INTRODUCTION

It is rightly said that finance is the lifeblood of business. No business can be carried
on without a suitable source of finance. The
financial manager is mainly responsible for
raising the required finance for the business.
There are several sources of finance and as
such the finance has to be raised from the right
kind of source.
NEED FOR LONG TERM FINANCING
Long term finance is needed due to the
following

reasons

i)Setting the firm : Long term finance is

needed to set up the firm. It is required to
purchase

fixed

assets

such

as

land

and

building, plant and machinery, furniture etc. ii)

Expansion
organisation

:
it

After
may

establishment
go

for

of

expansion

the
of

business activities to increase the volume of

business. Long term finance is required to

finance expansion programme.
iii) Modernisation : A business organisation
may go for modernization to cope with the
changing time. New Machines, technology is
required

to

bring

innovation.

It

requires

finance.
iv) Diversification : Long term finance is
required to finance diversification schemes of
the organisation. Diversification is necessary to
meet

the

changing

requirement

of

the

organisation.
v) Replacement : Existing machines become
outdated

due

to

passage

of

time.

Such

machines are required to be replaced by new

machines. For this purpose finance is required

NEED OF SHORT TERM FINANCING

A business organisation needs short term

financing due to the following reasons :
I) Business cycle : Business cycle brings
changes in demand and supply of products and
services. In case of boom, there is more
demand. Hence more capital is required.
ii) Liquidity : It is the capacity of the
orianisation to meet urgent needs. Short term
financing helps to maintain liquidity of the
organisation.
iii) Operating efficiency : It required timely
replacement of old machines and equipments
and employment of more labour to improve
operating efficiency.
iv) Nature of business : Requirement of
short term financing varies according to the
nature

of

business.

manufacturing

organisation requires more capital. to meet

short term requirements.

v) Credit sales : Credit sales reduce the cash

balance of the organisation. In case of credit
sales the organisation /requires more funds to
carry day to day activities

CLASSIFICATION OF SOURCES OF
FINANCE
The sources of finance can be classified as
follows :
1 According to Period
i)

Short-Term

finance

The

finance

is

generally required for a period of one year or

the business cycle which may be slightly
greater than period of one year.

ii) Medium-Term finance : This is also called

intermediate finance. The period of medium
term finance may be 3 to 5 years
iii) Long-Term finance : The Long term
finance generally exceeds 5 years period.
2 According to Ownership
Finance can be classified on the basis of
ownership as ownership capital and borrowed
capital.
3 According to source of generation
Capital can be raised through internal sources
such as retained earnings and depreciation.
Finance
external

can

also

sources

debentures etc.

be
such

generated
as

through

shares

and

AutomobiILE SECTOR BASED ON THEIR

SOURCES OF FINANCE
MAHINDRA & MAHINDRA(Amt in
Cr)
SOU 201 201 201
RCE 2

S OF
FINA
NCE
EQU 294 295 295
ITY
RET

.52 .16 .16

118 143 164

AIN

76.

63.

96.

ED

57

76

03

EAR
NIN
GS

DEB 317 322 274

TS

4.2

7.0

5.1

COMMENTS:
1.Company

Equity

share

capital

has

been

constant this means that companys has not

issued any new share capital in 3 years.
2.Proportion of retained earnings has

been

increasing every year which is the positive sign

of the company, i.e the companys profits has
been increasing, in future company can utilized
the amount of reserves for issue od bonus
shares, purchase of asset or to settle any claim
of debt.
3.As compared to the year 2012 in year 2013 ,
the amount of debt has shown a increase of
1.67%.
4.Company should reduce its debts proportion.

TATA MOTORS (AmT IN CR)

SOU 201 201 201
RCE

S OF
FINA
NCE
EQU 634 638 643
ITY
RET

.75 .07 .78

189 184 185

AINE 91.

96.

32.

77

87

26

EAR
NIN
GS
DEB 110 142 145
TS

11.

68.

15.

63

69

53

Comments:
1.Year by Year the portion of equity has been
increasing as well as the portion of debt
has been increasing.
2.Retained earnings has been increasing on
yearly basis.

ASHOK LEYLAND(Amt in cr)

SOU
RCE
S OF 20
FINA 12
NCE
EQUI 26
TY

20

20

13

14

26

26

6.0 6.0 6.0

7

RETA 26

41

41

INED 32. 89. 81.

EAR

34

04

82

S
DEB

38

35

23

TS

83. 04. 95.

NING

91

82

53

COMMENTS:
Amt of equity has been constant
where as the amount of retained earnings has
has been doubles as compared to previous
year 2012.
Amt o f debt has showing a
decreasing trend thats menas the companys is
trying to reduce the debt proportion.
EICHER MOTORS Ltd(Amt in
cr)

SOUR 20

20 201

CES

12

13 4

27

27 27.

OF
FINA
NCE
EQUI
TY

.0

RETAI 60

4
79 120

NED

2.0 4.

EARN 5

6.5

INGS
DEBT 20. 4

01
Comments:
Amt of equity has been increased

on little proportion
Company has reduced its debt
burden.

Reserves has been increased i.e

the company is the company is

able to pay its

debt and the profits of the company are also

increased.
WORKING CAPITAL
Every organization commercial as well as
non-commercial requires some amount fixed
capital for procurement of fixed asseis viz.
1and

and

furnitures
addition

building,
and

to

plant

fixtures,

fixed

capital

and

machinery,

vehicles
an

etc.

In

organization

requires additional capital for financing day to

day activities. Such capital which is required for
financing day to day activities is called as
working capital. Working capital is required for
smooth conduct of business activities. It is the
working capital which decides success or
failure of an organisation. It is the life blood of
an organization. Shortage of working capital
has always been the biggest cause of business

failure.

Lack

of

considerable

foresight

in

planning working capital needs of the business,

has forced even profitable business entities,
the so called 'blue-chip' companies, to the
brink of insolyency. Working Capital is the
warm blood passing through the arteries and
veins of the business and sets-it ticking. New
firms wind up for want of working capital. Even
giants tumble like pack of cards through the
drying

up

of

working

capital

reservoirs.

Liquidity and profitability are the two aspects of

paramount importance in a business. Liquidity
depends

on

the

profitability

of

business

activities and 'profitability .is hard to achieve

without sufficient liquid resources. Both these
aspects are closely inter related.
Control of working capital and forecasting
working capital is a continuous process and
therefore,

part

and

parcel

of

the

overall

management of the business. In this chapter,

we shall study the vital aspects such as

concepts of working capital s importance in
business

activities

and

decision-making

process.

DEFINITIONS .
Working Capital, like many other financial
and accounting terms, has been used different
people in different senses. One school of
thought

believes,

as

all

capital

resources

available to a business organisation - from

shareholders,

bondholders,

and

creditors

(secured and unsecured) 'works' .up in the

business activities to generate revenues and
facilitate future expansion and growth, they are
to be considered as 'working capital'.
Another school of thought links "working
capital"

with

current

assets

and

current

liabilities. According to them; the excess of

current assets over current liabilities is to

be rightly considered as the 'working capital' of
a business organization.
Before

providing

the

apt

definition

of

working capital needed for our discussion in,

this chapter, let us analyze a few more
definitions

available

on

working

capital.

Hoagland defines working capital as follows

'Working capital is descriptive of that
capital which is not fixed. But, the more
common use of working capital is to
consider it as the difference between the
book value of the current assets and the
current liabilities."
This

definition,

as

we

have

seen;

is

acceptable to the accountants. Gerestenberg

defines working capital as follows :
"Circulating

Capital

means

current

assets of a. company that are changed in

the ordinary course of business from one

form to another, as for example, from

cash

to

inventories,

inventories

to

receivables and receivables to cash". The

definition of working capital given by Subbing
is more illustrative. He defines working capital
as "the amount of funds necessary to cover the
cost of operating the enterprise. Working
Capital in a going concern is a revolving fund, it
consists of cash receipts from sales which are
used to cover the cost of current operations".
The

Accounting

American

Principles

Institute

of

Board
Certified

of

the

Public

Accountants define working capital as under :

"Working Capital is represented by the excess
of current assets over current liable and
identify as the relatively liquid portion of the
total enterprise capital which constitutes a
margin or buffer for maturing obligations within
the ordinary operating cycle of the business.
WORKING CAPITAL CYCLE

Alternatively known as 'Operating Cycle

Concept' of working capital. This concept is
based on the continuity of flow of funds
through business operations. This flow of value
is caused by different operational activities
during a given period of time. T h e operational
activities of an organization may comprise :
a) Purchase of raw materials,
b) Conversion of raw materials into finished
products,
c) Sale of finished products and
d) realization of accounts receivable.
Material cost is partly covered by trade
credit

from

suppliers

and

successive

operational activities also involve cash flow. If

the flow continues without any interruption,
operational activities of the company will also
continue smoothly. Movements of cash through
the above processes is called 'circular flow of

cash'. The period required to complete this flow

is called 'the operating period' or 'the operating
cycle.

SUPPLY

CHAIN

MANAGEMENT

AUTOMOBILE INDUSTRY

CASH MANAGEMENT

OF

INDIAN

ASPECTS OF CASH MANAGEMENT Cash

management has thefollowing aspects
1. Cash Budgeting
Cash Budget
This represents the cash receipts
and

cash

payments

and

estimated

cash

balance for each month of the period for which

budget is prepared. Cash budget is a device for
controlling and co-coordinating the financial
side of a business. Cash budget serves the
following purposes :
a) To ensure that sufficient cash is
available whenever required,
b) To point out any possible shortage of
cash so that necessary steps
taken

to

meet

the

shortage

can be
by

making

arrangement with the bank for overdraft or loan,

c) To point out any surplus cash so that

management can invest it in interest fetching
securities.
Preparation of Cash Budget :
Usually the responsibility of preparing the cash
budget lies on the Treasurer or other Financial
Executive. Cash budget has to be prepared by
estimating cash receipts and cash payments.
Estimating Cash Receipts :
Cash is received on the following
accounts :
a) Cash Sales,
b) Collection from Debtors,
c) Interest / Dividends on Investment,
d) Sale of Assets etc.,
e) Loans, Advances, Deposits etc. likely
The person who is responsible for the budget has

to estimate how the budget period on the above

accounts
GROWTH DRIVERS

Growth in the Road Sector

An Enabling Regulatory Environment
New Product Launches
Easy Financing Schemes
Increasing Consumer Demand
Cost Competitiveness

The Demand for Indian Automobiles Increasing

Globally.
Overall Economic Growth has been sustained.
Taxes & Duties are low.
Per Capita Income increasing.
The Country Working Population is Growing.
Most Indian Auto Players focusing on small cars
segment.

 Disposable income in Rural Agricultural sector

is increasing.
The availability of Low Cost Skilled Manpower
widespread.

CURRENT SCENERIO IN AUTOMOBILE

INDUSTRY
Higher Interest rates slow down the Growth of
Auto Industry.
High Input cost (high commodity cost) denting
the margins of auto players.
Lower Level Middle Class consumer still
preferring Two Wheelers.
Inflation also played major role in slow growth
of auto sector.
Higher Petrol price lead to more sales of Diesel
& LPG fuel variant Cars.

CAPITAL BUDGETING
MEANING OF CAPITAL BUDGETING
Capital budgeting refers to planning the
deployment of available capital for the purpose
of maximizing the long term profitability of the
firm. It is the decision to invest its current
funds

most

efficiently

in

the

long

term

activities in anticipation of flow of future

benefits

over

series

of

years.

Capital

budgeting is the process to identify, analyze

and select investment projects whose returns
(cash flows) are expected to extend beyond
one year. Investment decisions would include :
i) Expansion
ii) Acquisition
iii) Modernization
iv) Replacement of long term assets.

Thus, Capital Budgeting decision means a

decision relating to planning for Capital Assets
as to whether or not money should be invested
in long-term projects. e.g. setting up a factory
or purchase of a new machine. It involves a
financial analysis of the various proposals
regarding a capital expenditure and to choose
the best out of the various alternatives. .The
Capital Budgeting decision therefore, involves
a current year outflow or a series of cash
outflows over a number of years in return for
an anticipated flow of future returns over a
period of time longer than one year. There is a
relatively long time period between the initial
outlay and the anticipated returns.
NATURE OF CAPITAL INVESTMENT
Capital budgeting decisions include
acquisition, replacement, expansion and
modernization of assets. Any investment
decision with long-term implications can be

looked at as a capital expenditure decision.

When a pharmaceutical firm decides to invest
in R D, a car manufacturer considers
investment in a new plant, an airline plans to
buy a fleet of aircraft, a hank plans
computerization, a firm plans to launch a new
product line. They are all capital budgeting
decisions. These decisions have the following
features:
i) Usually involves huge outlays.
ii) Decisions are difficult.
iii) They have long-term consequences.
iv) Growth of an organization depends on the
quality of such decisions.
v) Higher degree of risk is involved.
vi) They benefit future periods.

vii) They have the effect of increasing the

capacity, efficiency, span of life regarding
future benefits.
viii) Funds are invested in long term activities.
IMPORTANCE
1.Affects financial stability : The capital
budgeting decision involves acquisition of fixed
assets,

which

are

relatively

costly,

and

therefore the decision affects the financial

stability and condition of any organization to a
greater extent.
2. Shapes destiny of a company : The
decision and its correctness shape the destiny
of a company's financial health. A wrong
decision can endanger the very survival of the
organization.
3. Not easily reversible: The decision, once
taken is not easily reversible since the fixed
asset bought may not. be suitable for any

alternative usage. In this case the firm will

incur more loss.
4. Difficult to take : This decision is not
very easy to make as its benefits accrue only in
the future. The future being uncertain, an
element of risk is involved. A failure to
estimate future cash inflows accurately can
lead the entire organization into a financial
crunch. Adding to this risk are the possibilities
of shifts in consumer preference, technological
advancement which cannot be predicted.
5.Maximise

returns

Most

of

the

organizations have a limited Capital Budget

and a large number of projects compete for
these limited funds. The firm must, therefore,
ration them in a way to maximize long-term
returns. Projects are therefore, to be ranked on
the basis of criteria like rate of return, risks
involved and the number of years over which
its return is expected to accrue. Thus, the

decision gathers even more importance in

times of Capital Rationing.
6. Risk and uncertainty It involves huge
amount of risk and uncertainty due to time
factor. The amount of capital expenditure is
recoverable over a very long period.
7. Improve profitability Finance is the life
blood of an organisation. Most of the firms face
difficulties i3 getting adequate finance. Hence,
available finance has to be used in such a
manner that it will improve profitability of the
organisation.
8. Effect on other projects: Long term
decisions affect the cash flow of other projects.
Hence, the impact or other projects should be
considered.
Classification
Proposals

of

Investment

Mutually Exclusive proposals In the

case of mutually exclusive proposals, the
selection of one proposal precludes the choice
of other proposals. The calculation of cash
outflow and inflows are similar to that of
replacement

situations.

These

proposals

compete with each other. For example, X Ltd is

considering the purchase of machine X or
machine Y. if the company has decided to
purchase

machine

X,

it

will

exclude

the

acceptance of machine
Independent Investment Proposals
It includes all such investments which 'are
being considered by the management for
performance

of

Investment

in

different

types

machinery,

of

tasks.

automobiles,

buildings, recreation centre are the examples

of

independent

investment

proposals.

Acceptance of each of these projects is done

on its merits without depending on the other

projects.
Contingent Investment Proposals
There

are

certain

projects

which

are

contingent upon the acceptance of the others.

For example, the management of a company
may contemplate to build employees quarters
and a Consumers Cooperative Stores: If it
decides not to construct the quarters, the need
of consumers' stores does not arise. If only the
quarters are constructed, the employees will
have problems in shopping. Such projects are
called as Contingent projects.
Replacement Proposals
The investments which are contemplated
for replacing old equipment so that the job can
be

performed

more

efficiently

are

replacements. In the case of replacement of an

existing machine by a new one, the relevant

cash out flows after tax should be considered.

If the new machine is to replace the existing
machine, the amount received from the sale
proceeds reduces the cash outflow required to
purchase the new machine. Calculation of cash
outflow in such a case is illustrated as follows.

Modernization Decisions
Replacement of a fixed asset due to
technological

obsolescence

is

known

as

modernization decision. The purpose is to

improve the efficiency and reduce cost. For

example,

replacement

of

Pentium

IV

computer by Intel Centrino Duo Computer.

Expansion Decisions
The existing production capacity is known
as expansion decision. The -purpose is to avoid
delay

in

customers

delivery
and

of

goods/services

increase

to

revenue.

Diversification Decision
Commencement of new product/services
lines is known as diversification decision. The
purpose is to reduce the risk of reduction in
revenues of existing products/ services For
example : starting an insurance business by L
& T Ltd.
EVALUATION TECHNIQUES METHODS
Following are the various methods' and
criteria involved in a Capital Budgeting
decision. They can be broadly classifi ed
into three broad categories :

1.Techniques which recognize Payback of

Capital employed.
2.Techniques which consider Accounting
Profi t.
3.Techniques which consider Time Value
of Money.

1.Pay-Back Method (PB) :

This is the simplest quantitative method for
appraising

capital

expenditure

case

is

decisions. This method evaluates the number

of years it takes for the future cash inflows to
pay back the initial cash outflow i.e. the

original cost of an investment. It is the time by

which the initial investment will be paid by the
project. It is the time required for the project to
break even. The cash inflows here mean the
annual profits after tax but before depreciation.
Depreciation is first reduced from the profits
given since it is a valid allowable expenditure.
This will give us the profit before tax from
which the tax liability for the year is deducted
to

get

the

Profits

Post

Tax.

However,

depreciation does not involve any outflow of

cash since it is not to be paid and is only an
accounting charge. Therefore, in order to find
the actual effective cash inflow it is then added
back to the profits post-tax before comparing
the same with the initial outflow to take the
capital

budgeting

decision.

Cash

Flow

Estimates : Following are the ingredient of cash

flow :

1) Tax effect : Cash flow for capital budgeting

has to be net of taxes. Hence, tax effect has to
be given special consideration. In cases of loss,
they can be carried forward and set off against
future income. Hence, the benefit of tax
savings will arise in future.
2)Effect of depreciation : Depreciation is a noncost item. It is deductible for determination of
taxable income. Depreciation has an effect on
taxable income and also the tax liability.
Amount, of depreciation in capital budgeting is
deducted to calculate profit and it is added
back to the profit after tax to calculate cash
inflow.

For

capital

budgeting

proposal,

depreciation is calculated as per Income Tax

Act.
3)Effect on other projects : Cash flow effects of
the

project

considered.

under
For

consideration

example,

must

company

be
is

manufacturing a new product which competes

with the existing product, it is likely that the

cash flow of the existing product may be
affected by the cash flow of the new product. In
such a case, the cash flow of the new product
should be adjusted. If the cash flow of the
existing product is reduced because of new
product, the cash flow from the new product
should be deducted by the reduction in cash
flow of the existing product..
4) Effect of Working Capital : Working capital is
the difference between current assets and
current liabilities. When a new project is
started, the requirement of cash, inventory and
the liabilities of creditors may arise. The
increase. in current assets may not match with
current liabilities. The increase in working
capital is added as an initial cost. Increase in
working capital has a positive effect on the
future cash inflows. Working capital has to be
adjusted in the beginning as cash outflow.

5) Salvage Value : It is the price of an

investment

realized

at

the

time

of

it

termination. These cash proceeds are treated

as cash inflows in the last year. In case of
replacement

decisions,

in

addition

to

the

salvage value of the nevi investment, the

salvage value of the existing investment now
and at the end o its life are also to he
considered.
6) Additional capital expenditure : In addition to
initial cash outflow in Ion term assets at the
start of the project the project, may need
additional capital investment. Such additional
expenditures are cash outflows taking place is
later years. It has to be considered while
calculating net cash flow during the life of the
project.

1)While

calculating

Cash

Flows

depreciation and tax should be ignored in

the following cases

a) If the tax rate is not given

b) If the question says, Ignore tax
c) If the company is a zero tax company or it
enjoys tax holiday
2. In absence of Information
a) Same amount of working capital invested
earlier is assumed to have been released in the
last year of the life of the project
b) Salvage value estimated earlier is assumed
to be realized in the last year of the project.
c) The sales assumed to have been realised at
the end of respective year
d)

The

fixed cost and variable

cost

are

assumed to have been incurred at the end of

the respective year.
e) Any saving of tax on negative profit before
tax (i.e. loss) should be calculated assuming
that the company has taxable income from

other sources against which such loss can be

set off.
If any amount is paid or received at the
beginning of any year, then the P.Vfactor of the
year of payment/receipt preceding should be
used.

Merits :
i) This method is quite simple and easy to
calculate. It clarifies that

there is no profit in

any project unless the pay-back period is over

as till then, only the cost is recovered.

ii) It favors projects with shorter pay-back

periods since risks normally stand to he greater
in long-term projects as future is uncertain.
iii) The method is very useful in situations
of Liquidity Crunch and high cost of capital as
faster

recovery

of

initial

investment

is

necessary.
iv) It is most suitable when the future is
uncertain.
v) It indicates to the prospective
investors when their funds are likely to

be

repaid.
vi) It does not involve assumptions
about the future interest rates.
Limitations:
1)The method stresses on capital recovery
ignoring the overall

profitability. It fails to

consider the returns which accrue after the

Pay-Back period is over. Two projects with equal

Pay-Back periods will be given the same

rankings although their inflows after the PayBack period may be different both in terms of
years and quantum.
ii) This method ignores the time value of
money

since

the

cash

inflows

are

discounted for the decision making process.

AVERAGE RATE OF RETURN

not

Internal Rate of Return (IRR) Method :

This is the second time-adjusted rate of return

method

for

appraising

capital

expenditure

decisions. It is the discount rate at which the

aggregate present value of inflows equal the
aggregate present value of outflows i.e. the
rate at which NPV = 0. In the Net Present Value
Method, the discount rate is normally equal to
the cost of capital which is external to the
project under consideration.
Merits :
i) It also considers the time value of money.
ii) It considers the cash flows over the entire
life of a project.
iii) It does not use the cost of capital to
determine the present value. It itself provides a
rate of return indicative of the profitability of
the proposal.
iv) It would also lead to a rise in share prices
and to maximisation of shareholder's wealth in
the same way as Net Present Value Method.

Limitations :
i)

The

procedure

for

its

calculation

is

complicated & at times tedious.

ii) Sometimes it leads to multiple rates which
further complicate its calculation.
iii) In case of more than one project, the project
with the maximum IRR may be selected which
may not turn out to be one which is the most
profitable in the long run.
iv) Projects selected on the basis of higher IRR
may not be profitable.
v) Unless the life of the project can be
accurately estimated, assessment of cash flows
cannot be done.