Working Capital Mgmt at OCIL
-
Upload
shikha-chaudhary -
Category
Documents
-
view
220 -
download
0
Transcript of Working Capital Mgmt at OCIL
-
8/8/2019 Working Capital Mgmt at OCIL
1/98
-
8/8/2019 Working Capital Mgmt at OCIL
2/98
ACKNOWLEDGEMENT
I feel privileged in expressing profound sense of gratitude and indebt ness to Mr.
Pankaj Goyal (Finance Controller & Company Secretary) who have
generously provided me the chance to work in the esteemed organization
ORIENT CERAMICS AND INDUSTRIES LTD. His able guidance, constant
encouragement and inspiration were instrumental in the completion of this
project.
Also I would like to express my profound sense of gratitude to the entire staff of
ORIENT CERAMICS AND INDUSTIRES LIMITED for providing me with
their valuable time and constant support.
Lastly, I would like to thank my faculty guide at Apeejay School of Management,
Prof. Pankaj Varshney for his support and vital inputs without which the project
would have not been completed on time.
-
8/8/2019 Working Capital Mgmt at OCIL
3/98
TABLE OF CONTENTS
EXECUTIVE SUMMARY4
RESEARCH METHODOLOGY..7
FINANCIAL AND COMPARATIVE ANALYSIS...19
FINDINGS AND OBSERVATIONS.76
BIBLIOGRAPHY...79
-
8/8/2019 Working Capital Mgmt at OCIL
4/98
CHAPTER 1
EXECUTIVE SUMMARY
-
8/8/2019 Working Capital Mgmt at OCIL
5/98
EXECUTIVE SUMMARY
The management of current assets deals with determination, maintenance, control
and monitoring the level of all the individual current assets. Current assets are
referred to as assets, which can normally be converted into cash within one year
therefore investment in current assets should be just adequate no more no less
to the needs of the business. Excessive investments in current assets should be
avoided, because it impairs firms profitability, as idle investment in current
assets and are non-productive and so they earn nothing, on the other hand
inadequate amount of working capital can threaten solvency of the firm, if it fails
to meet its current obligations.
Thus working capital is a qualitative concept as
1. It indicates the liquidity position of the company and,
2. It suggests the extent to which working capital needs may be financed by
permanent source of funds. Current assets should be sufficiently in excess
of current liabilities to constitute a margin or buffer for maturing
obligation within the ordinary operating cycle of business.
The basic learning objective behind the study was
1. Computation of Working Capital Management
2. Presentation of Credit Monetary Assessment (CMA)
3. Ratio Analysis
On the basis of above calculations following conclusions are made
Orient Ceramics as of now is following aggressive policy, which
means that company is maintaining lower ratio of current assets to fixed assets.
However, in 2006 the company has inclined towards a conservative approach.
-
8/8/2019 Working Capital Mgmt at OCIL
6/98
The company has both long term as well as short term sources for
current assets financing. It implies that company follows matching principle
for raising funds.
Also, the company has high collection period as compared to its
competitors which show that money has been unnecessarily blocked with the
debtors.
So to overcome the above problems following are the recommendations
Increase the proportion of current assets over fixed assets to come to
proper proportion of current assets and fixed assets.
Company should shift from aggressive policy to conservative current
assets policy
Company should reduce its holding period.
-
8/8/2019 Working Capital Mgmt at OCIL
7/98
CHAPTER 2
RESEARCH METHODLOGY
-
8/8/2019 Working Capital Mgmt at OCIL
8/98
RESEARCH METHODOLOGY
PROJECT OBECTIVE
1. The project is aimed at evaluating the financial status of Orient Ceramics
and Industries Ltd. And then doing the comparative analysis with its
competitors i.e. Somany Ceramics Ltd. and Kajaria Ceramics Ltd.
2. Studying the working capital management at Orient Ceramics and
Industries Ltd. and estimating the working capital management for 2006-
07 and then forecasting for 2007-08.
METHODOLOGY
The methodology to be adopted for the project is explained as under
1. The initial step of the project was studying about the company and then
evaluating the financial position of the company on the basis of ratio
analysis.
2. Comparing the firms financial position with respect to its competitors i.e.
Somany Ceramics Ltd. and Kajaria Ceramics Ltd. with the help of
following ratios
Liquidity Ratios
Solvency/ Leveraging Ratios
Coverage Ratios
Activity/ Turnover Ratios
Profitability Ratios
3. The project focussed on the study of the overall working capital
management at the organization, for which the following study and
analysis was undertaken
-
8/8/2019 Working Capital Mgmt at OCIL
9/98
Study of Credit Monetary Assessment (CMA) form and its
preparation for the current year.
It also included the ratio analysis of the financial statement so that
the profitability and liquidity trade-off could be analyzed.
SCHEDULE
The complete project was for duration of 8 weeks. The project had been divided
into two stages with approximate time period allotted to each stage. Both the
stages along with their approximate time were as follows
Stage 1 (approx 2 weeks):
The study of companys financial position by doing ratio analysis of the financial
statement so that the profitability and liquidity condition of the organization could
be studied closely and then comparing it with the financial statement of Somany
Ceramics Ltd. and Kajaria Ceramics Ltd.
Stage 2 (approx 6 weeks):
The study of the overall working capital management of the company was the
first step. Under this stage the operating plan was prepared and the study andanalysis of Credit Monetary Assessment (CMA) form was done. This included the
estimation of the working capital requirement for 2006-07 and then forecasting
for the year 2007-08.
SCOPE OF THE STUDY
Studying Working Capital Management of Orient Ceramics and Industries Ltd.
and benchmarking it with 2 of its competitors.
-
8/8/2019 Working Capital Mgmt at OCIL
10/98
OVERVIEW OF TILE INDUSTRY
Total size of ceramic tile industry at present is more than $ 32 billion globally,
and it is growing at 7.7% CAGR with China being the largest producer,
accounting for close to a third of total world production. The size of Indian
ceramic tile industry is around Rs. 6300 crore. Indian ceramic tile industry grew
at an average rate of 12% in the three year period 2002-2005 and at around 16%
in the year 2006. It is expected to grow at 18% in the year 2007 and maintain a
rate close to 20% and above in the coming year because of the thrust on
development of commercial spaces, retail revolution in the country, housing and
rising middle class income.
In fact this spurt in construction activity has primarily pushed India at the 5 th
position in terms of tiles production. India has displaced Indonesia and has
become the 5th largest manufacturer of ceramic tiles after China, Spain, Italy and
Brazil, contributing about 4.2% to the world production.
The ceramic tiles industry in India has followed similar trends as the international
industry, which has characterized by excess capacities and falling margins.
Countries like Malaysia, Thailand, Indonesia, Sri Lanka and Vietnam are setting
up their own plants. China has emerged as a major competitor. Producers from
Spain and Italy have the advantage of lower transportation costs while exporting
to USA and Germany, which are major importing countries. The Indian industry
has developed an export market although at lower end. In volume it constitutes
half a percent of the global market. Presently Indian does not figure in the list of
major exporting countries. But this reality could change as Indian exports are
rising at the rate of 15% per annum. The top-end of the global export market is
presently dominated by Italy (40.8%) and Spain (26.4%).
-
8/8/2019 Working Capital Mgmt at OCIL
11/98
Despite a strong growth in demand, the domestic tile industry has seen a
considerable decline in realizations over the past few years due to over capacity in
the domestic market, as well as increasing competition faced by the organized
segment from semi-organised and un-organised players and from cheap imports.
Further the industry is fuel incentive, the cost of which has also increased sharply
over the past few years and more so in year 2006. Thus declining realizations
coupled with increasing costs have put a pressure on profit margins of most
players in the industry.
Ceramic tile industry can be classified into three segments wall tiles segment,
floor tiles segment and vitrified & porcelain tiles segment. At present, in India the
market share of these segments are 42%, 45% and 13% respectively. Ceramic
tiles are produced both in organised as well as in unorganized sector.
The growing housing construction and replacement market along with the demand
for real estate from retail players over the next couple of years in malls etc would
create a huge demand for the tile industry in the country.
Over the long term, the prospect for the tile industry is encouraging as the ceramic
tile penetration is still very low. The per capita consumption in India is as low as
0.15 sq. mtr as compared to China (2 sq. mtr), Europe (6 sq. mtr), Brazil (2.5 sq.
mtr). Even a consumption of 1 SQM translates into six folds increase in the output
of Indian economy. The tile industry predominantly had two products in the form
of Mosaic and Ceramic tiles. Post liberalization, in 1993-94, a new technology
tile, vitrified tiles was introduced in the markets.
-
8/8/2019 Working Capital Mgmt at OCIL
12/98
Vitrified tiles, which are the fastest growing segment worldwide, have also
become fastest growing segment in the Indian market. Vitrified tiles are primarily
used on floors and are fast replacing marble and granite, especially in large
projects like hotels and complexes. Current size of vitrified tile industry is Rs.
1500 crore.
The introduction of vitrified tiles in the Indian market has signaled a paradigm
shift, in terms of users preference. Vitrified tiles, which are terms as tiles of the
future are increasingly becoming popular and displacing the ceramic tiles.
Internationally these tiles are already the major sellers. The main factor which
drives the growth of vitrified tiles is the quality of the product as compared to
Ceramic tiles.
Pricing point of vitrified tiles has reached a state in India wherein it is easily
affordable and consequently, consumers are moving from ceramic to vitrified
tiles. If one goes to any commercial mall or complex, they find vitrified tiles that
have a high gloss value, shine and a larger format compared to ceramic tiles.
Per Ca
0.15
2
6
7
-
8/8/2019 Working Capital Mgmt at OCIL
13/98
-
8/8/2019 Working Capital Mgmt at OCIL
14/98
CERAMIC TILE INDUSTRY STATISTICS
1 World Production 6400 million sq. mt.
2 India's share 200 million sq. mt.
3 World Ranking ( in production) 7
4 Per capita consumption 0.15 sq. mt.
5 Global Industry Growth Rate 6%
6
Growth Rate (India Domestic
Market) 12%
7
Organised Industry Turnover
(India) INR 22.50 Billion
Glazed Wall Tile Share 40%
Glazed Floor Tile Share 46%
Unglazed Vitrified Tile Share 8%
Glazed Porcelain Tile Share 6%
Unorganized Industry TurnoverGlazed Wall Tile Share 57%
Glazed Floor Tile Share 35%
Unglazed Vitrified Tile Share 6%
Glazed Porcelain Tile Share 2%
8 Investment in last 5 years INR 20 Billion
9 Organised sector
Share of Production 56%
No. of units 15
Revenue (excise duty) INR 2.3 Billion per annum approx.
10 Unorganised Sector
Share of Production 44%
No. of units
200 approx. (70% based in Gujarat
region)
Revenue (excise duty) INR 0.7 Billion per annum or less
-
8/8/2019 Working Capital Mgmt at OCIL
15/98
ORIENT TILES
Orient Ceramics And Industries Limited (OCIL), an ISO 14001 Company, was
incorporated as a Public Limited Company on 18th May, 1977 for themanufacture of ceramic tiles with an installed capacity of 5,000 TPA at
Sikandrabad, Distt. Bulandshahr (U.P.). It is located at a distance of approx.40
kms from Delhi.
In 1981, OCIL became a subsidiary of Somany-Pilkington's Ltd. (SPL), and as a
result of phased expansions, the manufacturing capacity was doubled from 5,000
Tons Per Annum (TPA) to 10,000 TPA.
By the end of 1993, OCIL was disassociated from SPL and Mr. Mahendra K.
Daga became Chairman & Managing Director. In 1994-95, OCIL's capacity was
further increased to 24,000 TPA. In 1996-97, another aggressive expansion
resulted in more than doubling of the plant capacity to 55,000 TPA.
OCIL's most recent expansion has increased its manufacturing capacity to 9
million square meters per annum.
The company today possesses the most state of the art technology, which enables
a finished tile to be packed untouched by hands within 2 hours from ceramic
powder. Orient Tiles are now sold in over 1200 outlets all over India, and
exported to Europe, South East Asia, Middle East and the SAARC countries.
As of 2006, the operating performance was satisfactory. The plant has increased
its capacity utilization during the financial year and running at peak level of
efficiency. The strengthening of marketing, which had positive impact and the
trend of increasing stock, has been arrested. Efforts are on to bring down the stock
and receivables to the desired level during the ensuing financial year. The
Company has maintained its market share and the volume of sales have increased.
-
8/8/2019 Working Capital Mgmt at OCIL
16/98
Realization prices continued to be under tremendous pressure. The Company is
working on a new strategy of repositioning its products.
Orient Tiles with 500 strong loyal and dedicated dealers all over India and 2000
sub dealers have strong hold in North and East but is expanding sales steadily in
South and West region. A wide range of size starting from 100mmX100mm to
300mmX400mm and continuous introduction of new exciting designs, close
liaison with trade and loyal dealers and better service to customers is what
distinguishes it and has placed the company within a very short span in forefront.
Established branches are already at Delhi, Chandigarh, Bahadurgarh, Kolkata
Mumbai, Indore, Bangalore, Hubli and Ahmedabad and propose to set up many
more in the different regions of the country. The trends of last five years have
been increasing prices and customers are willing to pay a premium to companies
manufacturing high quality tiles. Even though there has been a reduction in the
excise duty, and the benefit has been passed on to the consumer, companies can
still increase price without an adverse effect on demand. There is no Govt. control
on pricing. Pricing is mostly a result of demand/supply forces, and depends a lot
on competition.
-
8/8/2019 Working Capital Mgmt at OCIL
17/98
Future prospects for Orient Tiles
As one of the fastest growing economies in the world, India has witnessed an
unprecedented boom in the Construction and Retail Estate sector. Prices for
commercial and residential lands are at an all time highs. City skylines all over
India are dotted with hundreds of new construction projects. There is no doubt
that as a national player and an important part of the supply chain to the
construction sector, Orient Tiles has a wonderful opportunity to continue to
aggressively expand its market share over the next few years.
Tourism in India has been growing at a fast pace. There is an increasing demand-
supply gap of hotel rooms both for regular and seasonal tourists and for event
specific visitors such as to the Commonwealth Games 2010. As most leading
architects and builders have pre-approved Orient for use at their new projects, the
company expects to gain a significant share of this construction boom in the
hospitality sector.
Individual buyers across India are gaining rapid international exposure to new
building materials, designs styles and product applications. Keeping this in mind,
Orient Tiles is investing heavily in expanding its dealer network across India to
make its high quality products available at the best retail outlets. This will lead to
a direct increase in exposure of Orients brand to the individual home
owners/buyers who are in the market for world-class tiles.
Indias diverse demographics contribute to a huge market for attractive priced,
budget tiles. Orient is quickly capitalizing on this relatively untapped market by
expanding its product portfolio with the addition of outsourced tiles from Gujarat.
To stay ahead in the creative field of special design and effects, Orient with its
advances microprocessor controlled profile cutting technology to let their
designers create masterpieces that are worthy of anybodys imagination.
-
8/8/2019 Working Capital Mgmt at OCIL
18/98
-
8/8/2019 Working Capital Mgmt at OCIL
19/98
SWOT ANALYSIS OF ORIENT CERAMICS AND
INDUSTRIES LID.
STRENGTHS
The cost of production of tiles in India is 25-30 per cent lower compared with the
US and Europe, mainly owing to labour costs.
WEAKNESS
Among the major weaknesses identified are non-availability of standard raw
materials with uniform properties, manpower with low technical skills and limited
facilities for technical skills and for technical education in ceramics production.
OPPURTUNITIES AND THREATS
Ceramics industry in India could gain through the construction boom in India, and
the average growth rate of the ceramics sector at present stands at 12 per cent. A
growth rate of 15 per cent is expected within a few years.
Tourism in India has been growing at a fast pace. There is an increasing demand-
supply gap of hotel rooms both for regular and seasonal tourists and for event
specific visitors such as to the Commonwealth Games 2010.
This apart, Indian ceramics industry is highly fragmented with very few large
players and a big number of Small and Medium Enterprises (SMEs) face
problems of poor economies of scale.
Thirdly, unorganized tile sector in India accounts for 70% of the total production
in India, which in some way possess major threat to major players.
In spite of the odds, European players have invested in India in recent years and
plan to continue doing so. For European companies the time of market entry is
interesting as import duties have decreased and the trend is expected to continue.
-
8/8/2019 Working Capital Mgmt at OCIL
20/98
CHAPTER 3
DATA ANALYSIS
-
8/8/2019 Working Capital Mgmt at OCIL
21/98
FINANCIAL AND COMPARATIVE ANALYSIS
LIQUIDITY RATIO
Liquidity ratio measures the short-term solvency, i.e. the firms ability to pay its
current dues and also indicate the efficiency with which working capital is being
used. Commercial banks and short-term creditors may be basically interested in
the ratio under this group.
Current Ratio or Working Capital Ratio
Current Ratio is a relationship of current assets to current liabilities.
Current assets mean the assets that are either in the form of cash or cash
equivalents or can be converted into cash or cash equivalents in a short-time (say,
within a years time) like cash, bank balances, marketable securities, sundry
debtors, stock, bills receivable, prepaid expenses and short-term loans and
advances. Current Liabilities means liabilities repayable in a short time like
sundry creditors, bills payable, outstanding expenses and bank overdraft or cash
credit.
Computation: The ratio is calculated as follows:
Current Ratio = Current Assets
Current Liabilities
Objective: The objective of calculating current ratio is to assess the ability of the
enterprise to meet its short-term obligations promptly. In other words, it is used to
assess the short-term financial position of the enterprise. Hence, it indicates the
backing available to current liabilities in the form of current assets.
As such, higher the current ratio better will be the situation. It is generally
accepted that current assets should be two times the current liabilities, then only
will realization from current assets be sufficient to pay the current liabilities on
time and enable the firm to meet other day-to-day expenses. However, a blind
-
8/8/2019 Working Capital Mgmt at OCIL
22/98
comparison of actual current ratio with the standard current ratio, may lead to
unrealistic conclusions. A very high ratio indicates idleness of funds, poor
investment policies of the management and poor inventory control, while a low
ratio indicates lack of liquidity and shortage of working capital.
Current Ratio 2002 2003 2004 2005 2006
Orient Tiles 1.145 1.126 1.057 1.234 1.538
Kajaria Tiles 2.02 1.99 1.543 1.043 1.211
Somany Tiles 1.132 1.036 1.037 1.528 1.55
C urrent Rat i
0
0.5
1
1.5
2
2.5
2002 2003 2004 2005 2006
Year
Rat io
Orien
Kajar
Soma
Intra firm interpretation
Current ratio of Orient Ceramics is showing an increasing trend after witnessing a
decline in 2004.
Inter firm interpretationOrient tile has the highest current ratio while Kajaria tile is witnessing a
continuous decline over the last 5 years. Somany tile has the highest figure for the
year 2006.
-
8/8/2019 Working Capital Mgmt at OCIL
23/98
Quick Ratio or Acid-test Ratio
Quick ratio is a relationship of liquid assets with current liabilities. It is a fairly
stringent measure of liquidity.
Liquid assets are those assets which are either in the form of cash or cash
equivalents or can be converted into cash within a very short period. Liquid assets
are computed by deducting stock and prepaid expenses from total current assets.
Stock is excluded from liquid assets because it may take some time before it is
converted into cash. Similarly prepaid expenses do not provide cash at all and are
thus, excluded from liquid assets.
Computation: The ratio is calculated as under:
Liquid Ratio = Liquid Assets
Current Liabilities
Objective: The objective of computing liquid ratio is to assess the short-term debt
paying capacity of the firm. A part of the current assets are not readily realizable
or convertible into cash. Accordingly, the current ratio does not indicate
adequately the ability of the enterprise to discharge the current liabilities as and
when they fall due. Liquid ratio is considered as a refinement of current ratio asnon-liquid portion of current assets is eliminated to calculate the liquid assets.
Thus it is a better indicator of liquidity.
A higher liquidity ratio indicted that there is sufficient assets available with the
organization which can be converted in the form of cash almost immediately to
pay off current liabilities. Hence, higher the liquid ratio better will be the
situation. A quick ratio of 1:1 is considered standard and ideal, since for every
rupee of current liabilities, there is a rupee of quick assets. A decline in the liquid
ratio indicates over-trading, which, if serious, may land the company in
difficulties.
-
8/8/2019 Working Capital Mgmt at OCIL
24/98
Quick Ratio 2002 2003 2004 2005 2006
Orient Tiles 0.34 0.36 0.28 0.34 0.47
Kajaria Tiles 0.77 0.68 0.59 0.35 0.43
Somany Tiles 0.33 0.26 0.3 0.48 0.55
Q u i c k R
00 . 2
0 . 4
0 . 6
0 . 8
1
2 0 0 2 2 0 0 3 2 0 0 4 2 0 0 5 2 0 0 6
Y e a
R a t i
O r i e
K a j a
S o m
Intra firm interpretation
Quick ratio of Orient Tiles had decreased in 2004 but since then has been on the
rise. The year 2006 has the highest current ratio which also means that the
liquidity of the firm is increasing which is mainly due to the increase in sundry
debtors.
Inter firm interpretation
Somany Tiles has the highest quick ratio in the year 2006 and is expected to rise
in the future whereas for Kajaria Tiles the trend for the last 5 years shows a
considerable decline.
-
8/8/2019 Working Capital Mgmt at OCIL
25/98
Cash Ratio
Cash ratio is a relationship of cash and marketable securities to current liabilities.
Trade investment or marketable securities are equivalent of cash. Therefore,
they are included in the computation of cash ratio.
Computation: The ratio is calculated as follows:
Cash Ratio = Cash & Bank Balance + Marketable Securities
Current Liabilities
Objective: Since cash is the most liquid asset, an enterprise must have to keep a
high amount of cash and its equivalent to current liabilities.
Cash Ratio 2002 2003 2004 2005 2006
Orient Tiles 0.05 0.02 0.02 0.03 0.02
Kajaria Tiles 0.07 0.06 0.04 0.03 0.05
Somany Tiles 0.08 0.04 0.03 0.06 0.07
C a s h Ra
0
0.02
0.04
0.06
0.08
0 .1
20 02 2003 2 00 4 200 5 20 06
Yea
R a t i
O r i e n
K aja r
S o m
-
8/8/2019 Working Capital Mgmt at OCIL
26/98
Intra firm interpretation
Cash ratio is showing a decreasing trend. It is influenced by the decrease in cash
and bank balances and increase in current liabilities. Since the marketable
securities are nil it has no effect on the cash ratio.
Intra firm interpretation
Cash ratio for Somany Tiles is decreasing but it still has the highest cash ratio in
the year 2006. Orient Tiles has the lowest cash ratio of all the three companies.
-
8/8/2019 Working Capital Mgmt at OCIL
27/98
Net Working Capital Ratio
Net Working Capital is used as a measure of firms liquidity. The difference
between current assets and current liabilities excluding short-term bank
borrowings is called net working capital.
Computation: The ratio is calculates as follows:
Net Working Capital Ratio = Net Working Capital
Net Assets
Net WorkingCapital Ratio 2002 2003 2004 2005 2006
Orient Tiles 0.15 0.13 0.06 0.23 0.35
Kajaria Tiles 1.02 1.00 0.54 0.04 0.21
Somany Tiles 0.13 0.04 0.04 0.53 0.56
N e t W o r king C a p it al
0
0.2
0.4
0.6
0.8
11.2
2002 2003 2004 2005 2006
Y e a r
R a t i
O r i e
K aj a
Soma
-
8/8/2019 Working Capital Mgmt at OCIL
28/98
Intra firm interpretation
The net working capital ratio had decreased to 0.06 in 2004 but then has risen
sharply to 0.35 by the end of financial year 2006.
Inter firm interpretation
Somany Tiles has the highest net working capital ratio which indicates that in
comparison to the other two companies it has a greater ability to meet its current
obligations.
-
8/8/2019 Working Capital Mgmt at OCIL
29/98
LEVERAGE/SOLVENCY RATIO
The term solvency implies ability of an enterprise to meet its long-term
indebtedness and thus, solvency ratios convey the long-term financial prospects of
the company. The shareholders, debenture-holders and other lenders of long-term
finance/term loans may be basically interested in the ratio falling under this
group. Following are the different solvency ratios:
Debt-Equity Ratio
The debt-equity ratio is worked out to ascertain soundness of the long-term
financial policies of the firm. This ratio expresses a relationship between debt
(external equity) and the equity (internal equity).
Debt means long-term loans, i.e. debentures, public deposits, loans (long term)
from financial institutions. Equity means shareholders funds, i.e. preference
share capital, equity share capital, reserves less losses and fictitious assets like
preliminary expenses.
Computation: The ratio is calculated as follows:Debt-Equity Ratio = Long-term Debt
Shareholders Equity
Objective: The objective of debt-equity ratio is to arrive at an idea of the amount
of capital supplied to the concern by the proprietors and of asset cushion or
cover available to its creditors on liquidation of the organization. This ratio is
sufficient to assess the soundness of long-term financial position. It also indicates
the extent to which the firm depends upon outsiders for its existence. In other
words, it portrays the proportion of total funds acquired by a firm by way of
loans.
-
8/8/2019 Working Capital Mgmt at OCIL
30/98
-
8/8/2019 Working Capital Mgmt at OCIL
31/98
Intra firm interpretation
Debt equity ratio of the firm is showing a decreasing trend. The ratio is decreasing
due to decrease in secured loans and also due to increase in equity. In 2002, the
firm had satisfactory debt equity ratio but since now it is decreasing the firm can
afford to take more debts, without taking much risk.
Inter firm interpretation
Of all the three companies Somany Ceramics has the highest debt equity ratio i.e.
2.41:1 as compared to Orient ceramics and Kajaria Ceramics which means that
Orient ceramics and Kajaria ceramics can afford to take debt more freely and
without taking much risk as compared to Somany Ceramics Ltd.
-
8/8/2019 Working Capital Mgmt at OCIL
32/98
Debt Ratio
Debt ratio is a relationship of Debt of a firm to its Capital Employed.
Computation: This ratio is calculated as follows:
Debt Ratio = Total Debt
Capital Employed
Objective: This ratio shows the proportion of interest bearing debt (also called
funded debt) in the capital structure.
Debt Ratio 2002 2003 2004 2005 2006
Orient 1.47 1.54 1.56 1.56 1.63
Kajaria 1.67 1.79 1.79 1.8 1.76
Somany 1.61 1.52 1.51 1.45 1.44
D e b t R a
0
0 . 5
1
1 . 5
2
2 0 0 2 2 0 0 3 2 0 0 4 2 0 0 5 2 0 0 6
Y e a
R a t i
O r i e
K a j a
S o m
-
8/8/2019 Working Capital Mgmt at OCIL
33/98
Intra firm interpretation
This ratio is showing an increasing trend due to decrease in net working capital of
the firm. In 2002 there was 47% debt in the capital structure which has now
increased to 63%.
Inter firm interpretation
Kajaria ceramics has the highest debt ratio as compared to its competitors which
means that it has maximum funded debt in its capital structure where as Somany
ceramics has the minimum funded debt in its capital structure as compared to its
competitors.
-
8/8/2019 Working Capital Mgmt at OCIL
34/98
-
8/8/2019 Working Capital Mgmt at OCIL
35/98
Interest Cover age Rati
0
1
2
3
4
2002 2003 2004 2005 2006
Year
Ratio
Orien
Kajari
Soman
Intra firm interpretation
It can be seen that the companys interest coverage ratio is just about satisfactory
and it is expected to rise further in the coming years, which is a good indicator for
the company. This ratio though is not very appropriate measure of interest
coverage because the source of interest payment is the cash flow before the
interest and taxes, not the profit before interest and taxes. This indicates that the
cash available for repayment of the interest will be more than the profit, as
depreciation will also be added in profit (because it is a non-cash expense).
Inter firm interpretation
Of all the four companies Kajaria ceramics has the highest interest coverage ratio
whereas Somany ceramics has the lowest.
-
8/8/2019 Working Capital Mgmt at OCIL
36/98
ACTIVITY (TURNOVER OR PERFORMANCE) RATIO
Turnover indicates the speed with which capital employed is rotated in the
process of doing business. Activity ratio measures the effectiveness with which a
concern uses resources at its disposal. The following are the important activity
(turnover or performance) ratios:
Inventory Turnover Ratio
Inventory turnover ratio indicates the efficiency of the firm in producing and
selling its product.
Computation: The ratio is calculated as follows:
Inventory Turnover Ratio = Cost of Goods Sold
Average Inventory
Objective: This ratio indicates the efficiency of management in turning over the
company's inventory and can is often used to compare with other companies in
the same field.
InventoryTurnover Ratio 2002 2003 2004 2005 2006
Orient 6.33 5.33 4.59 4.3 4.76
Kajaria 5.22 5.07 5.76 6.28 6.07
Somany 4.29 3.6 3.55 3.48 3.96
-
8/8/2019 Working Capital Mgmt at OCIL
37/98
Invento ry T urnover R
0
1
2
3
4
5
6
7
2002 2003 2004 2005 2006
Year
R a t i
Orie
Kajar
Soma
Intra firm interpretation
The ratio (no. of times) had the highest figure in 2002 which was indicative of a
good inventory management as compared to its competitors in the same year.
Now in 2006, the figure is increasing indicating the increase in efficiency in the
management of the inventory. This shows that the company is having sufficient
amount of sales.
Inter firm interpretation
Kajaria ceramics has the highest inventory turnover ratio and Somany ceramics
has the lowest. This indicates that Kajaria ceramics has the most efficient
inventory management system as compared to its other two competitors.
-
8/8/2019 Working Capital Mgmt at OCIL
38/98
Inventory Holding Period
When the number of days in a year (taken as 360) is divided by the inventory
turnover ratio, we obtain Inventory Holding Period.
Computation: The ratio is calculated as follows:
Inventory Holding Period = 360
Inventory Turnover
Objective: It shows how rapidly the inventory is turning into receivables through
sales. A high inventory turnover is indicative of good inventory management.
InventoryHolding Period 2002 2003 2004 2005 2006
Orient 56.87 67.54 78.43 83.72 75.63
Kajaria 68.96 71 62.5 57.32 59.3
Somany 83.91 100 101.4 103.44 90.9
Inventory Holding Period
0
20
40
60
80
100
120
2002 2003 2004 2005 2006
Year
No. of Days
Ori ent
Kajari
Soman
-
8/8/2019 Working Capital Mgmt at OCIL
39/98
-
8/8/2019 Working Capital Mgmt at OCIL
40/98
Debtors Turnover Ratio
When a firm extends credit to its customers, debtors are created. The liquidity
position of the firm depends on the quality of the debtors to a great extent.
Computation: This ratio is calculated a follows:
Debtors Turnover Ratio = Credit Sales
Average Debtors
Objective: It indicates the number of times debtors turnover each year. The higher
the value of debtors turnover, the more efficient is the management of credit.
Debtor TurnoverRatio 2002 2003 2004 2005 2006
Orient 9.41 8.42 7.79 7.66 7.11
Kajaria 4.69 5.12 5.67 6.54 7.6
Somany 10.15 9.22 8.89 7.62 7.6
Debtors Turnover Rat i
0
2
4
6
8
10
12
2002 2003 2004 2005 2006
Year
Ratio
Orient
Kajari
Soman
-
8/8/2019 Working Capital Mgmt at OCIL
41/98
Intra firm interpretation
Higher value of debtor turnover is indicative of efficient management of credit.
However, for the firm the value is continuously declining over the past 5 years
suggesting that the firm has a lenient policy of credit which has resulted in this
decline.
Inter firm interpretation
Among the three, only Kajaria ceramics has witnessed an increase every year as a
result of better credit granting policies given to its customers and this trend is
expected to increase further. It is only for the other two companies that the figure
has declined every year.
-
8/8/2019 Working Capital Mgmt at OCIL
42/98
-
8/8/2019 Working Capital Mgmt at OCIL
43/98
Intra firm interpretation
The firm should try to reduce its debtors holding period which is slightly high. By
this the funds which are blocked with the customers, and hence are becoming idle,
can be reduced and that the money can be utilized for other profitable purposes.
Inter firm interpretation
Kajaria and Somany have a satisfactory holding period that indicates that not
much of funds are blocked with the customers in comparison to the other
company. Both these companies share the same holding period. Secondly, only
Kajaria ceramics seems to bring down this value by a constant rate every year
indicating an effective credit policy.
-
8/8/2019 Working Capital Mgmt at OCIL
44/98
Fixed Assets Turnover Ratio
Computation: The ratio is calculated as follows:
Fixed Assets Turnover Ratio = Sales
Net Assets
Fixed Assets include net fixed assets, i.e. fixed assets after providing for
depreciation.
Fixed AssetTurnover Ratio 2002 2003 2004 2005 2006
Orient 0.94 0.86 0.89 0.94 1.07
Kajaria 0.87 0.9 0.97 0.92 0.94
Somany 0.9 0.83 0.82 0.79 0.96
F i x e d A ss e t s T u r n o v e r
0
0.5
1
1.5
2002 2003 2004 2005 2006
Y ea
R a t i
O r i e
K a ja
Soma
-
8/8/2019 Working Capital Mgmt at OCIL
45/98
Current Assets Turnover Ratio
Computation: This ratio is calculated as follows:
Current Assets Turnover Ratio = Net Sales
Current Assets
Current AssetTurnover Ratio 2002 2003 2004 2005 2006
Orient 2.59 2.23 2.21 1.96 1.96
Kajaria 1.87 1.94 2.15 2.47 2.39
Somany 2.22 2.19 2.3 2.09 2.17
C urrent A ssets T urnover R ati
0
0.5
1
1.5
2
2.5
3
2002 2003 2004 2005 2006Year
Ratio
Orien
Kajari
Soma
Objective: A high assets turnover ratio (fixed assets and current assets) indicates
the capability of the organization to achieve maximum sales with the minimum
investment in assets. It indicates that the assets are turned over in the form of sales
more number of times. As such, higher the ratio better will be the situation.
Intra firm interpretation
Fixed asset turnover has increased in comparison to last year. It is mainly due to
increase in sales, and also due to the decrease in fixed assets. For current assets
turnover the ratio has marginally decreased. However it indicates that the firm is
-
8/8/2019 Working Capital Mgmt at OCIL
46/98
able to achieve maximum sales with minimum investment in the assets and the
assets are turned over in the form of sales more number of times.
Inter firm interpretation
Orient ceramics have the highest fixed assets turnover whereas Kajaria ceramics
have the highest current assets turnover in comparison to its competitors.
-
8/8/2019 Working Capital Mgmt at OCIL
47/98
PROFITABILITY RATIO
Profit as compared to the capital employed indicates profitability of the concern.
A measure of profitability is the overall measure of efficiency. The different
profitability ratios are as follows:
Gross Profit Ratio
The gross profit ratio establishes the relationship of gross profit on sales to net
sales of a firm, which is calculated in percentage.
Gross Profit is the difference between net sales on one hand and either of the
following on the other hand:
a) Manufacturing cost or factory cost or production cost in case of
manufacturing concerns.
b) Cost of purchase, expenses directly related to purchase and the
adjustments for stock variations if any, in case of trading concerns.
Computation: This ratio is calculated by the following formula:
Gross Profit Ratio = Gross Profit x 100
Net Sales
Objective: Gross Profit ratio is a reliable guide to the adequacy of selling prices
and efficiency of trading activities. This ratio should be adequate to cover the
administration and marketing expenses and to provide for fixed charges,
dividends and building up of reserves. Following are the objectives of calculating
this ratio:
a) To determine the selling price so that there is adequate gross profit to
cover the operating expenses, fixed charges, dividends and building to
reserves.
b) To determine how much the selling price per unit may decline without
resulting in losses on operations of the firms.
-
8/8/2019 Working Capital Mgmt at OCIL
48/98
c) Gross Profit Ratio, when compared to earlier years, if significantly
different is a reason for the management to investigate the change.
A high gross profit ratio may indicate that the organization is able to produce or
purchase at a relatively lower cost. As such, a higher ratio will be desirable.
Gross ProfitRatio 2002 2003 2004 2005 2006
Orient 13% 14.35% 11.21% 12.64% 12.8%
Kajaria 6.98% 9.68% 11.32% 15.36% 15.42%
Somany 7.51% 3.43% 3.43% 4.74% 6.01%
G r o s s P r o f i t M
0
5
10
15
20
2002 2003 2004 2005 2006
Y e a
P e r c e n t
Or ie
K aj a
Soma
Intra firm interpretation
The gross profit ratio for the year ending March 2006 has increased as compared
to the last two years. This is due to the fact that the company now has a 100%utilization rate of its production plant as compared to 97% a year ago. It is
expected that the gross profit ratio will increase very significantly in the coming
years.
-
8/8/2019 Working Capital Mgmt at OCIL
49/98
Inter firm interpretation
Kajaria ceramics has the highest gross profit ratio as compared to Orient and
Somany ceramics respectively which indicates that the operating expenses of
Kajaria ceramics is less. Thus Orient and Somany ceramics should try to increase
its gross profit ratio.
-
8/8/2019 Working Capital Mgmt at OCIL
50/98
Net Profit Ratio
The net profit ratio establishes the relationship between net profit and net sales,
expressed in percentage form.
Net Profit is derived by deducting administrative expenses and marketing
expenses, finance charges and making adjustments for non-profit expenses and
incomes.
Computation: This ratio is calculated as follows:
Net Profit Ratio = Profit after tax x 100
Net Sales
Objective: The net profit ratio determines the overall efficiency of the firm.
Net Profit Margin 2002 2003 2004 2005 2006
Orient 3.07% 2.57% 1.77% 2.98% 3.11%
Kajaria 1.15% 4.15% 5.02% 8.49% 8.01%
Somany 2.16% -1.2% -0.82% -0.56% 1.08%
Net Profit Margin
-2
0
2
4
6
8
10
2002 2003 2004 2005 2006
Year
Per centage
Ori ent
Kajari
Somany
-
8/8/2019 Working Capital Mgmt at OCIL
51/98
Intra firm interpretation
Net profit ratio has increased significantly over the last two years. The reason for
this being that the company has achieved 100% production efficiency of its plant.
This ratio is expected to rise in the coming years as the firm expects higher net
sales and high increase in profit in the fiscal 2007.
Inter firm interpretation
Of all the three companies Kajaria ceramics seems to increase its net profit
margin drastically which however went down a little in 2006. It can also be
noticed that the percentage change in net profit ratio is more than the percentage
change in the gross profit ratio which however indicates that for the company
apart from raw materials other expenses have also increased. Somany ceramics
registered a sharp decline in 2003 and continued to remain so till 2005.
-
8/8/2019 Working Capital Mgmt at OCIL
52/98
Return on Equity (ROE)
Computation: This ratio is calculated as follows:
Return on Equity = Profit after Tax
Shareholders Equity
Objective: ROE is calculated to see the profitability of the owners investments.
Return onEquity 2002 2003 2004 2005 2006
Orient 9.12% 11.13% 15.48% 9.09% 8.24%
Kajaria 31.35% 9.10% 7.30% 4.65% 4.81%
Somany 14.77% -16.44% -31.95% -26.63% 16.29%
Return On Equity
-40
-30
-20
-10
0
10
20
30
40
2002 2003 2004 2005 2006
Year
Percentage
Orient
Kajaria
Soman
Intra firm interpretation
ROE has been on a decline since 2005, which indicates that the firm is not using
resources effectively. Since this ratio is of great interest to the present and
prospective shareholders and also of great concern to the management that has the
responsibility to maximize the owners welfare.
-
8/8/2019 Working Capital Mgmt at OCIL
53/98
Inter firm interpretation
Somany ceramics after a relatively poor performance for the past three
consecutive years has registered a stupendous growth indicating the efficiency in
managing the resources. On the other hand, Kajaria ceramics have the lowest
ratio.
-
8/8/2019 Working Capital Mgmt at OCIL
54/98
Return on Capital Employed (ROCE)
Return on Capital Employed measures the profitability of the capital employed in
the business. A high ROCE indicates a better and profitable use of long term
funds of owners and creditors. As such, a high ROCE will always be preferred.
Computation: The ratio is calculated as:
Return on Capital Employed = Profit after tax + Interest on fixed liabilities x 100
Capital Employed
Return on
CapitalEmployed 2002 2003 2004 2005 2006
Orient 14.48 13.37 7.91 11.34 15.81
Kajaria 11.39 13.66 15.22 18.02 16.75
Somany 10.06 5.18 5.45 6.54 9.72
R e tur n o n C a p i t al E
0
5
10
15
20
2002 2003 2004 2005 2006
Y e a
R a t i o ( i n
Or i
K aj
Som
-
8/8/2019 Working Capital Mgmt at OCIL
55/98
Intra firm interpretation
Return on Capital Employed shows an increasing trend due to increase in PBIT
(profit before interest and tax). It is expected to grow significantly for the year
2006-07. As such, a high ROCE is always preferred as it increases the value of
capital employed by the firm for its business operations.
Inter firm interpretation
Barring Kajaria ceramics, the other two firms are showing increasing trend due to
increase in their PBIT respectively. Orient ceramics has the highest ROCE
followed by Somany and Kajaria respectively.
-
8/8/2019 Working Capital Mgmt at OCIL
56/98
Earnings Per Share
EPS is a widely used ratio to measure the profits available to the equity
shareholders on a per share basis. EPS is calculated on the basis of current profit
and not on the basis of retained profits.
Computation: The ratio is calculated as follows:
Earnings Per Share = Profit After Tax (PAT)
No. of Equity Shares
Objective: As such, increasing EPS may indicate the increasing trend of current
profits per equity shares. However, EPS does not indicate how much of the
earnings are paid to the owners by the way of dividends and how much of the
earnings are retained in the business.
Earnings PerShare 2002 2003 2004 2005 2006
Orient 6.54 5.47 4 7.44 9.06
Kajaria 1.79 6.6 8.94 16.83 3.73
Somany 6.43 0 0 0 4.49
Earnings Per Shar
0
5
10
15
20
2002 2003 2004 2005 2006
Year
Orient
Kajari
Soman
-
8/8/2019 Working Capital Mgmt at OCIL
57/98
Intra firm interpretation
Earnings per Share has shown a steep rise which is mainly due to increase in
profits offered to shareholders on a per share basis or increase in retained earnings
in the business. Therefore the firm should try to continue with its increase in EPS.
Intra firm interpretation
Kajaria Ceramics has shown the sharpest decline in EPS as compared to its other
two competitors. Since Somany ceramics posted a net loss for three consecutive
years therefore EPS is zero. Orient ceramics is able to maintain its increasing
trends.
-
8/8/2019 Working Capital Mgmt at OCIL
58/98
CONCEPTS OF WORKING CAPITAL
There are two concepts of Working Capital Gross and Net.
Gross Working Capitalrefers to the firms investment in current assets. Current
Assets are the assets which can be converted into cash within an accounting year
and include cash, short-term securities, debtors, bills receivable (accounts
receivable or book debt) and stock (inventory).
Net Working Capitalrefers to the difference between Current Assets and Current
Liabilities. Current Liabilities are those claims of outsiders, which are expected to
mature for payment within an accounting year, and include creditors (accounts
payable), bills payable and outstanding expenses. Net working capital can be
positive or negative. A positive net working capital will arise when current assets
exceed current liabilities. A negative new working capital occurs when current
liabilities are in excess of current assets.
Focusing on management of Current Assets
The gross working capital concept focuses attention on two aspects of current
assets management:
1. How to optimize investment in Current Assets?
2. How should Current Assets be financed?
The consideration of the level of investment in current assets should avoid two
danger points excessiveorinadequate investments in current assets. Investment
in current assets should be just adequate to the needs of the business firm.
Excessive investment in current assets should be avoided because it impairs the
firms profitability, as idle investment earns nothing. On the other hand,
inadequate amount of working capital can threaten the solvency of the firm
-
8/8/2019 Working Capital Mgmt at OCIL
59/98
because of its inability to meet its current obligations. It should be realized that
the working capital needs of the firm may be fluctuating with changing business
activity. The management should be prompt to initiate an action and correct
balances.
Another aspect of the gross working capital points to the need of arranging funds
to finance current assets. Whenever a need for working capital fund arises due to
the increasing level of business activity or for any other reason, financing
arrangements should be made quickly. Similarly, if suddenly, some surplus funds
arise they should not be allowed to remain idle, but should be invested in short
term securities. Thus, the financial manager should have knowledge of the
sources of working capital funds as well as investment avenues where idle funds
may be temporarily invested.
Focusing on management of Liquidity
Net working capital is a qualitative concept. It indicated the liquidity position of
the firm and suggests the extent to which working capital needs may be financed
by permanent sources of funds. Current assets should be sufficiently in excess of
current liabilities to constitute margin or buffer for maturing obligations within
the ordinary operating cycle of business. In order to protect their interests, short-
term creditors always like a company to maintain current assets twice the level of
current liabilities. However, the quality of current assets should be considered in
determining the level of current assets vis--vis current liabilities. A weak
liquidity position posses a threat to the solvency of the company and makes it
unsafe and unsound. A negative working capital means a negative liquidity, and
may be harmful for the companys reputation. Excessive liquidity is also bad it
may be due to mismanagement of current assets. Therefore, prompt and timely
action should be taken by the management to improve and correct the imbalances
in the liquidity position of the firm.
-
8/8/2019 Working Capital Mgmt at OCIL
60/98
-
8/8/2019 Working Capital Mgmt at OCIL
61/98
OPERATING AND CASH CONVERSION CYCLE
A firm should aim at maximizing the wealth of its shareholders, so the firm
should earn sufficient returns on its operations. Earning a steady amount of profit
requires successful sales activity. The firm has to invest enough funds in current
assets for generating sales. Current assets are needed because sales do not convert
into cash instantaneously. There is always an Operating Cycle involved in the
conversion of sales into cash.
There is difference between current and fixed assets in terms of their liquidity. A
firm requires many years to recover the initial investment in fixed assets such as
plant and machinery or land and building. On the contrary, investment in current
assets is turned over many times a year. Investment in current assets such as
inventories and debtors (accounts receivables) is realized during the firms
operating cycle that is usually less than one year.
Operating cycle is the time duration required to convert sales, after the conversion
of resources into inventories, into cash.
The operating cycle of manufacturing company involves three phases:
Acquisition of resources such as raw material, labour, power and fuel.
Manufacture of the product which includes conversion of raw materials
into work-in-progress into finished goods.
Sale of the producteither for cash or on credit. Credit sales create account
receivable for collection.
These phases affect cash flows, which most of the time, are neither synchronized
nor certain. They are not synchronized because cash flows usually occur before
cash inflows. Cash inflows are uncertain because sales and collections which give
rise to cash inflows are difficult to forecast accurately. Cash outflows, on the
-
8/8/2019 Working Capital Mgmt at OCIL
62/98
other hand, are relatively certain. The firm is, therefore, required to invest in
current assets for smooth, uninterrupted functioning. It needs to maintain liquidity
to purchase raw materials and pay expenses such as wages and salaries, other
manufacturing, administrative and selling expenses and taxes as there is hardly a
matching between cash inflows and outflows. Cash is also held to meet any future
exigencies. Stock of raw materials and work-in-progress are kept to ensure
smooth production and to guard against non-availability of raw material and other
components. The firm holds stock of finished goods to meet the demand of
customers on continuous basis and sudden demand from some customers. Debtors
are created because goods are sold on credit for marketing and competitive
reasons. Thus, a firm makes adequate investment in inventories, and debtors, for
smooth, uninterrupted production and sale.
Length of Operating Cycle
The length of the operating cycle can be calculated in two ways:
a) Gross Operating Cycle
b) Net Operating Cycle
a) Gross Operating Cycle
The Gross Operating Cycle of a manufacturing concern is the sum of Inventory
Conversion Period and Debtor (receivable) Conversion Period. Thus, Gross
Operating Cycle is given as follows:
Gross Operating Cycle = Inventory Conversion Period + Debtors Conversion Period
Inventory Conversion Period is the total time needed for producing and selling the
product. It is the sum of (1) raw material conversion period (2) work-in-progress
conversion period (3) finished goods conversion period.
-
8/8/2019 Working Capital Mgmt at OCIL
63/98
Raw Material Conversion Period it is the average time period taken to
convert material into work-in-progress. Raw material conversion period
depends on (a) raw material consumption per day, and (b) raw material
inventory. Raw material consumption per day is given by the total raw
material consumption divided by the number of days in the year (say 360).
The raw material conversion period is obtained when raw material inventory
is divided by raw material consumption per day.
Raw Material Conversion Period = Raw Material Inventory
[Raw Material Consumption] /360
Work-in-progress Conversion Period it is the average time taken to
complete the semi-finished or work-in-process. It is given by the following
formula:
Work-in-process Conversion Period = Finished Goods Inventory
[Cost of Production] / 360
Finished Goods Conversion Period it is the average time taken to sell
the finished goods. It can be calculated as follows:
Finished Goods Conversion Period = Finished Goods Inventory
[Cost of goods sold] / 360
Debtors Conversion Period it is the average time taken to convert debtors
into cash. It represents the average collection period. It is calculated as
follows:
Debtors Conversion Period = Debtors
[Credit sales] / 360
-
8/8/2019 Working Capital Mgmt at OCIL
64/98
b) Cash Conversion or Net Operating Cycle
Net operating cycle is the difference between Gross Operating Cycle and
Creditors (payables) Deferral period.
Credit Deferral Period it is the average time taken by the firm in paying its
suppliers. It is calculated as follows:
Creditors Deferral Period = Creditors
[Credit Purchases] / 360
In practice, a firm may acquire resources (such as raw materials) on credit and
temporarily postpone payment of certain expenses. Payables, which a firm can
defer, are Spontaneous Sources of Capital to finance investment incurrent
assets, the Creditors Deferral Period is the length of time the firm is able to defer
payments n various resource purchases.
Net Operating Cycle is also referred to as Cash Conversion Cycle. It is the net
time interval between cash collections for sale of the product and cash payments
for resources acquired by the firm. It also represents the time interval over which
additional funds, called working capital, should be obtained in order to carry out
the firms operations. The firm has to negotiate working capital from sources such
as commercial banks. The negotiated sources of working capital financing are
called Non-spontaneous sources. If net operating cycle of a firm increases, it
means further need for negotiated working capital.
There are two ways of calculation of cash conversion cycle. One is that
depreciation and profit should be excluded in the computation of cash conversion
-
8/8/2019 Working Capital Mgmt at OCIL
65/98
cycle since the firms concern is with cash flows associated with conversion are
cost; depreciation is a non-cash item and profits are not costs.
A contrary view is that a firm has to ultimately recover total costs and make
profits; therefore the calculation of operating cycle should include depreciation,
and even the profits.
The above operating cycle concepts related to a manufacturing firm. Non-
manufacturing firms such as wholesalers and retailers will not have the
manufacturing phase. They will acquire stock of finished goods and convert them
into debtors and debtors into cash. Further, service and financial enterprises will
no have inventories of goods (cash will be their inventory). Their operating cycles
will be the shortest. They need to acquire cash, then lend (create debtors) and gain
convert lending into cash.
-
8/8/2019 Working Capital Mgmt at OCIL
66/98
Determinants of Working Capital
Nature of Business
The working capital requirement of the firm is closely related to the nature of its
business. A service firm, like an electricity undertaking or a transport corporation,
which has a short operating cycle and which sells predominantly on cash basis,
has a modest working capital requirement. On the other hand, a manufacturing
concern like a machine tools unit, which has a long operating cycle and which
sells largely on credit, has a very substantial working capital requirement.
Seasonality of Operations
Firms, which have marked seasonality in their operations usually, have high
fluctuating working capital requirements. If the operations are smooth and even
through out the year the working capital requirement will be constant and will not
be affected by the seasonal factors.
Production Policy
A firm marked by pronounced seasonal fluctuations in its sales may pursue a
production policy, which may reduce the sharp variations in working capital
requirements.
Market Conditions
The market competitiveness has an important bearing on the working capital
needs of a firm. When the competition is keen a large inventory of finished goods
is required to promptly serve customers which may not be inclined to wait
because other manufacturers are ready to meet their needs. In view of competitive
conditions prevailing in the market, the firm may have to offer liberal credit terms
to the customers resulting in higher debtors. Thus, the capital requirements tend to
be high because of greater investment in finished goods inventory and accounts
receivable. On the other hand, a monopolistic firm may not require larger working
-
8/8/2019 Working Capital Mgmt at OCIL
67/98
capital. It may ask customer to pay in advance or to wait for some time after
placing the order.
Condition of Supply
The time taken by the supplier of raw material, goods, etc. after placing an order,
also determines the working capital requirement. If goods as soon as or in a short
period after placing an order, then the purchaser will not like to maintain a high
level of inventory of that good. Otherwise, larger inventories should kept e.g. in
case of imported goods.
Business Cycle Fluctuations
Different phases of business cycle i.e. boom, recession etc. also affect the working
capital requirement. In case of recession period there is usually dullness in
business activities and there will be an opposite effect on the level of working
capital requirement. There will be a fall in inventories and cash requirement etc.
Credit Policy
The credit policy means the totality of terms and conditions on which goods are
sold and purchased. A firm has to interact with two types of credit policies at a
time. One, the credit policy of the supplier of raw materials, goods, etc., and two,
the credit policy relating to credit which it extends to its customers. In both the
cases, however, the firm while deciding the credit policy has to take care of the
credit policy of the market. For example, a firm might be purchasing goods and
services on credit terms but selling goods only for cash. The working capital
requirements of this firm will be lower than that of a firm, which is purchasing
cash but has to sell on credit basis.
Operating Cycle
Time taken from the stage when cash is put into the business up to the stage when
cash is realized. Thus, the working capital requirement of a firm is determined by
a host of factors. Every consideration is to be weighed relatively to determine the
-
8/8/2019 Working Capital Mgmt at OCIL
68/98
working capital requirement. Further, the determination of working capital
requirement is not once a while exercise; rather a continuous review must be
made in order to assess the working capital requirement in the changing situation.
There are various reasons, which may require the review of the working capital
requirement e.g., change in credit policy, change in sales volume, etc.
Issues in Working Capital Management
Working capital management refers to the administration of all components of
working capital cash, marketable securities, debtors (receivables), and stock
(inventories) and creditors (payables). The financial manager must determine
levels and composition of current assets. He must see that right resources are
tapped to finance current assets, and that current liabilities are paid in time.
There are many aspects of Working capital management which make it an
important function of the financial manager.
Time working capital management requires much of the financial
managers time. Investment working capital represents a large portion of the total
investment in assets. Actions should be taken to curtail unnecessary
investment in current assets.
Criticality - working capital management has great significance for all
firms but it is very critical for small firms. Small firms in India face a
severe problem if collecting their dues debtors. Further, the role of current
liability is more significant in case of small firms as, unlike large firms,
they face difficulty in raising long-term finances.
Growth the need for working capital is directly related to the firms
growth. As sales grow, the firm needs to invest more in inventories and
debtors. Continuous growth in sales may also require additional
investment in fixed assets.
-
8/8/2019 Working Capital Mgmt at OCIL
69/98
Liquidity vs. Profitability; Risk-Return Trade-off
A larger investment in current assets under certainty would mean a low rate of
return on investment for the firm, as excess investment in current assets will not
earn enough return. A smaller investment in current assets, on the other hand,
would mean interrupted production and sales, because of frequent stock-outs and
inability to pay creditors in time due to restrictive policy.
Given a firms technology and production policy, sales and demand conditions,
operating efficiency etc., its current assets holdings will depend upon its working
capital policy. It may follow a conservative or an aggressive policy. These
policies involve risk-return trade-offs. A conservative policy means lower return
and risk, while an aggressive policy produces higher return and risk.
The two important aims of the Working capital management are:profitability and
solvency, used in the technical sense, refers to the firms continuous ability to
meet maturing obligations. If the firm maintains a relatively large investment in
current assets, it will have no difficulty in paying claims of creditors when they
become due and ill be able to fill all sales orders and ensure smooth production.
Thus, a liquid firm has less risk of insolvency; that is, it will hardly experience a
cash shortage or a stock-out situation. However, there is a cost associated with
maintaining a sound liquidity position. A considerable amount of the firms funds
will be tied up in current assets, and to the extent this investment is idle, the firms
profitability will suffer.
To have higher profitability, the firm may sacrifice solvency and maintain a
relatively low level of current assets. When the firm does so, its profitability will
improve as fewer funds are tied up in idle current assets, but its solvency would
be threatened and would be exposed to greater risk of cash shortage and stock-
outs.
-
8/8/2019 Working Capital Mgmt at OCIL
70/98
Estimating Working Capital Needs
Current Assets Holding Period: To estimate working capital requirements
on the basis of average holding period of current assets and relating them to
costs based on the companys experience in the precious years. This method is
essentially based on the operating cycle concept.
Ratio of Sales: To estimate working capital requirements as a ratio of sales
on the assumption that current assets change with sales.
Ratio of Fixed Investments: To estimate working capital requirements as a
percentage of fixed investment.
Policies for Financing Fixed Assets
A firm can adopt different financing policies vis--vis current assets. Three types
of financing may be distinguished:
Long-term Financing: The sources of long term financing include
ordinary share capital, preference share capital, debentures, long-term
borrowings from financial institutions and reserves and surplus (retainedearnings).
Short-term Financing: The short-term financing is obtained for a short
period less than one year. It is arranged in advance from banks and other
suppliers of short-term finance in the money market. It includes working
capital funds of banks, public deposits, commercial papers, factoring of
receivables etc.
Spontaneous Financing: It refers to the automatic sources of short-term
funds arising in the normal course of a business. Trade (suppliers) credit and
outstanding expenses are examples of spontaneous financing.
-
8/8/2019 Working Capital Mgmt at OCIL
71/98
The real choice of financing current assets, once the spontaneous financing have
been fully utilized, is between the long-term and short-term sources of finance.
Depending on the mix of short-term and long-term financing, the approach
followed by a company may be referred to as:
Matching Approach
Conservative Approach
Aggressive Approach
Matching Approach
The firm following matching approach (also known as Hedging approach) adopts
a financial plan which matches the expected life of the sources of funds raised to
finance assets. For e.g., a ten-year loan may be raised to finance a plant with an
expected life of ten years. The justification for the exact matching is that, since
the purpose of financing is to pay for assets, the source of financing and the assets
should be relinquished simultaneously. Using long-term financing for short-term
assets is expensive, as funds will not be utilized for the full period. Similarly,
financing long-term assets with short-term financing is costly as well as
inconvenient as arrangement for the new short-term financing will have to be
made on a continuing basis.
-
8/8/2019 Working Capital Mgmt at OCIL
72/98
-
8/8/2019 Working Capital Mgmt at OCIL
73/98
Aggressive Approach
An aggressive policy is said to be followed by the firm when it uses more short-
term financing than warranted by the matching plan. The firm finances a part of
its permanent current assets with short-term financing. The relatively more use of
short-term financing makes the firm more risky.
-
8/8/2019 Working Capital Mgmt at OCIL
74/98
THE OPERATING CYCLE AND WORKING CAPITAL
The working capital management of a firm depends, to a great extent up on the
operating cycle of the firm. The operating cycle may be defined as the time
duration starting from the procurement of goods or raw materials and ending with
the sales realization. The length and nature of the operating cycle may differ from
one firm to another depending on the size and nature of the firm.
The investment in working capital is influenced by four key events in the
production and sales form:
Purchase of raw materials
Payment of raw materials
Sale of finished goods
Collection of cash for sales
(Source: http://www.ediindia.org/)
http://www.ediindia.org/http://www.ediindia.org/ -
8/8/2019 Working Capital Mgmt at OCIL
75/98
Operating Cycle Period: the firm begins with the purchase of raw material,
which are paid for after a delay, which represents the accounts payable period.
The firm converts raw material into finished goods and then sell the same. The
time that, elapses between the purchase of raw material and the collection of cash
for the sales is referred to as the operating cycle. The length or time duration of
the operating cycle of any firm can be defined as the sum of its inventory
conversion period and the receivable conversion period.
1. Inventory Conversion Period (ICP): The time tag between the purchase of
raw material and sale of finished goods is the inventory conversion period. In
the manufacturing firm the ICP consists of Raw Material Conversion Period
(RMCP), Work-in-Process Conversion Period (WPCP), and the Finished
Goods Conversion Period (FGCP). RMCP refers to the period for which the
raw material is generally kept in stores before it is used to the production
department. The WPCP refers to the period for which the raw material
remains in the production process before it is taken out as a finished unit. The
FGCP refers to the period for which finished goods remain in the stores before
sold to a customer.
2. Receivables Conversion Period (RCP): It is the time required to convert
the credit sales into cash realization. It refers to the period between the
occurrence of credit sales and collection from debtors.
-
8/8/2019 Working Capital Mgmt at OCIL
76/98
The total of ICP and RCP is also known as Total Operating Cycle Period (TOCP).
The firm might be getting some credit facilities from the supplier of raw material,
wage earners, etc. This period for which the payment of these parties are deferred
or delayed is known as Deferral Period (DP). The Net Operating Cycle (NOC) of
the firm is arrived at by deducting the DP from the TOCP. NOC is also known as
Cash Cycle.
RMCP = (Avg. raw material stock/total raw material stock)*360
WPCP = (Avg. work-in-process/ total work-in-process)*360
FGCP = (Avg. finished goods/ total cost of goods sold)*360
RCP = (Avg. receivables/ total credit sales)*365
DP = (Avg. creditors/ total credit purchases)*365
In respect of these formulations, the following points are noteworthy:
a) The Average value in the numerator is the average of opening balance
and closing balance of the respective item. However, if only the closing
balance is available, then even the closing balance may be taken as the
Average.
b) The figure 360 represents the number of days in a year. It is taken for
the purpose of ease in calculation.
-
8/8/2019 Working Capital Mgmt at OCIL
77/98
c) The total figure in the denominator refers to the total value of the item in
a particular year.
d) In the calculation of RMCP, WPCP, and FGCP, the denominator is
calculated at cost-basis and the profit margin has been excluded. The
reason being that there is no investment of funds in profits as such.
The working capital is calculated for the Orient Ceramics and Industries Ltd.
on the next page and final holding month for the inventories, debtors and
creditors are given in the table on page 92 (done as a part of formulation of
Credit Monetary Assessment).
-
8/8/2019 Working Capital Mgmt at OCIL
78/98
-
8/8/2019 Working Capital Mgmt at OCIL
79/98
TOTAL OPERATING PLAN
-
8/8/2019 Working Capital Mgmt at OCIL
80/98
BALANCE SHEET
31-Mar-06 31-Mar-05 31-Mar-04 31-Mar-03 31-Mar-02
I Sources of Funds
1 Shareholders' Funds
a) Share Capital 46800000 46800000 46800000 46800000 46800000
b) Reserves & Surplus 311632842 277571085 254965420 246926239 232175126
358432842 324371085 301765420 293726239 278975126
2 Loan Funds
a) Secured Loans 341631793 422226436 459714381 536449132 579635839
b) Unsecured Loans 65277612 65126016 51565966 40002966 49747966
406909405 487352452 511280347 576452098 629383805
3 Deferred Tax Liability (Net) 69799835 86020167 95925572 103375725 96016225
TOTAL 835142082 897743704 908971339 973554062 1004375156
II Application of Funds
1 Fixed Assets
a) Gross Block131446594
8 1296783214124499393
9122137232
0 1186214360
b) Less: Accumulated Dep. 796866805 691936142 587870273 488980150 401851403
c) Net Block 517599143 604847072 657123666 732392170 784362957
d) Capital Work-in-progress 12367553 5979234 15874166
517599143 604847072 669491219 738371404 800237123
2 Current Assets, Loans & Advances
a) Inventories 302581377 286356858 270348448 209654699 175637720b) Sundry Debtors 218613540 175249922 137327170 145360133 98373292
c) Cash & Cash Balances 7529947 13521928 9036845 7249883 15735703
d) Other Current Assets 234831 329229 692168 423453 1094048
e) Loans and Advances 129762563 89759465 37929382 44930951 50184855
658722258 565217402 455334013 407619119 341025618
Less: Current Liabilities & Provisions
a) Current Liabilities 244656371 223127082 181714829 156776859 126267997
b) Provisions 96522948 48193688 34139064 15659602 12878223
341179319 271320770 215853893 172436461 139146220
Net Current Assets 317542939 293896632 239480120 235182658 201879398
Miscellaneous Expenditure 2258635TOTAL
835142082 898743704 908971339 973554062 1004375156
-
8/8/2019 Working Capital Mgmt at OCIL
81/98
PROFIT AND LOSS ACCOUNT
31-Mar-06 31-Mar-05 31-Mar-04 31-Mar-03 31-Ma
INCOME Sales
Less: Excise Duty recovered on sales 1400620319 1196455422 1101150054 1026231178 100411
Net Sales 103250837 83240148 93974937 116341703 12219535
EXPENDITURE Other Income 1297369482 1113215274 1007175117 909889475 881916
Increase/(Decrease) in stocks 12766478 20373228 13191274 34754088 153283
4679684 42870378 20595033 37258673 319057
1314815644 1176458880 1040961424 981902236 929150
Purchases (Traded Goods)
Manufacturing and Other Expenses 8421836 18915277 14618602 9753542 173523
PROFIT Finance Charges (Net) 1076315188 960573288 856757422 752977082 704170
Depreciation 50907926 45734377 46210407 71841563 771264
105717715 105443182 103456929 102027589 808135
1241362665 1130666124 1021043360 936599776 879462
Profit before tax
Add: Provision for Current Tax 73452979 45792756 19918064 45302460 496880
Add: Provision for Deferred Tax[charges/(releases)] 44000000 19,000,000 7900000 9200000 450000
Add: Provision for Fringe benefit tax -17220332 -8905405 -7450153 9684387 145665
Add: Profit after Tax 3200000
Add: Adjustments in respect of Fixed Assets sold 43473311 35698161 19468217 26418073 306214
Adjustments in respect of Revaluation Reserve 186050
Income Tax adjustments for earlier years 9396679
APPROPRIATION Prior Period Adjustments (Net) -111413 46765 -2978325 -2835239
Balance Brought Forward -761949 -4672673 -1059236 171984 101746
98470394 85864729 82825548 107065526 917925
Profit available for Appropriation
141070343 116936982 98256204 140217023 123617
Proposed Dividend
Provision for Tax on Dividend 7488000 7488000 6552000 6552000 655200Transfer to General Reserve 1050192 978588 839475 839475
Surplus carried to Balance Sheet 10000000 10000000 5000000 50000000 100000
122532151 98470394 85864729 82825548 107065
Basic/Diluted Earnings Per Share (Rs.) 141070343 116936982 98256204 140217023 123617
9.1 6.64 3.3 7.08 6.54
-
8/8/2019 Working Capital Mgmt at OCIL
82/98
CREDIT MONETARY ASSESSMENT
-
8/8/2019 Working Capital Mgmt at OCIL
83/98
Opening Statement
31.03.05 31.03.06 31.03.07 31.03.08
audited Audited projctns projctns
GROSS SALES
Domestic sales 115.98 136.17 163.86 242.21
Export sales 2.69 2.73 4.00 6.00
Trading Sales 0.98 1.16 34.00 79.60
Total 119.65 140.06 201.86 327.81
Less excise duty 8.32 10.32 12.43 18.39
Deduct other items
Net sales ( item 1 - item 2 ) 111.33 129.74 189.43 309.42
% age rise (+) or fall (-) in net 10.53 16.54 46.01 63.34sales compared to previous
year (annualised)
Cost of Sales
Raw materials (including 40.84 42.55 73.64 136.16
stores and other items used
in the process of manufacture)
(a) imported 3.21 5.69 6.85 10.13
(b) Indigenous 37.63 36.86 66.79 126.03
Other spares 9.86 11.45 13.14 18.44
(a) Imported 1.54 1.24 1.49 2.20
(b) Indigenous 8.32 10.21 11.65 16.24
Power and fuel 17.96 19.58 23.14 35.36
Direct labour 3.80 4.04 5.61 9.18
(Factory wages & salary)
Other mfg. Expenses 2.21 1.47 1.80 2.33
Depreciation 10.54 10.57 9.24 11.25
SUB TOTAL (I TO VI) 85.21 89.66 126.57 212.72
ADD: Opening stocks-in-
Process 1.29 1.41 0.97 1.10
Sub-total 86.50 91.07 127.54 213.82
Form II : Sheet 2 31.03.05 31.03.06 31.03.0731.03.0
8
0 audited Audited projctns projctns
Deduct : Closing stocks-in-
-
8/8/2019 Working Capital Mgmt at OCIL
84/98
process 1.41 0.97 1.10 1.66
Cost of Production 85.09 90.10 126.44 212.16
Add : Opening stock of
finished goods 12.93 17.08 17.99 18.91
SUB-TOTAL 98.02 107.18 144.43 231.07
Deduct closing stock of
finished goods 17.08 17.99 18.91 29.88
SUB-TOTAL ( Total cost 80.94 89.19 125.52 201.19
of sales)
Selling general and administrtive
expenses 23.28 29.39 47.02 81.14
SUB-TOTAL (5+6) 104.22 118.58 172.54 282.33
Operating profit before interest 7.11 11.16 16.89 27.09
( 3-7 )
Interest 4.57 5.09 6.64 10.06
Operating profit after interest 2.54 6.07 10.25 17.03
( 8-9 )
Add other non-operating income
(a) Misc. Income 1.89 1.15 1.36 2.00
(b)Export Incentives 0.15 0.13 0.19 0.29
(c) Sale of Key Man Policy - - - -
(d)
Sub-total ( income ) 2.04 1.28 1.55 2.29
Deduct other non-operating expenses
(a)Prior Period Adj. 0.46 0.09 - -
Sub-total ( expenses ) 0.46 0.09 - -
Net of other non-operating 1.58 1.19 1.55 2.29
income/expenses
Profit before tax/loss[10+11(iii)] 4.12 7.26 11.80 19.32
Provision for taxes 1.01 3.00 4.06 7.26
Net profit/loss ( 12-13 ) 3.11 4.26 7.74 12.06
(a) Equity dividend paid-amt
(Already paid+ B.S. provision) 0.85 0.85 1.06 1.06
(b) Dividend Rate 16.00 16.00 20.00 20.00Retained profit ( 14-15 ) 2.26 3.41 6.68 11.00
Retained profit/Net profit (% age) 72.67 80.05 86.30 91.21
-
8/8/2019 Working Capital Mgmt at OCIL
85/98
Liabilities Statement
(Rs. in Crores)
31.03.05 31.03.06 31.03.07 31.03.08
audited Audited projctns projctns
CURRENT LIABILITIES
1 Short-term borrowings from
banks(including bills purchased,
discounted & excess borrowing
placed on repayment basis)
(i.) From applicant banks 25.83 27.73 33.00 48.00
(ii.) From other banks
(iii) Of which BP & BD
SUB TOTAL 25.83 27.73 33.00 48.00
2 Short term borrowings from
others
3 Sundry Creditors (Trade) 13.21 13.37 17.13 26.46
4 Advance payments from custo- 2.46 2.61 3.76 6.11
mers/deposits from dealers
5 Provision for taxes
6 Dividend payable 0.85 0.85 1.06 1.06
7 Other statutory liabilities 1.51 1.48 2.13 3.46
(due within one year)
8 Deposits/instalments of term 10.70 5.88 12.30 9.25
loans/DPGs/Debentures,etc.
(due within one year)
9 Other current liabilities &
provisions(due within 1 Yr)
(specify major items) 6.41 8.40 8.13 9.44
EXPENCE PAYABLE
E OTHERS 6.41 8.40 8.13 9.44
Deffered payment for sales tax.
(due within one year)
SUB-TOTAL (B) 35.14 32.59 44.51 55.78
TOTAL CURRENTLIABILITIES 60.97 60.32 77.51 103.78
-
8/8/2019 Working Capital Mgmt at OCIL
86/98
-
8/8/2019 Working Capital Mgmt at OCIL
87/98
Assets Statements
(Rs. in Crores)
31.03.05 31.03.06 31.03.07 31.03.08
ASSETS audited audited projctns Projctns
26 Cash and bank balances 1.07 0.29 1.37 1.27
27 Investment (other than long 0.28 0.46 0.50 0.60
term investment)
(i) Government & other
Trustee Securities
(ii) Fixed Deposits with Banks 0.28 0.46 0.50 0.60
28 (i) Receivables other than 14.27 19.52 33.65 54.64
deferred & exports (include
bills purchased and
discounted by Banks)
(ii) Export receivables(include
bills purchased and
discounted by banks)
29 Instalments of deferred
receivables(due with in one yr.)
30 Inventory: 28.63 30.26 33.29 50.44
(i)Raw materials(including stores 5.47 6.44 7.80 11.22
& other items used in the