.100 lakhs was earned. More than the profit, the ratio of profit to sales and the ratio of profit to networth is useful to understand the performance of a company. Thus if profit grew from Rs 100 lakhs to Rs 125 lakhs, while it is good, what is more important is how it stacked up against the sales achieved or the net worth deployed.

Hence, ratio analysis facilitates intra firm comparison. i.e. comparison of your company’s performance in the current year with your company’s performance in the previous year.

It also facilitates inter firm comparison. i.e. comparison of your company’s performance in the current year with your competitor’s performance in the current year.

Peer review, as this is called, helps you benchmark your performance with your peers. Ratios help in ascertaining the financial health of the company and also its future prospects.

These ratios can be classified under various heads to reflect what they measure. There may be a tendency to work a number of ratios. But we believe that being thorough in the computation and interpretation of a few ratios (Say 20-25) would be ideal, since too much of analysis could lead to paralysis.

Computing Ratios

When a ratio has a P&L figure both in the numerator and in the denominator or has a balance sheet figure both in the numerator and in the denominator it is called a straight ratio.

Where it has the P&L figure in the numerator and the balance sheet figure in the denominator or the balance sheet figure in the numerator and the P&L figure in the denominator it is called a cross or hybrid ratio.

Classification of Accounting Ratios

 

Classification of Accounting Ratios / Financial Ratios

(A)Traditional Classification or

Statement Ratios

(B)Functional Classification or Classification According to

Tests

(C)Significance Ratios or Ratios

According to Importance

Profit and loss account ratios or revenue/income statement ratios

Balance sheet ratios or position statement ratios

Composite/mixed ratios or inter statement ratios

Profitability ratios Liquidity ratios Activity ratios Leverage ratios or

long term solvency ratios

 

Primary ratios Secondary ratios

 

A. LIQUIDITY RATIOS

Liquidity refers ti the ability of a concern to meet its current obligations as and when there becomes due. the short the short term obligation of a firm can be met only when there are sufficient liquid assets.

The short term obligation are met by realizing amounts from current, floating (or) circulating assets. the current asset should either be calculated liquid (or) near liquidity, they should be convertible into cash.

To measure the liquidity of he firm the following ratios can be calculated and analyzed.

1. Current ratio

2. Quick ratio (or) acid test ratio

3. Cash position ratio (or) absolute liquid ratio.

A1. Current ratio

Current ratio may be defined as the relationship between current assets

and current liabilities. This ratio is also known as "working capital ratio".

It is a measure of general liquidity and is most widely used to make the

analysis for short term financial position or liquidity of a firm. It is

calculated by dividing the total of the current assets by total of the current

liabilities.

Equation :

Current Ratio = Current Assets / Current Liabilities

Or

Current Assets : Current Liabilities

Components :

Current assets Current liabilities

Cash in hand Outstanding (or) accrued expenses

Cash at bank Bank overdraft

Bills receivable Bills payable

Inventories Short term advances

Work in progress Sundry creditors

Marketable securities Dividend payable

Short term investment Income tax payable

Sundry debtors

Prepaid expenses

A2. Quick ratio

Liquid ratio is also termed as "Liquidity Ratio",  "Acid Test Ratio" or

"Quick Ratio". It is the ratio of liquid assets to current liabilities. The true

liquidity refers to the ability of a firm to pay its short term obligations as

and when they become due.

Equation :

Liquid Ratio = Liquid Assets / Current Liabilities

Components

Quick assets Current liabilities

Cash in hand Outstanding (or) accrued expenses

Cash at bank Bank overdraft

Bills receivable Bills payable

Marketable securities Short term advances

Short term investment Sundry creditors

Sundry debtors Dividend payable

Prepaid expenses Income tax payable

A3. Absolute liquid ratio

Equation :

Absolute liquid ratio= Absolute liquid assets/Current liability

B. LEAVERAGE RATIO

The leverage or solvency ratio refers to the ability of a concern to meet its

long term obligation. Accordingly, long term solvency ratio indicate firm’s

ability to meet the fixed interest and costs and repayment schedules

associated with its long term borrowing.

The following ratio serves the purpose of determining the solvency

of the concern.

1. Debt equity ratio

2. Proprietor ratio

3. Fixed assets to long term fund

B1. Debt equity ratio

Debt-to-Equity ratio indicates the relationship between the external equities or outsiders funds and the internal equities or shareholders funds.

It is also known as external internal equity ratio. It is determined to ascertain soundness of the long term financial policies of the company.

Equation :

Debt Equity Ratio = External Equities / Internal Equities

Or

Outsiders funds / Shareholders funds

Components:

Outsider’s fund Shareholders fund

Borrowing fund Equity share capital

Reserves and surplus

B2. Proprietary ratio

This is a variant of the debt-to-equity ratio. It is also known as equity ratio or net worth to total assets ratio.

This ratio relates the shareholder's funds to total assets. Proprietary / Equity ratio indicates the long-term or future solvency position of the business.

Equation :

Proprietary or Equity Ratio = Shareholders funds / Total Assets

Components:

Shareholders fund Total assets

Equity share capital Fixed assets

Reserves and surplus Current assets

B3. Fixed assets to long term fund

Fixed assets to long term fund ratio establishes the relationship between fixed assets and shareholders funds.

The purpose of this ratio is to indicate the percentage of the owner's funds invested in fixed assets.

Equation :

Fixed Assets to long term Fund = Fixed Assets / long term Fund

C. ACTIVITY RATIO

Funds are invested in various assets in business to make sales and earn

profits. The efficiency with witch assets are managed directly affects the

volume of sales. An activity ratio measures the efficiency assets these ratios

are called “turnover ratios” because they indicate the speed with which

assets are converted or turned in to sales.

1. Inventory turnover ratio

2. Debtors turnover ratio

3. Working capital turnover ratio

4. Fixed assets turnover ratio

5. Creditors turnover ratio

C1. Inventory turnover ratio

Stock turn over ratio and inventory turn over ratio are the same. This

ratio is a relationship between the cost of goods sold during a particular

period of time and the cost of average inventory during a particular period.

It is expressed in number of times. Stock turn over ratio/Inventory turn over

ratio indicates the number of time the stock has been turned over during

the period and evaluates the efficiency with which a firm is able to manage

its inventory. This ratio indicates whether investment in stock is within

proper limit or not.

Equation :

Inventory Turnover Ratio = Cost of goods sold / Average inventory at cost

Or

Net Sales / Inventory

C2. Debtors turnover ratio

A concern may sell goods on cash as well as on credit. Credit is one of the important elements of sales promotion. The volume of sales can be increased by following a liberal credit policy.

The effect of a liberal credit policy may result in tying up substantial funds of a firm in the form of trade debtors (or receivables). Trade debtors are expected to be converted into cash within a short period of time and are included in current assets. Hence, the liquidity position of concern to pay its short term obligations in time depends upon the quality of its trade debtors.

Equation :

Debtors Turnover Ratio = Net Credit Sales / Average Trade Debtors

C3. Working capital turnover ratio

Working capital turnover ratio indicates the velocity of the utilization of net working capital.

This ratio represents the number of times the working capital is turned over in the course of year and is calculated as follows:

Equation :

Working Capital Turnover Ratio = Cost of Sales / Net Working Capital

Working capital = Current assets – Current liabilities

C4. Fixed assets turnover ratio

Fixed assets turnover ratio is also known as sales to fixed assets ratio. This ratio measures the efficiency and profit earning capacity of the concern.

Higher the ratio, greater is the intensive utilization of fixed assets. Lower ratio means under-utilization of fixed assets. The ratio is calculated by using following Equation :

Equation :

Fixed Assets Turnover Ratio = Cost of Sales / Net Fixed Assets

Net fixed assets = Fixed assets – Depreciation

C5. Creditors turn over ratio

This ratio is similar to the debtors turnover ratio. It compares creditors with the total credit purchases.

It signifies the credit period enjoyed by the firm in paying creditors. Accounts payable include both sundry creditors and bills payable. Same as debtors turnover ratio, creditors turnoverratio can be calculated in two forms, creditors turnover ratio and average payment period.

Equation :

Creditors Turnover Ratio = Credit Purchase / Average Trade Creditors

D. PROFITABILITY RATIO

The primary objective of business undertaking is to earn profits. Because

profit is the engine, that drives the business enterprise. The important ratio

which highlights the profitability of the firm would be as follows.

1. Gross profit ratio

2. Net profit ratio

3. Operating ratio

4. Return on total assets

5. Reserves and surplus to capital ratios

6. Earning per share

7. Return on investment.

D1. Gross profit ratio

Gross profit ratio (GP ratio) is the ratio of gross profit to net sales expressed

as a percentage. It expresses the relationship between gross profit and

sales.

Equation :

Gross Profit Ratio = (Gross profit / Net sales) × 100

Net sales = Sales – Sales return, Gross profit = net sales – COGS

D2. Net profit ratio

Net profit ratio is the ratio of net profit (after taxes) to net sales. It is

expressed as percentage.

Equation :

Net Profit Ratio = (Net profit / Net sales) × 100

D3. Operating ratio

Operating ratio is the ratio of cost of goods sold plus operating expenses to net sales. It is generally expressed in percentage.

Operating ratio measures the cost of operations per dollar of sales. This is closely related to the ratio of operating profit to net sales.

Equation :

Operating Ratio = [(Cost of goods sold + Operating expenses) / Net sales] × 100

D4. Return on total assets

A ratio that measures a company's earnings before interest and taxes (EBIT) against its total net assets. The ratio is considered an indicator of how effectively a company is using its assets to generate earnings before contractual obligations must be paid. 

Equation :

ROTA = EBIT/ Total assets

EBIT= Net income + Interest expenses + Taxes

D5. Reserves and surplus to capital ratio

It reveals the policy pursued by the company with regard to growth shares.

A vary high ratio indicates a conservative dividend policy and increased

plugging back to profit. Higher the ratio better will be the position.

Equation :

Reserves and surplus = Reserves and surplus / Capital

D6. Earning per share

Earnings per share ratio (EPS Ratio) is a small variation of return on equity

capital ratio and is calculated by dividing the net profit after taxes and

preference dividend by the total number of equity shares.

Equation :

Earnings per share (EPS) Ratio = (Net profit after tax − Preference dividend) / No. of equity shares

The earnings per share is a good measure of profitability and when

compared with EPS of similar companies, it gives a view of the comparative

earnings or earnings power of the firm. EPS ratio calculated for a number of

years indicates whether or not the earning power of the company has

increased.

D7. Return on investments

It is the ratio of net profit to share holder's investment. It is the relationship between net profit (after interest and tax) and share holder's/proprietor's fund.

This ratio establishes the profitability from the share holders' point of view. The ratio is generally calculated in percentage.

Equation :

Return on share holder's investment = [Net profit (after interest and tax) / Share holder's fund] × 100

Advantages of the ratio analysis  

1. Helpful in analysis of Financial Statements.

2. Helpful in comparative Study.

3. Helpful in locating the weak spots of the business.

4. Helpful in Forecasting.

5. Estimate about the trend of the business.

6. Fixation of ideal Standards.

7. Effective Control.

8. Study of Financial Soundness.

Limitations of the ratio analysis

1.   Comparison not possible if different firms adopt different

accounting policies.

2.   Ratio analysis becomes less effective due to price level

changes.

3.   Ratio may be misleading in the absence of absolute data.

4.   Limited use of a single data.

5.   Lack of proper standards.

6.   False accounting data gives false ratio.

7.   Ratios alone are not adequate for proper conclusions.

8.   Effect of personal ability and bias of the analyst. 

WORKING CAPITAL ANALYSIS

Meaning of the working capital

Capital required for a business can be classified under two main categories via,

1) Fixed Capital 2) Working Capital

Every business needs funds for two purposes _ For its establishment _ To carry out its day- to-day operations

Long terms funds are required to create production facilities through purchase of fixed assets such as P&M, land, building, furniture, etc. Investments in these assets represent that part of firm’s capital which is blocked on permanent or fixed basis and is called Fixed Capital.

Funds are also needed for short-term purposes for the purchase of raw material, payment of wages and other day–to-day expenses etc. These funds are known as Working Capital.

In simple words, working capital refers to that part of the firm’s capital which is required for financing short- term or current assets such as cash, marketable securities, debtors & inventories.

Funds, thus, invested in current assts keep revolving fast and are being constantly converted in to cash and this cash flows out again in exchange for other current assets. Hence, it is also known as revolving or circulating capital or short term capital.

Working capital (abbreviated WC) is a financial metric which

represents operating liquidityavailable to a business, organization, or other

entity, including governmental entity. Along with fixed assets such as plant

and equipment, working capital is considered a part of operating capital.

Net working capital is calculated as current assets minus current liabilities.

It is a derivation of working capital, that is commonly used in valuation

techniques such as DCFs (Discounted cash flows). If current assets are less

than current liabilities, an entity has aworking capital deficiency, also

called a working capital deficit.

Concepts of working capital

There are two concepts of working capital: 1. Gross working capital 2. Net working capital

The gross working capital is the capital invested in the total current assets of the enterprise. Current assets are those Assets which can convert in to cash within a short period normally one accounting year.

CONSTITUENTS OF CURRENT ASSETS

1) Cash in hand and cash at bank

2) Bills receivables

3) Sundry debtors

4) Short term loans and advances.

5) Inventories of stock as:a. Raw materialb. Work in processc. Stores and sparesd. Finished goods

6. Temporary investment of surplus funds.

7. Prepaid expenses

8. Accrued incomes.

9. Marketable securities.

In a narrow sense, the term working capital refers to the net working. Net working capital is the excess of current assets over current liability, or, say:

NET WORKING CAPITAL = CURRENT ASSETS – CURRENT IABILITIES.

Net working capital can be positive or negative. When the current assets exceeds the current liabilities are more than the current assets. Current liabilities are those liabilities, which are intended to be paid in the ordinary course of business within a short period of normally one accounting year out of the current assts or the income business.

CONSTITUENTS OF CURRENT LIABILITIES

1) Accrued or outstanding expenses.

2) Short term loans, advances and deposits.

3) Dividends payable.

4) Bank overdraft.

5) Provision for taxation, if it does not amount to approximate of profit.

6) Bills payable.

7) Sundry creditors.

The gross working capital concept is financial or going concern concept whereas net working capital is an accounting concept of working capital. Both the concepts have their own merits.

Classification of working capital

Working capital may be classified in to ways:

On the basis of concepts On the basis of time

Gross working capital Permanent or Fixed working capital

Net working capital Temporary or Variable working

capital

PERMANENT OR FIXED WORKING CAPITAL

Permanent or fixed working capital is minimum amount which is required to ensure effective utilization of fixed facilities and for maintaining the circulation of current assets. Every firm has to maintain a minimum level of

raw material, work- in-process, finished goods and cash balance. This minimum level of current assts is called permanent or fixed working capital as this part of working is permanently blocked in current assets. As the business grow the requirements of working capital also increases due to increase in current assets.

TEMPORARY OR VARIABLE WORKING CAPITAL

Temporary or variable working capital is the amount of working capital which is required to meet the seasonal demands and some special exigencies. Variable working capital can further be classified as seasonal working capital and special working capital. The capital required to meet the seasonal need of the enterprise is called seasonal working capital. Special working capital is that part of working capital which is required to meet special exigencies such as launching of extensive marketing for conducting research, etc.

Temporary working capital differs from permanent working capital in the sense that is required for short periods and cannot be permanently employed gainfully in the business.

Importance or advantage of adequate working capital

    SOLVENCY OF THE BUSINESS :  Adequate working capital helps in maintaining the solvency of the business by providing uninterrupted of production.

     Goodwill:   Sufficient amount of working capital enables a firm to make prompt payments and makes and maintain the goodwill.

     Easy loans :  Adequate working capital leads to high solvency and credit standing can arrange loans from banks and other on easy and favorable terms.

     Cash Discounts: Adequate working capital also enables a concern to avail cash discounts on the purchases and hence reduces cost.

     Regular Supply of Raw Material:   Sufficient working capital ensures regular supply of raw material and continuous production.

     Regular Payment Of Salaries, Wages And Other Day TO Day Commitments:   It leads to the satisfaction of the employees and raises the morale of its employees, increases their efficiency, reduces wastage and costs and enhances production and profits.

     Exploitation Of Favorable Market     Conditions:   If a firm is having adequate working capital then it can exploit the favorable market conditions such as purchasing its requirements in bulk when the prices are lower and holdings its inventories for higher prices.

     Ability To Face Crises:   A concern can face the situation during the depression.

     Quick And Regular Return On Investments:   Sufficient working capital enables a concern to pay quick and regular of dividends to its investors and gains confidence of the investors and can raise more funds in future.

     High Morale: Adequate working capital brings an environment of securities, confidence, high morale which results in overall efficiency in a business.

EXCESS OR INADEQUATE WORKING CAPITAL

Every business concern should have adequate amount of working capital to run its business operations. It should have neither redundant or excess working capital nor inadequate nor shortages of working capital. Both excess as well as short working capital positions are bad for any business. However, it is the inadequate working capital which is more dangerous from the point of view of the firm.

DISADVANTAGES OF REDUNDANT OR EXCESSIVE WORKING CAPITAL

1.     Excessive working capital means ideal funds which earn no profit for the firm and business cannot earn the required rate of return on its investments.

2.     Redundant working capital leads to unnecessary purchasing and accumulation of inventories.

3.     Excessive working capital implies excessive debtors and defective credit policy which causes higher incidence of bad debts.

4.     It may reduce the overall efficiency of the business.

5.     If a firm is having excessive working capital then the relations with banks and other financial institution may not be maintained.

6.     Due to lower rate of return n investments, the values of shares may also fall.

7.     The redundant working capital gives rise to speculative transactions

DISADVANTAGES OF INADEQUATE WORKING CAPITAL

Every business needs some amounts of working capital. The need for

working capital arises due to the time gap between production and

realization of cash from sales. There is an operating cycle involved in sales

and realization of cash. There are time gaps in purchase of raw material and

production; production and sales; and realization of cash.

Thus working capital is needed for the following purposes:

       For the purpose of raw material, components and spares.

       To pay wages and salaries

       To incur day-to-day expenses and overload costs such as office expenses.

       To meet the selling costs as packing, advertising, etc.

       To provide credit facilities to the customer.

       To maintain the inventories of the raw material, work-in-progress, stores and spares and finished stock.

For studying the need of working capital in a business, one has to study the

business under varying circumstances such as a new concern requires a lot

of funds to meet its initial requirements such as promotion and formation

etc. These expenses are called preliminary expenses and are capitalized.

The amount needed for working capital depends upon the size of the

company and ambitions of its promoters. Greater the size of the business

unit, generally larger will be the requirements of the working capital.

The requirement of the working capital goes on increasing with the growth

and expensing of the business till it gains maturity. At maturity the amount

of working capital required is called normal working capital.

There are others factors also influence the need of working capital in a

business.

Factors affecting working capital requirement

1.  NATURE OF BUSINESS: The requirements of working is very limited in public utility undertakings such as electricity, water supply and railways because they offer cash sale only and supply services not products, and no funds are tied up in inventories and receivables. On the other hand the trading and financial firms requires less investment in fixed assets but have to invest large amt. of working capital along with fixed investments.

2.  SIZE OF THE BUSINESS: Greater the size of the business, greater is the requirement of working capital.

3.  PRODUCTION POLICY: If the policy is to keep production steady by accumulating inventories it will require higher working capital.

4.  LENTH OF PRDUCTION CYCLE: The longer the manufacturing time the raw material and other supplies have to be carried for a longer in the process with progressive increment of labor and service costs before the final product is obtained. So working capital is directly proportional to the length of the manufacturing process.

5.  SEASONALS VARIATIONS: Generally, during the busy season, a firm requires larger working capital than in slack season.

6.  WORKING CAPITAL CYCLE: The speed with which the working cycle completes one cycle determines the requirements of working capital. Longer the cycle larger is the requirement of working capital.

 

  

7.  RATE OF STOCK TURNOVER: There is an inverse co-relationship between the question of working capital and the velocity or speed with which the sales are affected. A

firm having a high rate of stock turnover wuill needs lower amt. of working capital as compared to a firm having a low rate of turnover.

8.  CREDIT POLICY: A concern that purchases its requirements on credit and sales its product / services on cash requires lesser amt. of working capital and vice-versa.

9.  BUSINESS CYCLE: In period of boom, when the business is prosperous, there is need for larger amt. of working capital due to rise in sales, rise in prices, optimistic expansion of business, etc. On the contrary in time of depression, the business contracts, sales decline, difficulties are faced in collection from debtor and the firm may have a large amt. of working capital.

10.  RATE OF GROWTH OF BUSINESS: In faster growing concern, we shall require large amt. of working capital.

11. EARNING CAPACITY AND DIVIDEND POLICY: Some firms have more earning capacity than other due to quality of their products, monopoly conditions, etc. Such firms may generate cash profits from operations and contribute to their working capital. The dividend policy also affects the requirement of working capital. A firm maintaining a steady high rate of cash dividend irrespective of its profits needs working capital than the firm that retains larger part of its profits and does not pay so high rate of cash dividend.

12. PRICE LEVEL CHANGES: Changes in the price level also affect the working capital requirements. Generally rise in prices leads to increase in working capital.

Others FACTORS: These are:

     Operating efficiency.      Import policy.

     Asset structure.      Management ability.

     Irregularities of supply.      Importance of labor.

WORKING CAPITAL ANALYSIS

As we know working capital is the life blood and the centre of a business.

Adequate amount of working capital is very much essential for the smooth

running of the business. And the most important part is the efficient

management of working capital in right time. The liquidity position of the

firm is totally effected by the management of working capital. So, a study of

changes in the uses and sources of working capital is necessary to evaluate

the efficiency with which the working capital is employed in a business. This

involves the need of working capital analysis.

The analysis of working capital can be conducted through a number of

devices, such as:

1.     Ratio analysis.

2.     Fund flow analysis.

3.     Budgeting.

Ratio analysis

Discussed earlier in the chapter 2

Fund flow analysis

Fund flow analysis is a technical device designated to the study the source from which additional funds were derived and the use to which these sources were put. The fund flow analysis consists of:

a.      Preparing schedule of changes of working capital

b.     Statement of sources and application of funds.

It is an effective management tool to study the changes in financial position (working capital) business enterprise between beginning and ending of the financial dates.

 Working capital budgeting

A budget is a financial and / or quantitative expression of business plans and polices to be pursued in the future period time.

Working capital budget as a part of the total budge ting process of a business is prepared estimating future long term and short term working capital needs and sources to finance them, and then comparing the budgeted figures with actual performance for calculating the variances, if any, so that corrective actions may be taken in future.

He objective working capital budget is to ensure availability of funds as and needed, and to ensure effective utilization of these resources.

The successful implementation of working capital budget involves the preparing of separate budget for each element of working capital, such as, cash, inventories and receivables etc.  

CASH FLOW ANALYSIS

Meaning of Cash flow 

Cash flow is essentially the movement of money into and out of your business; it's the cycle of cash inflows and cash outflows that determine your business' solvency.

Meaning of Cash flow analysis 

Cash flow analysis is the study of the cycle of your business' cash inflows and outflows, with the purpose of maintaining an adequate cash flow for your business, and to provide the basis for cash flow management.

Cash flow analysis involves examining the components of your business that affect cash flow, such as accounts receivable, inventory, accounts payable, and credit terms.

By performing a cash flow analysis on these separate components, you'll be able to more easily identify cash flow problems and find ways to improve your cash flow.

A quick and easy way to perform a cash flow analysis is to compare the total unpaid purchases to the total sales due at the end of each month.

If the total unpaid purchases are greater than the total sales due, you'll need to spend more cash than you receive in the next month, indicating a potential cash flow problem.

Cash flow is truly the lifeblood of any small business. So when tight credit starts choking your cash flow, it's important that you act right away to remove the blockage and get your business' cash flow flowing again. Here are five quick things you can do to improve your small business' cash flow.

1. Invoice promptly.

Many small businesses have a regular billing routine such as invoicing clients and/or customers at the end of the month - leaving money that could be sitting in their bank accounts improving their cash flow in someone else’s pockets! Instead of waiting to invoice, bill right away when the job is completed. If your business involves billing for hours of time, invoice twice monthly instead of once to get some of your money coming in sooner.

2. Ask for partial payment up front.

Instead of waiting to invoice until a job is completed, ask for a percentage of the bill to be paid before the work starts. For instance, you might charge 40% of the bill as a retainer or proof of good faith with the remainder due on completion of the task. Or break the bill into thirds, asking for a third before work starts, a third while the project is ongoing and a third upon completion. It's a common business practice and one you should be taking advantage of if you can.

3. Give a reward for quick payment.

Money you are owed but don't collect is a real cash flow drain. You can get some customer and/or clients to pay immediately by offering them a discount if they pay within a certain time frame, giving your cash flow a nice boost. A 2% discount for paying within ten days is the most common scenario.

4. Go after receivables.

Make it a regular practice to review your receivables and identify accounts that are late paying or overdue. Then make the phone call or send out the letter or email requesting payment. Some clients and/or customers just need reminding. And when reminding doesn't work? Time to put the collections agency to work.

5. Pay bills only when they're due.

Check your suppliers' payment terms and determine when payment is due (30, 60 or 90 days). Then wait to pay until whenever the due dates are rather than paying right away. Timing your business' bill payments this way will help keep your cash flow flowing, as it will keep the cash in your business longer.

These are just some of the things you can do to get your cash flow moving again - some of the quicker, easier things. The other things you can do can take longer to implement but are well worth doing, especially if you are having or anticipate having cash flow problems.

Steps involving in cash flow analysis

1. This type of cash flow analysis is called cash budgeting analysis. It is part of your firm's financial forecasting plan. Determine the amount of cash that will flow into your firm during the month. If you are just starting your business, you should include the beginning balance in cash that you want to have available every month. There would also be the amount of sales you have during the first month. Sales would include both cash sales and sales that you make to your customers who pay on credit. Here's an example you can follow to develop your Schedule of Cash Receipts (Sales Receipts).

2. Determine the amount of cash that will flow out of your firm during the month. You will have expenses. You will probably have to buy office supplies. Other monthly expenses may include advertising, vehicle expenses, pay roll expenses, just to name a few. You will have some quarterly expenses, such as taxes. You may have expenses that just occur occasionally, like purchases of computer equipment, vehicles, or other larger expenses. Here is an example of a Schedule of Cash Payments that is the second step of the cash budget.

3. You want the cash that will flow into your firm (Step 1) to be greater than the cash that will flow out of your firm (Step 2). This means that your monthly cash inflow needs to be greater than your monthly cash outflow so you will have sufficient cash to operate your firm. Here's a blank worksheet you can use to calculate your cash inflow or cash receipts and another blank worksheet you can use to calculate your cash payments.

4. Your ending balance for the first month becomes the beginning balance for the second month. You do the same type of analysis. Each month, you may have to add more items to your cash flow analysis as your business grows. You need to decide what the minimum ending cash

balance is that you find acceptable for your firm and aim toward that figure each month.

5. If your cash flow turns negative for any one month, you will have to borrow money for that month from family or friends, investors, or from a bank or other financial institutions. Then, if your cash flow is positive the next month, you can repay that loan.

6. Keep on doing this each month for your forecasting period. Try to keep your borrowing to a minimum and your cash inflow greater than your outflows. Remember that this cash budget is a financial forecasting document but try to follow it as closely as possible. Here is an example of a completed Cash Budget, based on the schedules already completed, that you can look at. Here is a blank worksheet you can use for your own company.

ECONOMIC VALUE ADDED(EVA) OR ECONOMIC PROFIT

INTRODUCTION

From a commercial standpoint, Economic Value Added (EVA™) is the most successful performance metric used by companies and their consultants. Although much of its popularity is a result of able marketing and deployment by Stern Stewart, owner of the trademark, the metric is justified by financial theory and consistent with valuation principles, which are important to any investor's analysis of a company. 

To many, the EVA™ metric (also known as "economic profit") basks in a mystique of complexity. But this tutorial will show you that this complexity is only an illusion. In fact, the entire metric is a development of three simple ideas: cash is king; some expense dollars are really investments in

"disguise"; and  equity  capital  is expensive. 

To help you understand EVA™ and its components, we exploring a different conceptual aspect of economic value added (EVA™) and demonstrating the associated calculations. Over the course of these chapters, we build an EVA™ calculation for the kemrock industries and exports limited (KIEL), a manufacturing company, using recent financial statements. And, at the end of this study of EVA™, we compare it to other performance metrics.

By the end of this chapter, you will not only be able to calculate EVA™ for yourself, but also, importantly, understand its strengths and weaknesses, observing how it is ideal for some situations, but also - contrary to some dogma - not necessarily the best performance metric for many other situations.

Because the term EVA™ is trademarked, for convenience’s sake, we will instead refer to it as economic profit throughout the chapter. This is a common practice and, for our purposes, there is no difference. 

OVERVIEW

Examining the components of economic profit and studying the finer points of its calculation require an understanding of its underlying principles. Here we look at how it matters as a performance measure - which is distinct from a wealth metric - and how it is closely related to market value added (MVA). Finally, in establishing an overall picture of economic profit, we help you undo any perceived complexity by showing how all of the calculations surrounding economic profit originate from three main ideas. 

To understand economic profit, it helps to distinguish between a performance metric and a wealth metric. A performance metric refers to a measure under company control, such as earnings or return on capital. A wealth metric, on the other hand, is a measure of value that - such as equity market capitalization or the price-to-earnings (P/E) multiple -depends on the stock market's collective and forward-looking view. Now, although these two types of metrics are distinct, they are related. 

The key criterion for the pairing of a performance and wealth metric is consistency: each half of the pair should reference the same group of capital holders and their respective claims' on company assets. For example, EPS by definition concerns the allocation of earnings to common shareholders; the P/E multiple refers to equity market capitalization, which is the value held by shareholders. 

Below is a chart listing a few performance metrics and their corresponding wealth metrics. Note that economic profit's corresponding wealth metric is market value added (MVA). We explore this relationship below as we come to understand specifically what economic value is and how works: 

Performance metric Wealth metric

Return on Equity (ROE), EPS growth P/E Ratio

Return on Capital (ROC or ROIC), Operating Income Growth

Ratio of: Entity value ÷ EBITDA

Economic Profit Market Value Added (MVA)

Free Cash Flow Equity Market Capitalization (price x common shares outstanding)

Cash Flow Return on Investment (CFROI) Total Shareholder Return (TSR)

Economic profit is based on the same idea of the Traditional approach. The only difference is that, under economic profit, the intrinsic value of the firm is broken into two parts: invested capital, plus the present value of future economic profits. Here is the comparison:

Traditional Approac h

Intrinsic Value = Present Value of Future Free Cash Flows 

Economic Profit  

Intrinsic Value = Invested Capital + Present Value of Future Economic Profits

As it breaks intrinsic value into parts, you can see why economic profit is often called "residual profit" or "excess earnings". Let's see how this works in Figure 2 below. We are using the same hypothetical assumptions, and the value of the firm's equity remains $40. In this case, however, the green bars in years one through five represent future economic profits, which represent a part of the future free cash flows will therefore always be less than the free cash flows. Later in this chapter we explain the economic calculation of the economic profits, but for now, it's enough to understand that they represent profits earned above the cost of capital. 

 

Economic profits represent the portion of free cash flows after a capital charge is subtracted. In this example, the future economic profits (which we're lucky enough to know) is discounted to a present value of $20 as represented by the tall green bar stacked on top of the dark blue bar, which represents the invested capital portion of $20. Together these contiguous bars show how economic profit divides a company's intrinsic value into two pieces.

The final step in understanding the relationship between these two pieces concerns MVA, which represents how the market values the firm above its invested capital. In our example it is simply the name given to the present value of the future economic profits - the tall green $20 bar. If, for example, this company happened to earn zero future economic profits (zero excess profits), the MVA would be zero, and the company's total value would simply be equal to its invested capital. 

Now of course the market does not predict future cash flows (or economic profits) perfectly, so we can speak of MVA in two different ways: the MVA as set by the market and the intrinsic (or theoretical) MVA as set by expected future economic profits. But, just as, according to the traditional valuation model, the firm's market valuation is expected to converge with its discounted free cash flow, the observed MVA is expected to converge with its discounted economic profit value. And here, by "observed MVA" we mean the equity market capitalization, minus the invested capital. 

COMPONENTS OF EVA

NOPAT: - Net Operating Profit After Tax

Capital: - Net working capital, net PP&E, goodwill, and other assets

Net operating assets adjusted for certain accounting distortions Asset write-downs, restructuring charges,

Net operating assets: Cash, receivables, inventory, prepaid Trade payable, accruals, deferred taxes Net property, plant, and equipment

Non-operating assets: Marketable securities, investments.

Cost of Capital: - Weighted average cost of capital

Capital charge: - Cost of capital * capital

Represents a rental charge for the use of the operating capital Minimum rate of return the operating capital should earn Calculated as the firm’s weighted average cost of capital

Economic value added: - NOPLAT less the capital charge

CALCULATING EVA

Three easy steps to find EVA are as follows.

1> Calculation of NOPAT2> Calculation of invested capital3> Pulling it all together

1> CALCULATING NOPAT

In finding economic profit, the essential step is to calculate net operating profit after taxes (NOPAT), and this chapter looks at how to do it. We get to NOPAT by translating - through a series of adjustments - an accrual-based income statement number into a cash-based profit number. Although there are three basic steps in the process of finding NOPAT, there is no single correct method for arriving at a final number.

The method an investor uses is a matter of how approximate or precise he or she wants to be. Some critics lament that economic profit requires 50-150 adjustments - but many users of economic profit agree that most of the answer is found after a dozen or even fewer adjustments. In fact, beyond a handful of adjustments, you are really only fine-tuning the NOPAT number. And, from an investor's standpoint, a multitude of adjustments simply are not necessary.

In using economic profit, the investor's priority is consistency and comparability. In other words, calculating economic profit with 99.9%

precision is less important than ensuring the method of calculation is consistent from year to year and from peer to peer.

The Stages of the Process Getting to NOPAT takes three basic steps:

1. Start with earnings before interest and taxes (EBIT).2. Make the key adjustments - these come in two flavors:

a. Eliminating accounting distortions (convert accrual to cash).b. Reclassifying some expenses as investments (i.e. capitalizing them

to the balance sheet).3. Subtract cash operating taxes.

2> CALCULATING INVESTED CAPITAL

Calculating invested capital is an important step in finding economic profit because a key idea underlying this metric is charging the company for its use of capital. In order for the company to generate a positive economic profit, it must cover the cost of using the invested capital. 

There is more than one way to get to invested capital, but here we use the following three-step method: 

1. Get invested book capital from the balance sheet.2. Make adjustments that convert accounting accruals to cash.3. Make adjustments that recognize off-balance-sheet sources of funds.

You will notice that steps 2 and 3 are mirror equivalents of steps we took in earlier chapter to calculate net operating profit after taxes (NOPAT). 

3> PULLING IT ALL TOGETHER

As a reminder, here is the basic economic profit calculation:

Economic Profit = NOPAT - Capital Charge (Invested Capital x WACC) 

Economic profit is NOPAT minus a capital charge, which represents a sort of rental fee charged to the company for its use of capital. In other words, economic profit is the profits (or returns) our company must generate in order to satisfy the lenders and shareholders who have "rented" capital to

the company. Keep in mind that economic profit is a period metric, like earnings or cash flow.

The only step that we need to perform before the ultimate economic profit calculation is to estimate the capital charge.

As a reminder, here is the basic economic profit calculation: The only step that we need to perform before the ultimate economic profit calculation is to estimate the capital charge.

Capital Charge Equals Invested Capital Multiplied by WACC

We already have discussed the calculation of invested capital in this chapter. Now we need to estimate weighted average cost of capital (WACC). This is the average return expected by the blended investor base. In order to calculate WACC, we need a cost of debt and a cost of equity.