Financial Management of PSUs: 1. What is the nature and scope of finance function in government companies?

What are the special features of financial function in government companies? mine Ans : Globalization of Indian economy has made it necessary for Public Sector Undertakings (PSUs) to be sound in terms of profitability and earnings per share. For PSUs to be selfsustaining organizations, Financial Management assumes a lot of significance. The nature of the finance function is shaped mainly by the structure of the organization. The nature of finance function of would be more complex for a multi-product, multi-unit and multi-functional undertaking than that for a PSU having a simple structure in terms of products and location. Over the years the organization for finance has been undergoing a shift from a pure functional and centralized type to decentralized and divisionalized type of organization. The finance function in PSUs is becoming more and more inclusive. It has grown beyond traditional boundaries to newer avenues such as restructuring and corporate governance.

The scope of the finance function has undergone a great transformation, the area of focus of the finance function has widened to include other functions having a bearing upon the management of investments and financing. The scope of the financial function in PSUs includes:

Projecting cash-flows by providing for risk. Determining financial resources required to meet the companies operating program. Forecasting the amount of requirement

Developing best plan to obtain external funds.

2. How are investment, financing and dividend decisions organized in government companies? Ans: Investment management : Investment proposals are examined by various agencies of the government including a Project Appraisal Division of the Planning Commission, the Department of Public Enterprises, the Public Investment Board, and the Cabinet Committee of Economic Affairs. The limits on capital expenditure and approvals required are : Upto Rs. 5 crore Upto Rs. 5-20 crore Upto Rs. 20-50 crore By the enterprise By the enterprise with integrated financial system To be approved by the administrative ministry

Proposals above Rs. 50 crore

By the Project appraisal division, public investment board and the Cabinet Committee on external affairs

Financing Decisions: The Government has been the main provider of equity and long term debt in PSUs. Internal financing plays an insignificant role as a source of financing. The financial institutions have provided about 2% of the total long term investment needs. Foreign equity/loans account for more than 10% of the

long term investment needs. Differed credits take a lions share of foreign finance. Private participation from Indian business and investors is about 11% of the total long term resources. Many PSUs have raised short term finance through commercial papers in the post 1990 period. Dividend payments in PSUs: In 1988-89, the dividends declared were less than 1% of the paid up capital. Due to a revised stipulation announced as a part of the New Economic Policy, these enterprises have to now declare 50% of their profits as dividends. However in 97-98, the dividends declared were a mere 30% of the net profit earned by these enterprises. The percentage increased in the years to follow and 70 % profits are now declared as dividends. It is very heartening to see that over the years the number of dividend declaring PSUs has increased along with the quantum of dividends declared.

3. What is the nature of working capital in government companies? What steps should be taken to improve the effectiveness of working capital management in government companies?

Ans: The management of working Capital is a vital element in PSUs. The working capital requirements of PSUs are generally met through cash credits and advances arranged with the State Bank of India and other nationalized banks. The amount of outstanding cash credits/advances drawn by the Central public enterprises (CPSUs) from Banks and others as on March 31st 2003 was Rs.69,294 crore.

In special cases non-plan loans are also advanced by the central Government to some enterprises for meeting their working Capital

requirements. As on March 31st 2003, a total of Rs. 1,815 crore was outstanding from 51 enterprises as working capital loan from the Central Government.

Steps that should be taken to improve effectiveness of working Capital management:

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Current liabilities should be given greater attention as a component of source of funds. Spread of awareness concerning the current techniques to working capital management. Avoid excess buildup of working capital by favourable credit management.

4. What is performance budgeting? What is Programme Budgeting? What are their pros and cons?

Ans: Performance Budgeting (PB):

It is a system wherein managers are provided with a flexibility to utilize department or organizations resources as required in return for their commitment to achieve certain performance results. PB is a system of planning, budgeting and evaluation that emphasizes the relationship between money budgeted and results expected.

Common characteristics of a Performance budget include:

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Organizations identification of mission goals and objectives. Linkage of strategic planning information with the budget. Development and integration of performance measures into the budget. Desegregation of expenditures into various broad areas (such as personnel, operating expenses and Capital outlays) rather than more specific line-items.

Advantages of PB are as follows:

PB has more of a policy-making orientation. It connects plans, measures and budgets. PB forces departments and policy makers to think about the big picture. PB provides better information about the impact of budget decisions on people. It gives the department increased budgetary flexibility and incentives for generating budget savings.

Disadvantages:

Emphasis on quantity, not quality of the activity being monitored.

The link between performance measures and resource allocations are subject to political choices. Lack of Credible and useful performance information. Difficulties arising in achieving Consensus on goals and measures.

Programme Budgeting: Under a program budgeting system, department or agency budget requests not only include the funding that it would like to receive, but also the outputs and outcomes they expect to produce as a result of that funding. The legislature then establishes performance targets fo outcomes and outputs in the implementing act to the appropriations act.

Department or agencies then report their actual performance in their long range programme plans and budget requests for the following fiscal year. Agencies may give incentives for performance that exceeds standards or disincentives for performance that falls below standards. These incentives and disincentives can be monetary or non-monetary. An example of a monetary incentive would be performance bonuses for employees and managers. An example of a non-monetary incentive would be an increase in budget flexibility.

Thus by its nature a programme budget focuses on the output services that the programme provides to its users. It also more readily relates to overall organizational goals and objectives

5. What is Zero-Base budgeting? How is it different from traditional budgeting? What are its merits and demerits? ANSWER:ZBB is a budgeting method for a corporation or government in which all expenditures must be justified afresh each year & not just in excess of the previous year. Under ZBB, nothing is considered as sacrosanct. Every time, the managers are supposed to start from scratch or writing on a clean slate. ZBB is claimed to be a new technique of planning & decision making. It reverses the working process of traditional budgeting. In traditional budgeting, departmental managers need to justify only increase over the previous year budget. This means what has been already spent is automatically sanctioned. While in ZBB, no reference is made to the previous level of expenditure. Every department function is reviewed comprehensively & all expenditures rather than only increases, are approved. The Zero-base is indifferent to whether the total budget is increasing or decreasing. Merits:

Elimination of obsolete, non-relevant decision packages. Increased or decreased levels of funding for some decision packages & addition of new decision packages. ZBB encourages budget participation at the operating level. As a result, managers & employees become more focused. The comprehensive resources cost analysis process is a strong internal planning characteristic of ZBB ZBB, when properly implemented holds great promise for assisting personnel of an organization to plan & make decisions about the most efficient & effective ways to use their available resources to achieve their defines mission, goals & objectives. Results in efficient allocation of resources as it is based on needs and benefits. Forces and derives managers to think critically in order to find out cost effective ways to improve operations.

Useful for service department where the output is difficult to identify. Increases communication and coordination within the organization. Managers and employees learn more about the organizations activities and problems.

Demerits:

Increase in paper work and time consuming. In certain areas of the organization, it is difficult to define decision units and decision packages. It forces the managers to justify every related to expenditure. Sometimes, certain departments like R&D may be threatened while production department would benefit. In the first year, cost of training, paper work and implementation of ZBB may go up because without its proper understanding, it cannot be successfully implemented. Organization may face some resistance from the employees and their unions. Difficult to administer and communicate the budgeting because more managers are involved in the process. Since ZBB threatens certain positions of the managers and executives, they may play games and politics.

6. Explain the steps in the process of zero-base budgeting? ANSWER:The development & implementation of the ZBB model requires managers & others in the organization to engage in several major planning, analytic & decision-making processes. These major processes of ZBB include the following:

Identification or redefining the mission and goals of the organization.

Identification of the organizations Decision Units and Decision Packages. Ranking of decision packages based on cost-benefit or qualitative criteria. Fixing a cut-off point for funding. Acceptance and allocation of resources. Budget execution. Monitoring and Evaluation.

7. What is a Memorandum of Understanding (MoU)? How is it structured? How does it help in performance improvement and measurement? ANSWER:MoU is supposed to be a freely negotiated document between the government, acting as a owner, & a specific PSU. It is also supposed to clearly specify the intentions, obligations & mutual responsibilities of both parties to the MoU. If either of the two conditions is violated, the effectiveness of the MoU as an instrument of performance improvement is bound to be affected. The basic philosophy guiding the MoU is to create an understanding between the government & the PUSs about the accountability of the latter to the former & the autonomy the former would provide to the latter in the task of achieving the objectives for which the PSUs were set up. It was expected that such an agreement would minimize the reference that the PSUs were expected to make to the government, on the one hand, & the control that the government would exercise on the PSUs to ensure their effective performance, on the other. The MoU makes an attempt to move the management of PSUs from management by controls & procedures to the management by results & objectives. Objectives of MoU system: 1. Measure the performance of the PSUs taking into account the complexities effusing social & financial objectives & translating them into measurable parameters. 2. Ensure simultaneous increase in autonomy as well as accountability.

3. Set up new institution & administrative & personnel. 4. Replace multiply principles with multiple objectives with clarity in goals & objectives. Structure of MoU The MoU is not merely a document, it is the way of life or a management system. This is tool for performance improvement incorporates within its fold three sub-system, namely, performance information system, performance evaluation system, & performance incentive system. Performance evaluation in MoU involves five steps. First three steps are taken at the beginning of he year & the last two steps are taken at the end of the year. Beginning of the year Step 1: CRITERIA SELECTION: - In this first step, one has to choose appropriate set of criteria to be included in the MoU. The criteria included in the MoU should mearsure only those aspects of the managerial performance which are under managers control. Performance criteria must be selected carefully & not arbitrarily. These should be based on the enterprises corporate plan that looks at three to five years in the future. They must also be consistent with plan & budgetary goals of the government. MoU is an instrument that measures the performance of the manager & not that of the enterprises. While selecting performance criteria this must be kept in mind and only those parameters that judge managerial performance should be selected. Step 2:- CRITERIA WEIGHT SELECTION:- For running an enterprise successfully a Chief Executive has to undertake a number of tasks. However, not all the tasks are of equal importance. A smart Chief Executive therefore, priorities his tasks based on his perception of relative importance of different activities in hand. In the interest of clarity of purpose it is necessary that from long list of things to do, the manager must be told what are the relative priorities so that he can allocate his time more effectively in achieving those priorities. Step 3:- CRITERIA VALUE SELECTION:-To understand on needs to distinguish between criteria & criteria value. Now, kilometers per liter in a criterion to measure efficiency of motor vehicles, however, 10 kilometer/liter

may be excellent for a truck bit it is very bad for a scooter. This value of 10 kilometer/liter is a criteria value. It is a value, which distinguish various levels of performance. The MoU is rated on a 5-point scale, where 1 represents excellent performance & 5 represents poor performance. This indeed is very heart of the MoU philosophy. Once you have specified the objectives for the managers you should not interfere in the operation & wait till the end of the year for them to deliver the goods. The selection of criterion value should be carried out through a participative process. Experience suggests that without a participative approach, targets tend to take the form of formal directives which are often overtly accepted & covertly resisted. These targets should be easy to understand & well defined. The sources of information which could assist in setting criterion values include:

The original objectives at the project formulation stage. Comparisons with similar undertakings of other selected developed & developing countries. Comparisons with the performance of the same firm in the previous years. Professional judgment by third parties. Professional judgment at the ministry level. Professional judgment at the enterprise level.

At the end of the year Step 4:- PERFORMANCE VALUATION:- The forth step is taken in the end of the year, when we look at the achievement of PSUs & compare them with the criteria values & determine the scores. This is the final step in the performance evaluation exercise cannot be mechanical procedure. The value of the composite scores will also lie between 1 & 5. If management has done excellent in all fonts including in the MoU, they will get a score of 1. It measures the ability of the enterprise to its own commitments. Step 5:- PERFORMANCE REWARD:- While performance evaluation of PSUs provide a measures of the degree of achievement of the objectives set out, evaluation by itself does not lead to improvement of performance. Unless performance evaluation is coupled with a system of rewards & penalties &

utilized as a means for that purpose, it provides no motivation to the PSUs for improving their performance. A transparent system of rewards & punishment is thus a corollary to the introduction of an objective performance evaluation system of the PSUs. Thus a performance rewards scheme constitutes an essential complement of MoU system.

Financial Management of Sick Units : 1. What are the causes of industrial sickness? Definition of sickness:The Companies Act ,2002 defines a sick company as one, i. ii. which has accumulated losses in any financial year equal to 50% or more of its average net worth during four years immediately preceding the financial year in question or which has failed to repay its debts within any three consecutive quarters on demand for repayment by its creditors.

Causes of sickness:The sickness in any industry can be caused by various reasons which can be categorized or because of i. ii. unfavourable external environment Managerial deficiency

Unfavourable external environmentThe firm may cause the sickness because of unfavourable external environment. External environment is the environment which affected the functioning of the firm and the control of these factors is not in hand of any industry.

Following are some factors which cause the sickness. a. Shortage of inputs like power or basic raw material b. Change in government policies c. Development of new technology d. Sudden decline in orders from the government e. Change in customer preferences f. Natural calamities g. Adverse international development Managerial deficiency These deficiencies can be classified as per the function like Production , finance , marketing, human resource. Under these function there are some other reason because of which the industry face the problem of sickness Production;a. Improper location b. wrong technology c. uneconomic plant size d. unsuitable plant & machinery e. poor quality control d. poor R&D f. poor maintenance

Finance: Finance is the lifeblood of business. It links and passes through all areas of a business unit. The problem areas may be because of,
1.

The promoters might have chosen a project which is beyond their financial capacity. This often happens due to over ambitious approach of entrepreneurs. A bigger project needs a bigger investment and accordingly a higher promoters contribution in absolute terms. If the promoters are not able to mobilize their contribution, with the sole idea of implementing the project, they often resort to borrowings, invariably at higher interest rates with the hope of clearing the high cost borrowings once the project takes off

2. Funding a project with a higher debt component than that it can safety bear is another reason for sickness, since such projects will not be able to service the high interest charges.

3. Using short term funds for acquiring fixed assets is an area of concern. This will put the liquidity position of the business in strain when the short term obligations become due for repayment.

4. Improper inventory management policy will lead to holding huge stock of finished products, late realization of debts from sundry debtors, lack of proper planning to pay to creditors of raw materials, etc., which will all have telling effects on the operation of a business unit.

Marketing; a. Inaccurate demand projection b. Improper product-mix c. Wrong product positioning d. Irrational price structure e. Inadequate sales promotion f. High distribution cost g. Poor customer service

Human resource a. Ineffective leadership b. Inadequate human resource c. Poor organization design d. Insufficient training e. Irrational compensation

2. List the symptoms which might indicate that sickness lies ahead.

As the sickness in any industry does not occur overnight, but develops gradually over time. Any sick industry shows some common symptoms. Those are : a. Delay in payment to supplier: When the company faces the problem of sickness the company fail to pay to its suppliers on time. As a result they always ask for the extension to pay the amount.

b. Irregularity in the bank account; The sick unit may fail to keep the regularity in the bank account which can be the sign of sickness.

c. Delay in payment to bank or financial institutions As the sick unit ask for the time to supplier for the payment the same way it can ask for bank or financial institutions for increase the limit of credit.

d. Frequent request to banks for additional credit In addition to delay in the payment to supplier and bank the sick unit might ask for the additional credit to meet its obligations.

e. Inability to take trade risk f. Extension of accounting period g. Low turnover of assets h. Decline in prices of shares; The prices of the sick unit or industry face the problem of reducing the share prices over a period of time

i. Excessive turnover of personnel j. Accumulation of inventories

3. Discuss the univariate analysis for predicting industrial sickness. Univariate analysis aims to predict sickness on the basis of a single financial ratio. Though many financial ratios were used by analysts for predicting sickness, there was no consensus as to what the most appropriate ratio is for the prediction of sickness. Such a situation prevailed till William H.Beaver published

his study on univariate analysis in the year 1966. Beaver examined the predicative power of 30 different financial ratios by choosing a sample of 79 firms that had become sick and 79 firms that were healthy for the same period of time. The sample was so chosen that for each failed (sick) firm, a healthy firm operating in the same industry and having comparative size was included in the sample set. For both the set of samples of 79 firms each, Beaver examined the behaviour of 30 different financial ratios during the period of 5 years prior to

the failure. The main finding of Beaver was that the ratio that is most useful in predicting impending sickness is the ratio of cash flow to total debt, since this ratio showed the minimum error in his prediction.

4. Discuss briefly how multivariate analysis may be employed for predicting industrial sickness. Univariate analysis examines the predictive power of individual financial ratios. The joint effect of more than one financial ratio in predicting sickness is not studied in univariate analysis. Multivariate analysis, on the other hand, aims to predict industrial sickness by studying the combined influence of several financial ratios. Altman. E.I. presented his model of multivariate analysis for predicting industrial sickness in the year 1966. In his model, Altman combined several financial ratios into a single index. He named this index as Z-score. His analysis was based on a statistical procedure known as multiple discriminate analysis (MDA). Altman studied a sample of 33 bankrupt firms along with a paired sample of 33 non-bankrupt firms. He examined 22 financial ratios to identify their combined influence on sickness and selected five ratios, which in his opinion jointly possess the maximum power to predict bankruptcy. Altman derived a discriminant function (Z) that contains five financial ratios. The discriminant function derived by Altman is as under:

Z = 1.20x1 + 1.40x2 + 3.30x3 + 0.60x4 + 0.999x5 Where, Z = discriminant score x1 = (working capital) (total assets) x2 = (retained earnings) (total assets) x3 = (earnings before interest and tax) (total assets)

x4 = (market value of equity) (book value of total debt) x5 = (sales) (total assets) A cut-off point for the Z score was determined by Altman in such a way that it minimized the overlap between bankrupt and non-bankrupt groups. Altman found that a cut off value of 2.675 for
Z minimized the possibility of misclassification. Thus, as per Altmans

analysis, firms with Z score less than 2.675 are prone to become bankrupt and firms with Z score more than 2.675 are free from the threat of bankruptcy.

4. What aspects should be covered in viability study? Ans : Revival of a sick unit When an industrial unit is identified as sick, a viability study should be conducted to assess whether the unit can be revived within a reasonable period. If the viability study suggests that the unit can be rehabilitated, a suitable plan must be undertaken, if the study indicates that the unit is better dead than alive steps are taken to liquidate it. Viability study It generally covers the following:Market Analysis

Market share behavior over the past few years Growth rate of total market Emergence of competition

Production/Technical Analysis

Technological capability of the firm Plant condition Supply of raw material

Finance

Liquidity position Leverage analysis

Personnel organization

Human Resource Leadership

Environment

Supply of raw material Availability of power, fuel and water

The viability study may suggest one of the following: a. The unit can be revived by adopting one or more of the following measures; debt restructuring, infusion of funds, correction of functional deficiencies, replacement of existing management because of its incompetence. b. The unit is not potentially viable- this essentially implies that the benefits expected from remedial measures are less than the cost of such remedial measures.

5. What are the unusual components of the revival programme? Ans : Revival Programme Usually involves:Settlement with creditors

A sick unit is not able to honour its commitments to its creditors. To alleviate its financial distress, a settlement scheme has to be worked out which may involve one or more of the following: rescheduling of principal and interest payment; waiver of interest; conversion of debt to equity; payment of arrears in installments. Provision of Additional Capital Typically a revival programme entails provision of additional capital. This may be required for modernization and repair of plant and machinery, for purchase of balancing equipments, for sustaining a new marketing drive, and for enhanced working capital needed to support a higher level of operations. The additional capital has to be provided on concessional terms, at least for the initial years, so that the financial burden on the unit is not high.

Divestment and Disposal The revival programme may involve divestment of unprofitable plants and operations and disposal of slow moving and obsolete stocks. The thrust of these actions should be to strengthen the liquidity of the unit and facilitate reallocation of resources for enhancing the profitability of the unit. Reformulation of product market strategy Many a business failures can be traced to an ill-conceived product market strategy. For reviving a sick unit, its product market strategy may have to be significantly reformulated to improve the prospects of its profitable recovery. Modernization of plant and machinery In order to improve manufacturing efficiency, plant and machinery may have to be modernized, renovated and repaired. This may be essential for attaining certain cost standards and quality norms for competing effectively in the market place. Reduction in manpower Generally, sick firms tend to be over-staffed. The revival programme must seek to reduce superfluous manpower. Remember an old managerial saw: The leaner the organization, the greater are its chances of survival.

Strict control over costs A profitable organization can afford wastefulness and laxity in its expenditures. A zero base review of all the discretionary expenses may be undertaken to eliminate programmes and activities which are a drain on the finances of the firm. Streamlining of operations Manufacturing, purchasing and selling operations have to be meticulously examined so that they can be streamlined. Value engineering, standardization, cost benefit analysis, and other approaches should be exploited fully to improve the efficiency of the operations. workers participation workers participation in management enhances employee commitment, motivation, and morale. Further, the suggestions offered by the workers result in improvements that lead to higher manufacturing efficiency and productivity. A sick unit which is being revived, can perhaps benefit even more from workers participation in management. Change of management A change in management may be necessary where the present management is dishonest. It has been observed that a new chief executive, who is competent and committed can often bring about dramatic results.

6. Discuss the common ingredients of corporate turnaround. Ans : A turnaround situation represents an unusual phase in the life history of a firm and requires a very different approach to management as compared to a normal situation. The key elements found commonly found in turnarounds are:

A change in the top management. A substantial involvement of top management in day to day operations.

An emphasis on projects that have a quick payoff. Opportunistic action, improvisation, crisis management, and short term expediency.

Turnaround Story TVS Suzuki It started operations in 1987-88 on an optimistic note. However its performance deteriorated in the following three years. While it still made profits in 1988-89, it incurred losses in 1990-90. By early 1991 the situation was pretty bad because of intense competition in the marketplace. With the determination to fight competition and improve performance, the company took a series of steps.

A six month, week by week, cost reduction drive focused on raw material cost, manpower cost and non value added expenditures, this led to a drop of 30% in operating costs. A massive exercise in value engineering undertaken in tandem with Suzuki, this resulted in a saving of Rs 10 million pm. A product improvement strategy to introduce a new model every few years, to build market share. A renewed marketing drive backed by a higher advertising outlay and a new marketing and vendor policy.