General Engineering Company (GEC)1

1. Early in January 1991, Mr. Pulok, credit officer of Rashtriya Bank, was studying the
request of the General Engineering Company Ltd. (GEC) for increasing the
company's cash credit limit, from the existing Rs.5 lakhs to Rs.8 lakhs. GEC
manufactures two-stage D.A. (Dissolved Acetylene) regulators. The bulk of their
sales were made to a public sector shipyard, a Naval dockyard and a large heavy
vessels fabricating unit. The fabricating unit was expected to make substantial
purchases in February and March, in view of a large contract received by it recently.
2. The provisional financial statements of GEC for the first nine months of 1990-91
were available (Exhibit 1). Additionally Mr. Pulok wanted the projected income
statement for the quarter ended 31st March 1991, the monthly cash forecast for this
quarter, and the projected balance sheet as of 31st March 1991.
3. In a cash credit account, a credit limit was sanctioned by the bank to a borrower,
usually for a one-year period. As security for the advance, the borrower normally
created a charge on current assets in favour of the bank. Both in order to ensure
that the borrower had a reasonable stake in the business and to protect the bank's
interests, in case of a fall in the value of the current assets, the bank stipulated a
"margin". In the case of GEC, the assets charged were inventories and receivables
and the margin stipulated against both was 30%. This meant that as on 31st
December 1990 borrowings by GEC could not exceed Rs.4.87 lakhs (70 per cent of
Rs.6.96 lakhs [inventories plus receivables]) although the sanctioned cash credit
limit was Rs.5 lakhs. Borrowers were expected to route all their receipts (such as
collections from sales) and payments (such as payment for purchase of raw
materials) through the cash credit account. A number of organisations usually
sought enhancement of their cash credit limits between January and March. Since
interest was paid on utilised credit and not on the sanctioned cash credit ceiling,
there was a tendency to overstate their credit requirements. Rashtriya Bank tried to
curtail these exaggerated requests as otherwise its own funds management became
problematic. Mr. Pulok, therefore, decided to prepare the financial forecasts himself.
He held detailed discussions with the senior managers of GEC as well as with the
representatives of their clients. Based on these, he collected the following
information.
4. Generally, 10 per cent of the sales was collected within the same month, 50 per cent
was collected in the month following sales, and 40 per cent was collected in the
second month following sales. This trend was expected to continue over the next
few months. GEC had sold 250 regulators and 300 regulators in November and
December 1990, respectively. They expected to sell 300 regulators in January 1991,
500 in February 1991 and 700 in March 1991. The selling price was Rs.800 per
regulator.
5. Production was linked to sales requirement and all items produced were sold in the
same month. No inventories of finished goods, or of work-in-progress were
maintained.
6. Raw materials were purchased in the beginning of each month, to meet that
months production requirements; and purchases were paid for in the beginning of
the following month. In the next three months, raw material consumption was
expected to be 50 per cent of sales. This was the level that prevailed in the last
quarter of 1990. Inventories of raw materials would be maintained throughout at
December 1990 levels.
1

Case prepared by R Srinivasan [Revision 10th August 2015]

7. The labour strength would be adjusted to meet production requirements. In the next
three months, wages were expected to be 25 per cent of sales. Wages would be paid
on the last day of the month.
8. Operating expenses would be Rs.20,000 per month. These would be paid in cash.
9. GEC was expected to add plant and equipment worth Rs.1 lakh in the quarter ending
31st March 1991, the payments for these would be made in February 1991.
Depreciation (including on the new assets) would be Rs.32,000 in the next three
months.
10. The term loan was repayable in annual instalments of Rs. 80,000. The next
instalment was due on 31st March 1991. Quarterly interest on this term loan, at
interest rate of 10% per annum, would also be paid on 31st March 1991.
11. Interest on public deposits at 16 per cent per annum was payable half yearly in June
and December. Out of the public deposits, Rs.1 lakh was due in 1991-92 (in fact by
December 1991). Rs 10,000 (10 per cent of this amount of Rs.1 lakh) had to be
invested in marketable securities (with maturity of nine months) on 31st March 1991.
12. Interest was payable on the cash credit at 18 per cent per annum. The bank
computed interest on the monthly closing cash credit balances and debited interest
to the cash credit account in June, September, December and March. It was
expected that interest on cash credit in the last quarter of 1990-91 would be around
Rs. 24,000.2
13. Estimated income tax, for the fiscal year ending 31st March, had to be paid in
advance in three instalments in September, December and March. GEC had
already paid the first two instalments in time and intended to pay a final
instalment on 15th March 1991. GEC would square the tax accounts (i.e. in the
balance sheet as of 31st March, the Advance tax would equal the Provision for
income- tax). The income tax rate was 50 per cent. Assume that income tax is
calculated on the profit before tax computed by you (i.e. financial accounting Profit
Before Tax is the same as taxable income).
14. For 1990-91, a dividend at 20 per cent (on the paid-up share capital) would be
proposed by the management, on 31st March 1991. Dividends would usually be paid
within 45 days of the Annual General Meeting (in which shareholders approval of
the dividends would be sought). This meeting would be held in June, 1991.
15. GEC would maintain a cash balance of Rs. 60,000, throughout.

2 Accept this number. The companion Financial Planning note will tell you
how this number was obtained.
2

Exhibit 1
GEC Provisional Income
Statement
for the period 1st April 1990 to 31st December 1990
(Rs.000s)
Sales
2000
Cost of goods sold
[1]
1590
Gross profit
410
Operating
expenses
180
Earnings before interest and
tax
230
Interest
[2]
130
Profit before tax
100
Tax
50
Profit after tax
50
[1] Consisting of raw material consumption 1000, wages 500,
and depreciation 90.
[2] Consisting of interest on term-loan 30, on public deposits 22,
and on cash-credit 78.
GEC Provisional Balance Sheet as of 31st December 1990
(Rs. 000s)
Net fixed assets
820
Cash
Accounts
receivable
Inventories
Advance tax
Total current
assets
TOTAL ASSETS

60
296
400
80
836
165
6

Accounts payable
Provision for income-tax
Cash credit
Current portion: Public
deposits
Current portion: Term loan
Total current
liabilities

120
50
436

786

Public deposits
Term loan

100
320

Paid-up Share
capital
Reserves as of

200
200

100
80

31.3.90
Profit in the period
1.4.90 to
31.12.90
Share Capital & Reserves
TOTAL LIABILITIES AND
EQUITY

50
450
165
6