SUMMER TRAINING REPORT SUBMITTED TOWARDS THE

PARTIAL FULFILLMENT OF POST GRADUATE DEGREE IN

INTERNATIONAL BUSINESS

“ANALYSIS OF WORKING CAPITAL FOR

DHARAMPAL SATYAPAL LTD.”

SUBMITTED TO SUBMITTED BY
Col. Mohan Ankit Goel

MBA-IB

ROLL NO. C-07

AMITY INTERNATIONAL BUSINESS SCHOOL, NOIDA

AMITY UNIVERSITY – UTTAR PRADESH

 COMPANY CERTIFICATE

TO WHOM IT MAY CONCERN

This is to certify that Ankit Goel , a student of Amity International Business School,
Noida, undertook a project on “Working Capital Analysis” at Dharampal Satyapal Ltd.
from 1st May’09 to 30th June’09.

Mr. Ankit Goel has successfully completed the project under the guidance of Mr. Neeraj
Goel. He is a sincere and hard-working student with pleasant manners.

We wish all success in his future endeavors.

Signature with date

(Name)

(Designation)

(Company Name)
 CERTIFICATE OF ORIGIN

This is to certify that Mr. Ankit Goel, a student of Post Graduate Degree in MBA-IB
(2008-2010), Amity International Business School, Noida has worked in the Dharampal
Satyapal Ltd. under the able guidance and supervision of Mr.Neeraj Goel, (Manager
finance), Company Birla Power Ltd.

The period for which he was on training was for 8 weeks, starting from 1st May’09 to 30th
June’09. This Summer Internship report has the requisite standard for the partial
fulfillment the Post Graduate Degree in International Business. To the best of our,
knowledge no part of this report has been reproduced from any other report and the
contents are based on original research.

Signature Signature

( FACULTY GUIDE ) ( Student )

 ACKNOWLEDGEMENT

I express my sincere gratitude to my industry guide Mr.Neeraj Goel, (Manager Finance),

(Company) Birla Power Ltd, for his able guidance, continuous support and cooperation
throughout my project, without which the present work would not have been possible.

I would also like to thank the entire team of Dharamal Satyapal Ltd, for the constant
support and help in the successful completion of my project.

Also, I am thankful to my faculty guide Col.Mohan of my institute, for his continued

guidance and invaluable encouragement.

Signature

(Student)
 TABLE OF CONTENTS

CHAPTER NO. SUBJECT

CH.-1.0 Executive Summary

Ch.-2.0 Research Methodology
2.1 Primary Objectives
2.2 Methodology
2.3 Schedule
2.4 Scope of study
2.5 Limitations

Ch.-3.0 Company Profile

3.1 Industry Profile

Ch.-4.0 Evaluation of financial position

4.1 comparative studies

Ch.-5.0 Critical Review of Literature

Ch.-6.0 Findings & Analysis & Observations
Ch.7.0 Recommendations
Ch.-8.0 Bibliography
Ch.-9.0 Annexture
9.1 Tables

Ch.-10.0 Case Study

Ch.-11.0 Sypnosis of project

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 firm’s profitability, as idle investment in
current assets and are non-productive and so they can 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 the working capital is a qualitative concept

1. It indicates the liquidity position of the firm and
2. It suggests the extent to which working capital needs may be
financed by permanent source of fund. Current assets should be
sufficiently in excess of current liabilities to constitute a margin
or buffer for maturing obligation within the ordinary cycle of
business.

The basic learning objective behind the study was-

• Computation of Working Capital Management

• Operating Cycle of the firm
• Financial plan estimated for 2007-2008 and projected for 2008-
2009
• Working capital credit limits
• Ratio analysis

On the basis of above calculations following conclusions can be made-

• Birla power ltd. has both long term as well as short term sources
for current asset financing. It implies that company follows
matching principle for raising funds.
• Right now company is following aggressive policy, which means
that company is maintaining lower ratio of current assets to fixed
assets.
 • Birla power solutions ltd has high collection peri0od which shows
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 as
per the basic norms and guidelines.
• Company should shift from aggressive policy to conservative
current assets policy.
• Company should reduce the holiday period else the company will
have to pay high carrying cost.

RESEARCH METHODOLOGY

PROJECT OBJECTIVE

• The project is aimed at evaluating the financial status of

Dharampal Satyapal Ltd and then doing the comparative analysis
with its competitors
• Studying the working capital management at Dharampal
Satyapal Ltd. and estimating the working capital requirements
for 2007-2008 and then forecasting for 2008-2009
• To find out if there is any relationship between the working
capital, sales and current assets of Birla Power

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 firm’s financial position with respect to its
competitors i.e. Hindustan Unilever Ltd., ITC and Kothari
Products with the help of following ratios-
• Liquidity ratios
• Solvency/Leveraging ratios
• Coverage ratios
• Activity/turnover ratios
• Profitability ratios
• Investors ratios
,
3. The project will focus on the study of overall working capital
management at the organizations, for which the following
study and analysis will be undertaken:
i ) This project is aimed to estimate the operating
plan for the year 2007-2008
ii ) This will also include the calculations and
analysis of the operating cycle for the company.

Iii ) Study of C M A form and to prepare for the

current year.

Iv) It will also include the ratio analysis of the

financial statement so that the profitability and liquidity trade off can
be analyzed.

SCHEDULE

The complete project will be for duration of 8 weeks. The project has
been divided into 2 stages with approximate time period allotted to
each stage. Both the stages along with their approximate timelines are
as follows:
STAGE 1 (APPROX 2 WEEKS)
The study of company’s financial position by doing ratio analysis of the
financial statement so that the profitability and liquidity condition of
the organization can be studied closely and then comparing it with the
financial statements of Coleman Cable Inc, Beacon Power Corp,
Powell Industries.

STAGE 2 (APPROX 6 WEEKS)

The study of the overall working capital management of the company
will be the first stage. Under this stage the operating plan will be
prepared and the study and analysis of the C M A form will be done.
This will include the estimation of working capital requirement for
2007-2008, forecasting for 2008-2009 and regression analysis and T
test for finding out the relationship between working capital, sales and
current assets.

SCOPE OF THE STUDY

Studying working capital management of the Birla Power ltd and
benchmarking it with 3 of its competitors.

LIMITATIONS

In spite of my continued efforts to make the project as accurate and

wide in scope as possible, certain limitations are becoming evident
while implementing the project. These limitations cannot be removed
and have to be accepted as permanent constraints in implementing
the project.
Some limitations, which have been identified, by me are:

1. Generalizations and calculated assumptions had to be

made in some areas while analyzing the financial
statements, ratios etc. due to non-availability of complete
information.
2. The segment wise and product wise study of the various
product segments and units of the company have been
 excluded from the scope of the project due to data and
time constraints.

COMPANY PROFILE

Dharampal Satyapal Group (DS Group) is more than Rs.

1400 crores diversified conglomerate, which is committed towards
high quality products & credited with several innovations over last
seven decades. The sagacity to weave its business around consumer
needs has conferred DS Group with a distinct value. Efficient capital
structure, cutting edge technology, operational discipline and a
widespread distribution network, have together attributed to enhance
‘Brand DS’, and enabled the organization to deliver continued growth
in all areas of operation.
Its undeterred pursuit for ‘Quality & Innovation’ has led the Company
to progress on a path of growth. The Group has consolidated its
position into diversified sectors like FMCG, Packaging,
Hospitality, Rubber thread, Cement and other businesses.

Beginning its journey with Tobacco, DS Group successfully ventured

into the arena of Foods & Beverages, alluring the consumers with a
wide range of beverages, spices, and ready-to-eat snacks under the
brand ‘Catch’. While ‘Catch’ Natural Spring Water and its variants
continue getting great response from consumers, ‘Catch’ Salt &
Pepper tabletop dispensers hold their supremacy as India’s first
rotatory table top dispensers. Catch Spices excessively continues to be
connoisseurs’ favorites. The latest products to be introduced under
catch brand are Catch Jal Jeera & Catch Nibu Pani.

In the Mouth Freshener Category, non-tobacco, Rajnigandha rules

the market as the world’s largest selling premium pan masala. ‘Pass
Pass’ has created a new product category all-together as India’s first
ever branded ‘all natural’ non supari assorted mouth freshener. Taking
forward the Indian tradition of eating and serving mouth fresheners
after meals, Rajnigandha, the premium mouth freshener brand, has
introduced a mild new flavour, “Meetha Mazaa- the Indian Mouth
freshener”. Reinforcing the emphasis on the quality at all levels,
Meetha Mazaa is revitalizing.

Recognizing the immense potential in the Hospitality Segment, DS

Group forayed into this segment with “The Manu Maharani’ at
Nainital, in 2001. The Group acquired the Airport Hotel at Kolkata. The
hotel is currently being revamped and renovated and will soon emerge
as an International standard destination with Five Star Hotel, a budget
hotel & large Convention Centre, in addition to a sprawling Commercial
area. The five star hotel building projects have also commenced in
Guwahati and Jaipur. In addition to the above ventures, land has been
acquired in cities like Udaipur, Shimla, Mussorie, Corbett Park, Manali
and Goa with plans to set up hotels & resorts. With a boom in tourism
sector, the group is all set to emerge as one of the leading players in
the hospitality segment.

Further pursuing its quest for diversification, DS Group has launched

colossal projects in the Packaging sector. DS Canpac Ltd., an eco
friendly revolutionary packaging technology, was launched in India in
association with Canpac – a leading Switzerland based packaging
major. A state-of-the-art plant at Noida offers packaging solutions to
other FMCG marketers as well as exporters of food products. The group
has also commissioned an ultra modern Flexible Packaging Unit in
Bonda.

A heat resistant latex Rubber thread plant has been set up at

Agartala to produce international quality rubber threads. Latex rubber
threads are made from natural rubber applying the most sophisticated
European technology. Following close behind is a first-of-its kind Steel
sheets plant coming up soon in the North East to produce cold rolled
sheets, CRCA and galvanized steel sheets.

In line with its vision of diversification, DS Group has entered the fast
growing Cement Industry. The Project is located at the Khliehriat
sub division of District Jaintia Hills in Meghalaya. The capacity of the
upcoming plant will be approximately 1 million tons Per Annum and will
have a captive power plant based on coal. This will be one of the
largest investments on new projects, by the Group.

As a significant step in Infrastructure Sector, DS Group has signed a

MOA with state Govt. of Meghalaya to set up a 240 MW Thermal
Power Plant, based on coal.

The group has manufacturing units in Noida, Delhi, Baroitwala in HP,

Kullu, Assam and Tripura. DS Group boasts of World Class Facilities
spread across the length and breadth of the country, to execute its
manufacturing processes with full adherence to international standards
of quality. Every stage of manufacturing is monitored with utmost care
and attention.

The company also has a widespread distribution network supported by

dealers and retailers. The group constantly upgrades its strength
through dealer network expansion, up -gradation of production
facilities and bringing greater consumer orientation, while maintaining
its commitments to high quality, innovation and consumer value
carried forward in all its diversification endeavors.

DS Group constantly nurtures its responsibility as a committed

corporate citizen, by regarding Corporate Social Responsibility as
an integral part of its Business Objectives.The Company has been
working in Assam and Tripura, on a wide range of CSR programmes
ranging from education to health and making tribal and ethnic
communities self reliant. Under the CSR initiatives the group is
renovating local schools, setting up a State level College and
developing heritage properties and construction of an eco lodge to be
owned and run by the tribal community.
While DS Group pursues leadership in its business spheres; it
simultaneously endeavors to promote common welfare through
multidimensional activities to work towards an all round development
of the society

DS Group makes constant improvisations in all its manufacturing

components, leading to the making of a perfect product. Be it the
sourcing of raw materials, the process of production, or packaging of
the final product, R&D remains the crux of DS Philosophy. Quality and
Innovation are the two core values that DS Group subsists on.

In its constant effort towards building trust among its audience, the
Group works strongly on the principles of integrity, dedication,
resourcefulness and commitment. A wide array of skills and substantial
depth of experience has not only led the Group to maintain its
leadership in its traditional businesses but has also resulted in
gradually gaining market in its relatively nascent forays.

The Stirring Saga of an Enterprise

In the early 20th century, when trade and commerce had not
witnessed the advent of brands and marketing warfare in India, Shri
Dharampalji – the founder of DS Group, set up a small perfumery shop
in Chandni Chowk, Delhi in the year 1929. The urge to create a
business around consumer tastes and preferences led Dharampalji to
innovate quality products. His sagacity revolutionized the market of
chewing tobacco and the shop in Chandni Chowk became renowned
not only in Delhi but even amongst the connoisseurs of tobacco in
other parts of India and the world. Blending modernity, technology and
tradition, Dharampalji’s son Satyapalji brought the dawn of a new era -
an era that saw a revolution. Satyapalji inherited qualities of high
virtues, innovation and aspiration for being the best in the business.
His in-depth knowledge of perfumes honoured him the title of
“Sugandhi” (perfumer). He is credited with blending tobacco with
various exquisite fragrances. He is also known for bringing the element
of quality and research hitherto unknown in this category. Under the
able stewardship of Satyapalji, the nation’s first ever-branded chewing
tobacco BABA was launched in 1964 which became an instant success
and widely popular in its category. And what followed later was an
array of premium brands like Tulsi and a host of others which have
established their leadership in their own category and created new
markets in its wake. Continuing the fervour of innovation and quality,
the Group set new benchmarks in Foods & Beverages. Innovative
tabletop sprinklers changed the way Indian households had been
enjoying salt and spices. Be it Catch spices or Catch Beverages, today
Catch stands for international quality and convenience. Mouth
fresheners like Rajnigandha and Pass Pass created new offerings and
established new categories. The Group has also ventured into a rapidly
growing hospitality sector with extensive five star properties in the
larger cities and boutique & heritage properties at tourist destinations.
The Group has also successfully ventured into Packaging, Rubber
Thread, Steel in the last few years. Since the launch of BABA, the
Group has never looked back, reaching for milestones year after year.
Thus, evolving from a single product to multiple brands, DS has
successfully woven over eight decades legend of innovation and
enterprise. And the quest for innovation continues……..

Establishing Benchmarks with Innovative First

• First to offer saffron flavoured chewing tobacco in the world

• First to launch branded chewing tobacco in India in metal

packaging
 • First and only chewing tobacco company in India to get ISO
9001:2000 certification

• First to introduce various kinds of spices in one-time use

packaging

• First to launch free flowing salt in revolutionary table top rotatory

dispensers in India

• First to introduce 100 per cent biodegradable, composite cans

packs which are pilfer proof, rust proof and leak proof using brine
and through vaccum evaporation process for food products

• First to introduce electronically beaten finest malleable silver

foils in India.

• First in India to bottle natural spring water which has been

awarded NSF certification from FDA, US : a hallmark of quality
and purity

• First to introduce soda processed with natural spring water

• First to introduce zero calorie tonic water

• First to launch 100% herbal mouth freshener - Pass Pass

Corporate
Office
 DS Group
A-85, Sector 2,
Noida 201301
Ph : 0120 4032200 , 3083333
Fax : 0120 2522592
email :
ds@dsgroupindia.com

Management Team

Overview of FMCG Industry

The Fast Moving Consumer Goods (FMCG) has to do with those
consumables which are regularly being consumed. Among the
first activities of the FMCG industry there is selling, marketing,
financing, purchasing, and so on. Recently this industry has also
launched in operations, supply chain, production, general
management, etc.

The Indian FMCG sector is the fourth largest in the economy and has a
market size of US$13.1 billion. Well-established distribution networks,
as well as intense competition between the organised and unorganised
segments are the characteristics of this sector. FMCG in India has a
strong and competitive MNC presence across the entire value chain. It
has been predicted that the FMCG market will reach to US$ 33.4 billion
in 2015 from US $ billion 11.6 in 2003. The middle class and the rural
segments of the Indian population are the most promising market for
FMCG, and give brand makers the opportunity to convert them to
branded products. Most of the product categories like jams,
toothpaste, skin care, shampoos, etc, in India, have low per capita
consumption as well as low penetration level, but the potential for
growth is huge.

The Indian Economy is surging ahead by leaps and bounds, keeping

pace with rapid urbanization, increased literacy levels, and rising per
capita income.

The big firms are growing bigger and small-time companies are
catching up as well. According to the study conducted by AC Nielsen,
62 of the top 100 brands are owned by MNCs, and the balance by
Indian companies. Fifteen companies own these 62 brands, and 27 of
these are owned by Hindustan Lever. Pepsi is at number three followed
by Thums Up. Britannia takes the fifth place, followed by Colgate (6),
Nirma (7), Coca-Cola (8) and Parle (9). These are figures the soft drink
and cigarette companies have always shied away from revealing.
Personal care, cigarettes, and soft drinks are the three biggest
categories in FMCG. Between them, they account for 35 of the top 100
brands.
 Exhibit I

THE TOP 10 COMPANIES IN FMCG SECTOR

S. Companies
NO.
1. Hindustan Unilever Ltd.
2. ITC (Indian Tobacco
Company)
3. Nestlé India
4. GCMMF (AMUL)
5. Dabur India
6. Asian Paints (India)
7. Cadbury India
8. Britannia Industries
9. Procter & Gamble Hygiene
and Health Care
10. Marico Industries

Source: Naukrihub.com

The companies mentioned in Exhibit I, are the leaders in their

respective sectors. The personal care category has the largest number
of brands, i.e., 21, inclusive of Lux, Lifebuoy, Fair and Lovely, Vicks,
and Ponds. There are 11 HLL brands in the 21, aggregating Rs. 3,799
crore or 54% of the personal care category. Cigarettes account for 17%
of the top 100 FMCG sales, and just below the personal care category.
ITC alone accounts for 60% volume market share and 70% by value of
all filter cigarettes in India.

The foods category in FMCG is gaining popularity with a swing of

launches by HLL, ITC, Godrej, and others. This category has 18 major
brands, aggregating Rs. 4,637 crore. Nestle and Amul slug it out in the
powders segment. The food category has also seen innovations like
softies in ice creams, chapattis by HLL, ready to eat rice by HLL and
pizzas by both GCMMF and Godrej Pillsbury. This category seems to
have faster development than the stagnating personal care category.
Amul, India's largest foods company, has a good presence in the food
category with its ice-creams, curd, milk, butter, cheese, and so on.
Britannia also ranks in the top 100 FMCG brands, dominates the
biscuits category and has launched a series of products at various
prices.

In the household care category (like mosquito repellents), Godrej and

Reckitt are two players. Goodknight from Godrej, is worth above Rs
217 crore, followed by Reckitt's Mortein at Rs 149 crore. In the
shampoo category, HLL's Clinic and Sunsilk make it to the top 100,
although P&G's Head and Shoulders and Pantene are also trying hard
to be positioned on top. Clinic is nearly double the size of Sunsilk.

Dabur is among the top five FMCG companies in India and is a herbal
specialist. With a turnover of Rs. 19 billion (approx. US$ 420 million) in
2005-2006, Dabur has brands like Dabur Amla, Dabur Chyawanprash,
Vatika, Hajmola and Real. Asian Paints is enjoying a formidable
presence in the Indian sub-continent, Southeast Asia, Far East, Middle
East, South Pacific, Caribbean, Africa and Europe. Asian Paints is India's
largest paint company, with a turnover of Rs.22.6 billion (around USD
513 million). Forbes Global magazine, USA, ranked Asian Paints among
the 200 Best Small Companies in the World

Cadbury India is the market leader in the chocolate confectionery

market with a 70% market share and is ranked number two in the total
food drinks market. Its popular brands include Cadbury's Dairy Milk, 5
Star, Eclairs, and Gems. The Rs.15.6 billion (USD 380 Million) Marico is
a leading Indian group in consumer products and services in the Global
Beauty and Wellness space.

Outlook

There is a huge growth potential for all the FMCG companies as the per
capita consumption of almost all products in the country is amongst
the lowest in the world. Again the demand or prospect could be
increased further if these companies can change the consumer's
mindset and offer new generation products. Earlier, Indian consumers
were using non-branded apparel, but today, clothes of different brands
are available and the same consumers are willing to pay more for
branded quality clothes. It's the quality, promotion and innovation of
products, which can drive many sectors.
 FINANCIAL ANALYSIS

LIQUIDITY RATIOS (SHORT- TERM LIQUIDITY)

Liquidity ratios measure the short term solvency, i.e., the firm’s 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 ratios under this group. They comprise of following
ratios:

• CURRENT RATIO OR WORKING CAPITAL RATIO

Current ratio is a relationship of current assets to current liabilities.

‘current assets’ means the assets that are either in the form of cash
or cash equivalents or can be converted into cash or cash equivalents
in short time(say within a year) like cash, bank balances, marketable
securities, sundry debtors, stock, bills receivables, prepaid expenses.
‘Current liabilities’ means liabilities repayable in as short time like
sundry creditors, bills payable, outstanding expenses, bank overdraft.

Computation. The ratio is calculated as follows:

Current ratio = Current assets

 Current liabilities

Objective.
• The ratio is mainly used to give an idea of the company's ability
to pay back its short-term liabilities with its short-term assets.

• The higher the current ratio, the more capable the company is of
paying its obligations. A ratio under 1 suggests that the
company would be unable to pay off its obligations if they came
due at that point.

• While this shows the company is not in good financial health, it

does not necessarily mean that it will go bankrupt - as there are
many ways to access financing - but it is definitely not a good
sign.

• The current ratio can give a sense of the efficiency of a

company's operating cycle or its ability to turn its product into
cash.

• An acceptable current ratio varies by industry. For most

industrial companies 1.5 is an acceptable CR. A standard CR for a
healthy business is close to 2.

• However, a blind 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 lower ratio
indicates lack of liquidity and shortage of working capital.

DS Kothari
Current ratio Group ITC HUL products
2008 2.35 1.60 0.66 3.48
Inference
DS Group is in a better position to meet its short term obligations as can be seen by a
current ratio. This is mainly due to high proportion of Loans & Advances and a
significantly low proportion of Debtors.
The CR in case of HUL is less than 1 implying that it would not be able to meet its
obligations if they fall due at that time since current liabilities exceed current assets
which is not a healthy proposition.
The ratio is acceptable in case of ITC.
For Kothari product the ratio is high mainly due to significantly high debtors and Loans
Advances.

• Liquid ratio or Quick ratio or Acid test ratio

Liquid ratio is a relationship of liquid assets with current liabilities. It is

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 short period.
Liquid assets are computed by deducting stock and prepaid expenses
from the 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 is as under:

Liquid ratio= Liquid assets

Current liabilities

Objective.
 • The ratio of current assets less inventories to total current
liabilities. This ratio is the most stringent measure of how well
the company is covering its short-term obligations, since the
ratio only considers that part of current assets which can be
turned into cash immediately (thus the exclusion of inventories).

• The ratio tells creditors how much of the company's short term
debt can be met by selling all the company's liquid assets at very
short notice. also called acid-test ratio.

• 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 as non-liquid portion of current assets is eliminated to
calculate the liquid assets. Thus it is a better indicator of
liquidity.

• 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.

DS Kothari
Quick Ratio Group ITC HUL products
2008 1.91 0.67 0.27 3.35

Inference
DS Group is better off than ITC and HUL in meeting the short -term debts by selling all
liquid assets of the company at a very short notice.
May be that ITC and HUL are indulged in over-trading. The company should try to keep
ratio greater than 1. Kothari product is also in an excellent position with a high Quick R
 SOLVENCY/LEVERAGE RATIOS (LONG-TERM
SOLVENCY)

The term ‘solvency’ implies ability of an enterprise to meet its long

term indebt ness and thus, solvency ratios convey the long term
financial prospects of the company. The shareholders, debenture
holders and other lenders of the long-term finance/term loans may be
basically interested in the ratios 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 equities) and the equity (internal equities).
Debt means long-term loans, i.e., debentures, public deposits, loans
(long term) from financial institutions. Equity means shareholder’s
funds, i.e., preference share capital, equity share capital, reserves less
losses and fictitious assets like preliminary expenses.

Computation. Te ratio is calculated as under:

Debt-Equity Ratio = Debt (Long-term Loans)

Equity (shareholder’s funds)

Objective.
• The objective of this 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.equity.
• 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.
• A high debt-equity ratio may indicate that the financial stake of
the creditors is more than that of the owners. A very high debt-
equity ratio may make the proposition of investment in the
organization a risky one.
• While a low ratio indicates safer financial position, a very low
ratio may mean that the borrowing capacity of the organization
is being underutilized.
• The debt/equity ratio also depends on the industry in which the
company operates. For example, capital-intensive industries
such as auto manufacturing tend to have a debt/equity ratio
above 2, while personal computer companies have a debt/equity
of under 0.5.
• The readers of financial management may remember that to
borrow the funds from outsiders is one of the best possible ways
to increase the earnings available to the equity shareholders,
basically due to two reasons:
a) The expectations of the creditors in the form of return on their
investment are comparatively less as compared to the returns
expected by the equity shareholders.

b) The return on investment paid to the creditors is a tax-deductible

expenditure.

Debt Equity DS
Ratio Group ITC HUL

2008 0.21 0.02 0.20

Inference
In ITC there is greater use of capital being supplied by the proprietor.
Borrowing capacity is being underutilised.
For DS Group and HUL the proportion of debt to shareholders fund is almost same.
However, there is greater use of long term debt in DS as compared to HUL.

• Total Assets to Debts Ratio

The total asset to debt ratio establishes a relationship between total

assets and the total long-term debts.
Total assets include fixed as well as current assets. However,
fictitious assets like preliminary expenses, underwriting commission,
share issue expenses, discount on issue of shares/debentures, etc.,
and debit balance of profit and loss account are not included. Long-
term debts refer to debts that will mature after one year. It includes
debentures, bonds, and loans from financial institutions.

Computation. This ratio is computed as under:

Total Assets to Debt Ratio = Total Assets

Long-term debts

Objective.
• This ratio is computed to measure the safety margin available to
the providers of long-term debts. It measures the extent of
coverage provided to long term debts by the assets o the firm.
• A higher ratio represents higher security to lenders for extending
the long-term loans to the business. On the other hand, a low
ratio represents a risky financial position as it means that the
business depends on outside loans for its existence.

Total Assets DS
to Debt Ratio Group ITC HUL

2008 6 79.48 64.58

Inference
In case of DS Group there is greater dependence on outside loans for financing the as
which is not a healthy sign.
In case of ITC there is greater safety margin available to the providers of long term de
In case of HUL it is satisfactory.
• Proprietary Ratio

The proprietary ratio establishes a relationship between proprietor’s

fund and total assets.
Proprietor’s fund means share capital plus reserves and surplus both of
capital and revenue nature. Loss, if any, should be deducted. Funds
payable to others should not be added.

Computation. This ratio is worked out as follows:

Proprietor’s Ratio = Proprietor’s Fund or Shareholders Fund

Total Assets

Objective.

 This ratio throws a light on the general financial position of the

concern. It shows the extent to which shareholders own the
business. This ratio is of particular importance to the creditors
as it helps them to ascertain the proportion of shareholder’s
funds in the total assets employed in the firm.
 The higher this Proprietary ratio denotes that the shareholders
have provided the funds to purchase the assets of the concern
instead of relying on other sources of funds like bank
borrowings, trade creditors and others.
 However, too high a proprietary ratio say 100%Â means that
management has not effectively utilize cheaper sources of
finance like trade and long term creditors. As these sources of
funds are cheaper, the inability to make use of it might lead to
lower earnings and hence a lower rate of dividend payout.
  This ratio is a test of credit strength as too low a proprietary
ratio would mean that the enterprise is relying a lot more on its
creditors to supply its working capital.

Proprietary DS Kothari
Ratio Group ITC HUL Products

2008 0.35 0.69 0.23 0.89

Inference
Highest ratio is for Kothari products indicating shareholders have provided majority of
to purchase the assets instead of relying on others sources of funds.
DS Group and HUL are majorly dependent on outsiders for funding the assets / workin
For ITC it is on a better side with major funding done by proprietors.
DS Group should increase the shareholders fund and try to bring the
ratio above 0.50.

• Total Debt Ratio

Total debt ratio is a relationship of Total Debt of a firm to its Capital

Employed.

Computation. This ratio is calculated as under.

Total Debt Ratio = Debt

Capital Employed
Objective.
 • A ratio that indicates what proportion of debt a company has
relative to its assets. The measure gives an idea to the leverage
of the company along with the potential risks the company faces
in terms of its debt-load.

• A debt ratio of greater than 1 indicates that a company has more

debt than assets, meanwhile, a debt ratio of less than 1 indicates
that a company has more assets than debt. Used in conjunction
with other measures of financial health, the debt ratio can help
investors determine a company's level of risk.

Total Debt DS
Ratio Group ITC HUL

2008 0.23 0.02 0.07

Inference
DS Group uses a greater proportion of debt as
compared to ITC and HUL.
ITC has a very low ratio debt ratio indicating there is more reliance on
capital provided
by the proprietors.

Fixed Assets to Capital Employed Ratio

Fixed assets to Capital employed ratio gives the amount of fixed assets
as a percentage of the capital employed of the company.
Computation. This ratio is calculated as follows:

Fixed Assets to Capital Employed = Net Fixed assets x 100

Capital Employed

Objective.
• This ratio indicates the extent to which the long term funds are
sunk into fixed assets.
• It has been an accepted principle of financial management that
not only fixed assets should be financed by way of long-term
loans but also a part of current assets or working capital should
be financed by way of long-term funds, and this part may be in
the form of permanent working capital.
• A very high trend of this ratio may indicate that a major portion
of long term funds is utilized for the purpose of fixed assets
leaving a small proportion for the investment in the current
assets or working capital.
• A very low trend of this ratio coupled with a constant declining
trend of current ratio may indicate an urgent for the introduction
of long-term funds for financing the working capital in the
business.

Fixed Assets
to Capital
Employed DS Kothari
Ratio Group ITC HUL Products

2008 0.13 1 1 1

Inference
This ratio indicates that a major portion of long-term funds is utilized
for the purpose of fixed assets leaving a small portion for the
investment in current assets or working capital. In DS group a small
proportion of capital employed is used for the purpose of fixed assets.

• Inventory to Net Working Capital Ratio

Inventory to Net working Capital Ratio tells how much of a company’s

funds are tied up in inventory.

Computation. The formula is as under:

Inventory to Net Working Capital = Inventory

Net Working Capital

Objective.

• Keeping track of inventory levels is crucial to determine the

financial health of a business.
• It is preferable to run a business as little inventory as possible on
hand, while not affecting potential sales opportunities.
• If this ratio is high compared to the average for the industry, it
could mean that the business is carrying too much inventory.

Inventory to
Net Working DS Kothari
Capital Ratio Group ITC HUL Products

2008 0.33 1.56 - 0.05

Inference
In DS Group Inventory form nearly one-third of the working capital
unlike in ITC where Inventories form majority of the Working capital
which is not a healthy proposition.

PROFITABILITY RATIOS

Profit as compared to the capital employed indicated profitability of the

concern. A measure of ‘profitability’ is the overall measure of
efficiency. The different profitability ratios are as follows:

• 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 administratitive and marketing

expenses, finance charges and making adjustments for non-operating
expenses and incomes.

Computation. This ratio is calculated as follows:

Net Profit ratio = Net Profit after taxes x 100

Net Sales
Objective.
• The net profit ratio determines the overall efficiency of the
business.It indicates that proportion of sales available to the
owners after the consideration of all types of expenses and costs
– either operating or non-operating or normal or abnormal.
• A high net profit indicates profitability of the business. Hence,
higher the ratio, the better the business is.

Net Profit DS Kothari

Ratio Group ITC HUL Products
 2008 0.11 0.22 0.14 0.38

Inference
Kothari product has been able to generate a high Net profit ratio
among the four.
For DS Group the ratio is on a lower side so it should aim to
achieve a higher ratio.

COVERAGE RATIOS

• Interest Coverage Ratio

The interest coverage Ratio establishes the relationship between PBIT

(Profits before interest and taxes) and Debt interest.

Computation. It is calculated as:

Interest Coverage Ratio = Profit before Interest and Taxes

Debt Interest

The numerator considers the profit before income tax and interest on
both term and working capital borrowings.
The denominator considers the interest charges, which are in the form
of interest on long-term borrowings and not the interest on working
capital facilities.

Objective.
 Interest coverage is a financial ratio that provides a quick picture
of a company’s ability to pay the interest charges on its debt.
  The 'coverage' aspect of the ratio indicates how many times the
interest could be paid from available earnings, thereby providing
a sense of the safety margin a company has for paying its
interest for any period.

 A company that sustains earnings well above its interest

requirements is in an excellent position to weather possible
financial storms.

 As a general rule of thumb, investors should not own a stock that

has an interest coverage ratio under 1.5. An interest coverage
ratio below 1.0 indicates the business is having difficulties
generating the cash necessary to pay its interest obligations.

 The ratio suffers from the following limitations:

a) The fixed obligations in the form of preference dividend or

installments of long-term borrowings are not considered.
b) The funds available for meeting the obligations of interest
payments may not be necessarily in the form of p[profits before
interest and taxes only, as the amount of [profits so calculated
may consider the amount of depreciation debited to Profit and
Loss Account which does not involve any outflow of funds.

Interest Coverage Kothari

Ratio DS Group ITC HUL Products

2008 4 41.37 74.48 361.63

Inference
Maximum interest coverage is available in case of HUL indicating it is in good capacity
the interest charges on debt. For ITC it is also good.
However, in case of DS Group it is lowest. All companies have been able to generate e
Profit necessary to meet their interest obligations.

This ratio indicates that the cash available for the repayment of the
interest will be more than profit, as depreciation will also be added in
profit (because it is a non-cash expense). So rather than maintaining
such high cash firm should try to reinvest its earnings rather then
blocking the available resources.

ACTIVITY (TURNOVER OR PERFORMANCE) RATIOS

Turnover indicates the speed with which capital employed is rotated in

the process of doing business. Activity ratios measure the
effectiveness with which a concern uses resources at its disposal. The
following are the important activity (turnover or performance) ratios:

• Capital Turnover Ratio

Capital Turnover ratio establishes between the Net Sales and the
Capital Employed of a firm.

Computation. This ratio is computed with the help of the following

formula:

Capital turnover ratio = Net sales

Capital Employed

Objective.
 This ratio indicates the effectives of the organization with which
the capital employed is being utilized.
 A high capital turnover ratio indicates the capability of the
organization to achieve maximum sales with minimum amount of
capital employed. It indicates that the capital turnover ratio
better will be the situation.

Capital Turnover DS Group ITC HUL Kothari

Ratio Products

2008 0.57 1.17 9.11 0.30

Inference
In DS Group and kothari products capital employed is not being utilised effectively to g
maximum sales. In case of ITC it is satisfactory.
Capital employed is utilised most effectively in case of HUL as it has been successfully
generate good amount of sales with the capital employed.

Capital turnover ratio indicates that the firm’s capital employed is

being efficiently used. This ratio indicates that the organization is able
to achieve maximum sales with minimum amount of capital employed.
It indicates that the capital employed is turned over in the form of
sales more number of times.

• Working Capital Turnover Ratio

The working capital turnover ratio indicates the number of times a unit
invested in working capital produces sale. In other words, this ratio
shows the efficiency in the use of short-term funds for achieving sales.

Working capital is computed by deducting current liabilities from

current assets. A careful handling of the short-term assets and funds
will mean a reduction in the amount of capital employed thereby
improving turnover.

Computation. The ratio is calculated as follows:

Working capital turnover ratio = Net sales

Working capital

Objective.
 A company uses working capital (current assets - current
liabilities) to fund operations and purchase inventory. These
operations and inventory are then converted into sales revenue
for the company.
  The working capital turnover ratio is used to analyze the
relationship between the money used to fund operations and the
sales generated from these operations.

 In a general sense, the higher the working capital turnover, the

better because it means that the company is generating a lot of
sales compared to the money it uses to fund the sales.

 A high, or increasing Working Capital Turnover is usually a

positive sign, showing the company is better able to generate
sales from its Working Capital. Either the company has been
able to gain more Net Sales with the same or smaller amount of
Working Capital, or it has been able to reduce its Working Capital
while being able to maintain its sales.

 As such, higher this ratio, the better will be the situation.

However, a very high ratio may indicate overtrading – the
working capital being meager for the scale of operations.

Working Capital Kothari

Turnover Ratio DS Group ITC HUL Products

2008 1.44 5.35 -7.84 0.93

Inference
For HUL it is coming out to be negative. In ITC there is better use of
working capital for
generating sales.
In DS Group the management needs to utilize the working capital in a better
manner so
that it can increase the sales.
• Inventory Turnover ratios

a) Raw Material Inventory Turnover

Computation. This ratio is calculated as follows:

Raw Material Inventory Turnover Ratio = Raw Material

Consumed
Average Raw Material
Inventory

Raw Material
Inventory DS Kothari
Turnover Group ITC HUL Products

2008 3.24 1.45 2.34 10.72

Inference
Raw material inventory turnover ratio is increasing for the DS
Group. Which indicates the increasing efficiency in the management
of the inventory This shows that the company is having sufficient of
sales.

b) Finished goods Inventory Turnover

Computation. This ratio is calculated as follows:

Net sales
Average Finished Goods Inventory

Finished Goods DS Group ITC HUL

 Inventory
Turnover

2008 26.42 13.36 18.70

Objective.
• A high inventory turnover ratio indicates that maximum sales
turnover is achieved with the minimum investment in inventory. As
such, as a general rule, high inventory turnover ratio is desirable.
• However, the high inventory turnover ratio should be viewed from
some more angles. Firstly, it may indicate that there is under
investment in inventory whereby the organization may loose
customer patronage f it is unable to maintain the delivery
schedule. Secondly, high inventory turnover ratio may not
necessarily indicate profitable situation.
• An organization, in order to achieve a large sales volume, may
sometimes sacrifice on profits, whereby a high inventory turnover
ratio may not result into high amount of profits.

On the other hand, a low inventory turnover ratio may indicate over
investment in inventory, existence of excessive or obsolete/non-
moving inventory, improper inventory management, accumulation
of inventories at the year end in anticipation of increased prices or
sales volume in near future and so on.
There can be no standard inventory turnover ratio which may be
considered ideal. It may depend on nature of industry and
marketing strategies followed by the organization.

Inference
DS Group has the highest ratio among the category which is a good
sign as it indicates the increasing efficiency in the management of
the inventory. This shows that the company is having sufficient
amount of sales. This ratio indicates that maximum sales turnover is
achieved with the minimum investment in inventory.
• Assets Turnover Ratios

 Asset turnover measures a firm's efficiency at using its assets in

generating sales or revenue - the higher the number the better.
 It also indicates pricing strategy: companies with low profit
margins tend to have high asset turnover, while those with high
profit margins have low asset turnover.
 A high Assets turnover ratio 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. S such, higher the
ratio, better will be the situation.

a) Total Assets Turnover

Computation. This ratio is computed using the following formula:

Total Assets Turnover Ratio = Net Sales

Total Assets

Total Assets DS Kothari

Turnover Group ITC HUL Products

2008 0.44 0.83 2.11 0.27

b) Fixed Assets Turnover

Computation. This ratio is calculated as follows:

Fixed Assets Turnover Ratio = Net Sales

Fixed Assets
 Fixed assets include net fixed assets, i.e., fixed assets after
providing for depreciation

Fixed Assets DS Kothari

Turnover Group ITC HUL Products

2008 4.40 1.87 7.96 7.17

c) Current Assets Turnover

Computation. This ratio is calculated s follows:

Current Assets turnover Ratio = Net Sales

Current Assets

Objective.
• A high Assets turnover ratio 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. S such, higher the ratio, better will be the
situation.

Current
Assets DS Kothari
Turnover Group ITC HUL Products

2008 0.82 2.00 4.07 0.67

• Debtors Turnover Ratio

Computation. The ratio will be computed as:

Debtors Turnover ratio = Net credit sales

Average sundry debtors

Objective.
• This ratio indicates the speed at which the sundry debtors are
converted in the form of cash. However this intention is not
correctly achieved by making the calculations in this way.

Debtors turnover Kothari

Ratio DS Group ITC HUL Products

2008 43 18 29 5

As such this ratio is normally supported by the calculations of Average

Collection Period which is calculated as under:

a) Calculation of Daily Sales

Net credit Sales

No of Working Day

Kothari
Daily Sales DS Group ITC HUL Products

2008 151 4016 3812 47

Inference
 It is highest in case of ITC followed by HUL and DS Group
respectively.

b) Calculation of Average Collection Period:

Average Sundry Debtors

Daily Sales

The average collection period as computed above should be compared

with the normal credit period extended to the customers. If the
average collection period is more than normal credit period allowed to
the customers, it may indicate over investment in debtors which may
be the result of over-extension of credit period, liberalization of credit
terms and ineffective collection procedures.

Average Kothari
Collection Period DS Group ITC HUL Products

2008 8 20 12 74

Inference
The firm should try to reduce its debtors holding period . By this, the
funds which are blocked with the customers, and hence are becoming
idle, can be reduced and that money can be utilized for other profitable
purposes.

• Creditors Turnover Ratio

Creditors DS
Turnover Ratio Group ITC HUL

2008 6.30 1.97 1.64

 Creditor Days DS Group ITC HUL

2008 57 182 219

Inference
The firm is having low credit holding period it can try to increase
is so that, those funds can remain with it for a longer period and
can be utilized for fulfilling the working capital requirement. For
this purpose firm can use little strict credit standards it can also
adopt discount policy.

RETURN ON INVESTMENT

The ratios computed in this group indicate the relationship between

the profits of a firm and investment in the firm. There can be three
ways in which the term ‘investment’ may be interpreted, i.e., Assets,
Capital Employed and Shareholder’s Funds. As such, there can be
three broad classifications of ROI:

Return on Assets (ROA)

Computation. This ratio is calculated as:

ROA = EBIT
Average Total Assets

Objective.
 An indicator of how profitable a company is relative to its total
assets. ROA gives an idea as to how efficient management is at
using its assets to generate earnings.
  The assets of the company are comprised of both debt and
equity. Both of these types of financing are used to fund the
operations of the company. The ROA figure gives investors an
idea of how effectively the company is converting the money it
has to invest into net income.

 The higher the ROA number, the better, because the company is
earning more money on less investment.

Return on Assets Kothari

(ROA) DS Group ITC HUL Products

2008 0.07 0.29 0.29 0.13

Inference
For ITC and HUL it is on same side indicating that assets have been
utilised well to generate earnings.
In case of DS Group and kothari products it is on a lower side so the management nee
make sure it utilises the assets well enough to generate good earnings.

• Return on Capital Employed (ROCE)

Computation. The ratio is calculated as:

Profit Before Interest & Taxes x 100

Average Capital employed

Objective.

 It is used in finance as a measure of the returns that a company

is realising from its capital employed.
  It is commonly used as a measure for comparing the
performance between businesses and for assessing whether a
business generates enough returns to pay for its cost of capital.
 ROCE 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.

Return on Capital Kothari

Employed DS Group ITC HUL Products

2008 0.09 0.38 1.01 0.14

Inference
A high ratio in case of HUL indicates a better and profitable use of long term funds of
owners
and creditors.
In case of ITC it is satisfactory. However, for DS Group and kothari products it is
low.
• Return on Shareholder’s Funds

It is calculated as:

Profit After Tax x 100

Shareholder’s funds

• This is the most popular ratio to measure whether the firm has
earned sufficient returns for its shareholders or not. As such, this
ratio is the most crucial one from the owners/shareholders point
of view. Higher the ratio better will be the situation.

DS Kothari
Return On Equity Group ITC HUL Products

2008 0.13 0.26 1.28 0.11

Inference
HUL has been able to generate exceptionally high ROSF. Higher the return more
satisfied
will be the shareholders.
For DS Group and ITC it is good but slightly on a lower side. Kothari product has the lo
return among the category.

INVESTOR RATIOS

• Earnings per Share (EPS)

Computation. The ratio is calculated as:

Net Profit after Taxes – preference Dividend

Number of Equity shares Outstanding

Objective.
• It is 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 profits and not on the basis of retained
profits.
• As such, increasing EPS may indicate the increasing trend of
current [profits per equity share. However, EPS does not indicate
how much of the earnings are paid to the owners by way of
dividend and how much of the earnings are retained in the
business.

Earnings per DS Kothari

share (Rs.) Group ITC HUL Products

2008 26.99 8.39 8.69 97.19

 CONCEPTS OF WORKING CAPITAL

There are two concepts of working capital – Gross and Net

• Gross Working Capital refers to the firm’s 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
receivables or book debts) and stock.

• Net Working Capital refers 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 asset exceed current
liabilities. A negative net 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:
a) How to optimize investment in current assets?
b) How should current assets be financed?

The considerations of the level of investment in current assets should

avoid two danger points- excessive or inadequate investment 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 firm’s profitability, as idle
investment earns nothing. On the other hand, inadequate amount of
working capital can threaten solvency of the firm because of its
inability to meet its current obligations. It should e 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 imbalances.
Another aspect of the gross working capital points to the need of
arranging funds to finance current assets. Whenever a need for
working capital funds arises due to the increasing level of business
activity or for nay other reason, financing arrangement 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 temporarily are invested.

Focusing on Liquidity management

Net working capital is a qualitative concept. It indicates 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 at a higher
level than current liabilities. However, the quality of current assets
should be considered in determining level of current assets vis-à-vis
current liabilities. A weak liquidity position possesses a threat to the
solvency of the company and makes it unsafe and unsound. A negative
working capital means a negative liquidity, and may prove to be
harmful for the company’s reputation. Excessive liquidity is also bad. It
may be due to mismanagement of current assets. Therefore, prompt
and timely action should be taken by management to improve and
correct the imbalances in the liquidity position of the firm.

For every firm, there is a minimum amount of net working capital,

which is permanent. Therefore, a portion of working capital should be
financed with permanent sources of funds such as equity share capital,
debentures, long-term debt, preference share capital or retained
earnings. Management must, therefore, decide the extent to which the
current assets should be financed with equity capital or borrowed
capital.

It may be emphasized that both gross and net concepts of working

capital are equally important for the efficient management of working
capital. There is no precise way to determine the exact amount of
gross or net working capital of a firm. A judicious mix of long and short
term finances should be invested in current assets. Since current
assets involve cost of funds, they should be put to productive use.

OPERATING AND CASH CONVERSION CYCLE

A firm should aim at maximizing the wealth of its shareholders, so the

firm should earn sufficient returns from 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 in a
year. Investment in current assets such as inventories and debtors
(accounts receivable) is realized during the firm’s operating cycle that
is usually less than a 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, labor power
and fuel etc.
• Manufacture of the product which includes conversion of raw
materials into work-in-progress into finished goods.
• Sale of the product either 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, on the other
hand, are relatively certain. The firm is, therefore, required to invest in
current assets for a 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.
Stocks 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 grass operating cycle of a manufacturing concern is the sum of

Inventory Conversion Period and debtors (receivable) conversion
period. Thus, Gross Operating Cycle is gives as follows:
 Inventory conversion Period + Debtors Conversion Period

Inventory Conversion Period:

The 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, and (3) finished goods
conversion period.

• Raw material conversion period

The raw material conversion period 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 par 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

Work-in-progress conversion period is the average time taken to

complete the semi-finished or work-in-progress. It is given by the
following formula:

Work-in-progress conversion period = work-in-progress inventory

[Cost of production]/360

• Finished goods conversion period

Finished goods conversion period is the average time taken to sell the
finished goods. It can be calculated as follows-

Finished goods inventory

 [Cost of goods sold]/360

Debtor’s conversion period:

Debtor’s conversion period is the average time taken to convert

debtors into cash. It represents the average collection period. It is
calculated as follows:

Debtors
[Credit sales]/360

b) cash conversion or Net operating cycle

Net operating cycle is the difference between Gross operating cycle

and creditors (payables) Deferral period.

Creditor’s deferral period:

Creditor’s deferral period is the average time taken by the firm in

paying its suppliers. It is calculated as follows:

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 in current assets. The creditor’s deferral period
is the length of time the firm is able to defer payments on various
resource purchases.

Net operating cycle is also referred to as cash conversion cycle. It is

the net time interval between cash collections from 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 firm’s
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 calculations of cash conversion cycle. One is

that depreciation and profit should be excluded in the computation of
cash conversion cycle since the firm’s concern is with cash flows
associated with conversion at cost; depreciation is a non-cash item and
profits re not costs.
A contrary view air 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 concept relates 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 not have inventory of goods
(cash will be their inventory). Their operating cycles will be the
shortest. They need to acquire cash, then lend (create debtors) and
again convert lending into cash.

BALANCED WORKING CAPITAL POSITION

The firm should maintain a sound working capital position. It should

have adequate working capital to run its business operations. Both
excessive as well as inadequate working capital positions are
dangerous from the firm’s point of view.
Excessive working capital means holding costs and idle funds,
which earn no profits for the firm. The dangers of excessive working
capital are as follows:

• It results in unnecessary accumulation of inventories. Thus,

chances of inventory mishandling, waste, theft and losses
increase.
• It is an indication of defective credit policy and slack collection
period. Consequently, higher incidence of bad debts results,
which adversely affects profits.
 • Excessive working capital makes management complacent which
degenerates into managerial inefficiency.
• Tendencies of accumulating inventories tend to make
speculative profits grow. This may tend to make dividend policy
liberal and difficult to cope with in future when the firm is unable
to make speculative profits.

Inadequate working capital is also bad as it not only impairs the

firm’s profitability but also results in production interrupts and in
efficiencies and sales disruptions. Inadequate working has the
following dangers:

• It stagnates growth. It becomes difficult for the firm to undertake

profitable projects for non-availability of working capital funds.
• It becomes difficult to implement operating plans and achieve
the firm’s profit target.
• Operating inefficiencies creep in when it becomes difficult even
to meet day-to-day commitments.
• Fixed assets are not efficiently utilized for the lack of working
capital funds
• Paucity of working capital funds render the firm unable to avail
attractive credit opportunities etc.
• The firm looses its reputation when it is not in a position to honor
its short-term obligations. As a result, the firm faces tight credit
terms.

An enlightened management should, therefore maintain the right

amount of working capital on a continuous basis. A firm’s net working
capital position is not only important as an index of liquidity but it is
also used as a measure of the firm’s risk. Risk in this regard means
chances of the firm’s being unable to meet its obligation on due date.
The lenders consider a positive net working capital as a measure of
safety. All other things being equal, the more the net working capital a
firm has, the less likely that it will default in meeting it current financial
obligations.

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

highly 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
who may not be inclined to wait because other manufactures 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 working capital requirements
tend to be high because of greater investment in finished goods
inventory and account receivables. On the other hand, a monopolistic
firm may not require larger working capital. It may ask customer to pay
in advance or to wait for some time after placing the order.

Conditions of Supply:
The time taken by a supplier of raw materials, 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 f that good.
Otherwise, larger inventories should be kept e.g. in case of imported
goods.

Business Cycle Fluctuations:

Different phases of business cycle i.e., boom, recession, recovery etc.
also effect 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 wor5king 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 o
the market. For example, a firm might be purchasing goods and
services on credit terms but selling goods only for cash. The working
capital requirement 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 weighted relatively to
determine the working capital requirement.
Further, the determination of working capital requirement is not once a
whole 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 sources 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 manager’s 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 of collecting their dues debtors.
Further, the role of current liabilities is more significant in case of
small firms, as, unlike large firms, they face difficulties in raising
long-term finances.
• Growth. The need for working capital is directly related to the
firm’s 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.

Liquidity vs. Profitability: Risk-Return Trade-off

A large 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 mea interrupted production
and sales, because of frequent stock-outs and inability to pay creditors
in time due to restrictive policy.
Given a firm’s technology and production policy, sales and demand
conditions, operating efficiency etc., its current assets holdings will
depend upon its working capital 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. Solvency, used in the technical sense,
refers to the firm’s continuous ability to meet maturing obligations. If
the fir maintains a relatively large investment in current assets, it will
have no difficulty in paying claims of creditors when they become due
and will 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 firm’s will be tied up in current assets, and
to the extent this investment is idle, the firm’s 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.

ESTIMATING WORKIN CAPITAL NEEDS

• Current Assets Holding Period. To estimate working capital

requirement on the basis of average holding period of current
assets and relating them to costs based on the company’s
experience in the previous 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 change with sales

• Ratio of Fixed Investment. To estimate working capital

requirements as a percentage of fixed investment.
POLICIES FOR FINANCING FIXED ASSETS

A firm can adopt different financing policies vis-à-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 (retained earnings).

• Short-Term Financing. The short-term financing is obtained for

a period less than one year. It is arranged in advance from banks
and other surplus of short-term finance in the money market. It
includes working capital funds from banks, public deposits,
commercial paper, 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 (supplier’s) credit and outstanding expenses are examples
of spontaneous financing.

The real choice of financing current assets, once the spontaneous

sources of 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 refereed 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 the assets, the source of financing for short-term
assets is expensive, as funds will not be utilized for the full period.
Similarly, financing the 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.

Temporary Current Assets Short-term financing

Current Assets

Permanent Current Assets Long-term financing

The above figure illustrated the matching approach over time. The
firm’s fixed assets and permanent current assets are financed with
long-term funds and as the level of these assets increases, the long-
term financing level also increases. The temporary or variable current
assets are financed with short-term funds and as their level increases,
the level of short-term financing also increases.

Conservative approach

Under a conservative plan, the firm finances its permanent assets and
also a part of temporary currents assets with long-term financing. In
the periods when the firm has no need for temporary current assets,
the idle long-term funds can be invested in the tradable securities to
conserve liquidity. The conservative plan relies heavily on long-term
financing and, therefore, the firm has less risk of facing the problem of
shortage of funds.

Temporary current assets Short-term

Financing
Current Assets (b)
(a)

Permanent current assets

Fixed assets Long-term

Financing

Time

The above figure illustrates conservative approach over time. It can be

seen that when the firm has no temporary current assets [e.g., at (a)
and (b)], the long-term funds released can be invested in marketable
securities to build up the liquidity position of the firm.

Aggressive approach

An aggressive approach 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.

Temporary current assets

Short-term
Financing
Current
Assets (b)
(a)

Permanent current assets Long-term

financing

Fixed Assets

Time

INVENTORY MANAGEMENT
  INTRODUCTION: Inventories constitute the most significant part
of current assets of a; large number majority of companies in
India. On an average, inventories are approximately 60 % of
current assets in public limited companies in India. Because of
the large size of the inventories maintained by the firm, a
considerable amount of funds is required to be committed to
them. It is, therefore, absolutely imperative to manage
inventories efficiently and effectively in order to avoid
unnecessary investment.

Inventories are stock of the product a company is manufacturing for

sale and components that make up the product. The various forms in
which inventories exist in a manufacturing company are:

 Raw materials are those basis inputs that re converted into

finished product through the manufacturing process. Raw
materials inventories are those units, which have been
purchased and stored for future productions.

 Work-in-progress inventories are semi-manufactured products.

They represent those products that need more work before they
become finished products for sale.

 Finished goods inventories are those completely manufactured

products, which are ready for sale. Stocks of the raw materials
and work-in-process facilitate production, while stock of finished
goods is required for smooth marketing operations. Thus the
inventories serve as a link between the production and the
consumption of goods.

The levels of the three kinds of inventories for the firm depend on the
nature of the business. A manufacturing firm will have substantially
high level of finished goods inventories and no raw material and work-
in progress inventories within manufacturing firm, there will be
differences.

THE OPERATING CYCLE AND WORKING CAPITAL

The working capital requirement of a firm depends, to a great extent
up on operating cycle of the firm. The operating cycle may be defined
as the time duration starting from the procurement of goods or raw
material 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 cycle form:

 Purchase of raw materials

 payment of raw materials
 sale of finished goods
 collection of cash for sales

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 receivables conversion period.

A) Inventory Conversion period (ICP): The time lag

between the purchase of raw material and the sale of
finished goods is the inventory conversion period. In the
manufacturing firm ICP consists of raw materials
conversion period (RPCP), work-in-progress 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 by the production
department. The WPCP refers to the period for which the raw
material remains in the production process before it is taken
out s a finished product. The FGCP refers to the period for
which finished goods remain in stores before being sold to a
customer.

B) 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.
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 o a
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 fro the
TOCP. NOC is also known as cash cycle.

RMCP = (AVG. raw material stock/ Total raw materials stock)*365

WPCP = (avg. work-in process/ Total work-in-process)*365
FGCP = (Avg. finished goods/ Total cost of goods sold)*365
RCP = (Avg. receivables / Total credit purchase)*365
DP = (Avg. creditors / Total credit purchase)*365

In respect of these formulations, the following points are note worthy:

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 “365” represents number of days in a year. It may also be
taken as “360” for the ease of calculation.
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, ad FGCP. The denominator is
calculated at cost-basis and the profit margin has been excluded. The
reason big that there is no investment of funds in profit as such.

The working capital ratios are calculated for the Birla Powers’s solutions ltd.
and final holding month for the inventories, debtors and creditors are given
below in the table.

Working Capital
For the year 2005

Total Operating Cycle = RMCP + WP/FGCP + RCP

= .48 + .37 + 1.79
= 2.64

Net Operating Cycle = TOC – DP

= 2.64 - .57
= 2.07

WORKING CAPITAL LIMITS

FUND BASED CREDIT LIMITS

1. CASH CREDIT/PACKING CREDIT:

The cash credit facility is similar to the overdraft arrangement. It is the most
poplar method of bank finance for working capital in India. Under the cash
credit facility, a borrower is allowed to withdraw funs from the bank up to the
cash credit limit. He is not required to borrow the entire sanctioned credit
once, rather, he can draw periodically to the extent of his requirement and
repay by depositing surplus funds in his cash credit account. Cash credit is
sanctioned against the security of current assets. Cash credit is the most
flexible arrangement from the borrower’s point of view.

2. DISCOUNTING OF BILLS

Under the purchase or discounting of bills, a borrower can obtain credit from
a bank against its bills. The bank purchase or discounts the borrower’s bills.
He amount provided under this agreement is covered within the overall cash
credit or overdraft limit
Before purchasing or discounting the bills, the bank satisfies itself as credit
worthiness of the drawer. Though, the item “bills purchased” implies that the
bank becomes owner of the bill. In practice, bank hold bills as security for the
credit. When a bill is discounted, the borrower is paid he discounted amount
of the bills, (visa, full amount of bill minus the discount charged by the bank).
The bank collects full amount on maturity. The major part of bank borrowings
comes through Discounting Bills. On this firm has to pay interest of 12%.

NON-FUND BASED

1. LETTER OF CREDIT
Commonly used in international trade, the letter o credit is now used in
domestic trade as well. A letter of credit, or L/C, is used by a bank on
behalf of its customers (buyer) to the seller. As per this document, the
bank agrees to honor drafts on it for the supplies made to the customer if
the seller fulfills the conditions laid down in the L/C.
The L/C serves several useful functions:

(i) It virtually eliminates credit risk, if the bank has a good standing.
(ii) It reduces uncertainty, as the seller knows the conditions that
should be fulfilled receive payment.
(iii) It offers safety to the buyer who wants to ensure that payment is
made only in conformity with the conditions of the L/C.

Letter of credit is non-fund based source credit that is why it is available at

very low rate i.e. 0.5%.

2. BANK GURANTEE
Bank Guarantee is very similar to Letter of Credit but it is provided for
much longer period compared to letter of credit. Very small portion of
working capital is funded by Bank Guarantee.

OBSERVATIONS

Audited Estim. Projn.

Audited 2004 2005 2006 2007
TOP
(months) 2.89 2.84 2.89 2.93
NOP
(months) 2.22 2.07 2.22 2.27
  Birla power solutions ltd. is having low holding period for the
inventories which shows that it is following aggressive policy, which
might result in loss of sales.
Therefore, in my opinion the firm should try to shift towards more
“conservative policy”. The selection of right kind of policy is very
necessary for the full utilization of fixed assets. Because of low inventory
level, the firm may not be able to fulfill its customers’ instantaneous
needs.

2005 2006 2007

Average collection period/debtors holding period
(days) 99.54 97.31 50.56

 The firm should try to reduce its debtor holding period especially
domestic debtor holing period which is slightly high (i.e. approx. 50
days for the year 2005). By this, the funds, which are blocked with
the customers, and hence are becoming idle, can be reduced and
tat money can be utilized for other profitable purposes.
2005 2006 2007
creditor days/ credit holding
period 27.91 48.5 33.53

 The firm is having low credit holding period it can try to increase is
so that, those funds can remain with it for a longer period n can be
utilized for fulfilling the working capital requirements. For this
purpose firm can be little strict credit standards it can also adopt
discount policy.

RECOMMENDATIONS

Current assets to fixed assets ratio

Birla Power Solutions Ltd. should determine the optimal level of

current assets so that the wealth of the shareholder’s is maximized.
It needs current assets and fixed assets to support a particular level
of current assets. As the firm’s output and sales are increasing and
 will also increase in projected year 2007, it shows that company
needs to increase the current assets.

The level of current assets can be measured by relating current

assets to fixed assets. Dividing current assets by fixed assets vs.
CA/FA ratio. Assuming a constant level of fixed assets, a higher
CA/FA ratio indicates a conservative assets policy and a lower CA/FA
ratio means an aggressive current policy other factors remaining
constant.

audited audited audited estimated projn.

year 2005 2006 2007 2008 2009
Current assets 27802.88 24986.64 32012.72 37672 42004
Fixed assets 61493.38 74792.63 75426.93 73579 71524
CA/FA 0.45 0.33 0.42 0.51 0.59

Company has an aggressive policy till 2005. This implies that

company is incurring high risk and low liquidity but in projected year
2007 company is moving from aggressive policy to conservative
policy in which there will be greater liquidity and lower risk. So I
would suggest the company to maintain conservative policy rather
than the aggressive one so as to cope up with the anticipated
changes and operating condition.

Current assets Financing Policy

Two types of policies- conservative which depends upon long-term

sources like debentures and aggressive which depends heavily
upon short term bank finance and seek to reduce dependence on
long term financing are suggested. The following table shows the
ratio between the long term and short term sources for Birla Power
Solutions ltd.

Conservative policy on one hand reduces the risk that the firm will
be unable to repay or replace its short-term debt periodically. It,
however, enhances the cost of financing because the long term
sources of finance, debt and equity, have a higher cost associated
with them. In 2005 the financial charges were Rs. 3477 lacks which
decreased to Rs. 2284 lacks in 2005 in 2006 it is estimated to be Rs.
2261 lacks. Hence it would be suggested to go for more short- term
financing as it may reduce the interest cost which will increase
profitability in return.

The Cost Trade Off

It is a different way of looking into risk-return trade off in terms of

the cost of maintaining a particular level of current assets. There
are two types of cost involved—the cost of liquidity and the cost of
illiquidity
If the firm’s level of current assets is very high, then it has
excessive liquidity. Its return on assets will be low, as funds tied up
in idle cash and stocks earn nothing and high level of debtors
reduces profitability. Thus, the cost increases with the level of
current assets.

The cost of illiquidity is the cost of holding insufficient current

assets. Birla power solutions Ltd. is presently not in a position to
honor its obligations because it carries too little cash. This may
force Birla Power ltd to borrow at high rate of interest. This will
adversely affect the credit worthiness of Birla Power ltd.
Thus company should maintain its current asse6s at the level where
the sum of both-cost of liquidity and cost of illiquidity is minimized.

Flexibility
It is relatively easy to refund short-term funds when for funds
diminishes. Long-term funds such as debenture loan or preference
capital cannot be refunded before time. Hence, Birla power ltd.
Should try to anticipate more in short-term funds than long-term
funds as it will reduce the interest rate and will increase the
liquidity.

Reduce the Operating cycle

Birla Power ltd. Should try to reduce its operating cycle. In year
ended 2005 company debtor collection period is 50 days. It shows
that company collecting period is very high. That’s why
unnecessarily company blocked its money with debtors. Hence
company should try to adopt new policies like cash credit policy and
discount credit policy.

BIBLIOGRAPHY

 I.M PANDEY
 Financial mgt using Financial modeling by Ruzbeh J.
Bodhanwala
  M.Y KHAN
 R.P Rustogi

Synopsis of the project

Birla Power Solutions Ltd.
Student’s Name:
Industry Guide:
Faculty Guide:
Objective.
• The project is aimed at evaluating the financial status of Birla
Power and then doing the comparative analysis with its
competitors
• Studying the working capital management at Birla Power
and estimating the working capital requirements for 2007-2008
and then forecasting for 2008-2009
• To find out if there is any relationship between the working
capital, sales and current assets of Birla Power

The project deals with the working capital management in Birla Power
solutions ltd. For the study of working capital in the first of all I have
looked on the company profile,
Because working capital requirements may differ vastly according to
the profile of industry. Then I will analyze the working capital
management and fulfillment policies of the company.

Birla Power deals with the production of gensets

Working capital, also called as net current assets, is the excess of
current assets over current liabilities. The efficient management of
working capital is important from the point of view of both liquidity and
profitability. Working capital management may be defined as the
management of firm’s resources and use of working capital in order to
maximize the wealth of shareholders.

A firm should maintain a sound working capital position and there

should be optimum investment in the working capital, working capital
refers to the administration of current assets, namely cash, marketable
securities, debtors, stock (inventories) and current liabilities.

The project will be dealing with the various components of working

capital i.e.

a) Raw Materials
b) Work-in-progress
c) Finished goods
d) Receivables etc.
An industry had s to hold raw materials and work-in-progress (semi-
finished goods) to maintain production flow and finished goods to meet
the timely needs of its customers. The working capital requirement is,
therefore, directly linked with the inventory and the time taken by the
purchasers of the goods to pay the account.

Inventory management involves a trade-of between the costs

associated with the keeping inventory versus the benefit of holding
inventory. Higher inventory results in increased cost from storage,
insurance, spoilage and interest on borrowed funds needed to finance
inventory acquisition. However, an increase in inventory lowers the
possibility of the loss of sales due to stock outs and the incidence of
production slowdowns from inadequate inventory.

Accounts receivables arise due to credit sales affected y the firm.

While it may appear advisable to sale against cash only, conditions in
the market like a highly competitive one, might compel a company to
give credit in order to affect sales. Moreover, extending the credit
often results in higher sales and hence higher profits. These
receivables are influenced by a number of factors like credit policy,
market strategy, pricing policy, type of buyers, credit allowed by the
competitors, etc.

Calculation of operating cycle period and its analysis will also be

apart of this project. The working capital requirement of the firm
depends, to a large extent upon the operating cycle of the firm. The
operating cycle may be defined as the time duration starting from the
procurement of the goods or raw material and ending with the sales
realization.

The operating cycle consists of the time required for the completion of
the chronological sequence of some or all of the following:

i) procurement of raw material and services

ii) conversion of raw material into work-in-progress
iii) conversion of work-in-progress in finished goods
iv) Sale of finished goods
v) Conversion of receivables into cash.
Operating cycle period: The length or the time period of the
operating cycle of any firm can be defined as the sum of its inventory
conversion period and the receivables conversion period.

a) Inventory conversion period: It is the time required for the

conversion
of the raw material into finished goods sales. In the manufacturing
firm it consists of raw material conversion period, work-in-progress
conversion period and finished goods conversion period.

b) Receivables conversion period: 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

The total on Inventory conversion period and receivables conversion

period is known as Total Operating Cycle Period (TOCP). The firm might
he 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
Deferral period from the Total Operating Cycle period.

Financing of working capital: The funds that are deployed on short

term are mainly used for the working capital or operating purposes. For
the day-to-day operations, a firm will have to provide money towards
the purchase of raw material, payment of salaries of employees, to
extent the credit to buyers of goods as well as to meet other day-to-
day obligations. However the firm can secure part of these funds from
its own suppliers of raw material and other needed suppliers.
Therefore, from the total requirement of funds for the operational
purposes, the credit the firm can obtain from others is deducted; the
difference would be the amount of money the firm has to find against
the working capital requirements.

Ratio Analysis of various factors will be done. With the help of ratio
analysis liquidity and profitability of the firm is analyzed.