17 jul cil
TRANSCRIPT
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1. COMPANY PROFILE
A SHORT CHRONOLOGICAL HISTORY OF THE COMPANY
Year Event
1774Warren Hastings initiates commercial coal mining at Raniganj (West
Bengal)
1815-1820 First Shaft Mine opened at Ranigunj
1835 Carr, Tagore & Company takes over the Ranigunj Coal Mines
1843Bengal Coal Company takes over Ranigunj Coal Mines and others; is first
Joint Stock Coal Company in India.
Up to 1900Minimal development; River transportation used to transport coal to
Calcutta; railway lines at Calcutta leads to expansion of Coal Production
Early 1900s Capacity at 6 million tons per annum
1955-56 Focus on Coal Industry; capacity up to 38.4 Million tones.
1956National Coal Development Corporation (NCDC) formed to explore and
expand coal mining in Public Sector
1972Coking Coal Industry Nationalized, Bharat Coking Coal Limited formed to
manage operations of all Coking Coal mines in Jharia Coalfield.
1973Non-coking coal nationalized; Coal Mine Authority Limited set up to
manage these mines; NCDC operations bought under the ambit of CMAL.
1975
Coal India Limited formed as holding Company with 5 subsidiaries viz.Bharat Coking Coal Limited (BCCL), Central Coalfields Limited (CCL),
Western Coalfields Limited (WCL), Eastern Coalfields Limited (ECL) and
Central Mine Planning and Design Institute Limited (CMPDIL).
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1985Northern Coalfields Limited (NCL) and South Eastern Coalfields Limited
(SECL) carved out of CCL and WCL
2000 Deregulation of coal pricing and distribution of coal
Coal India Limited has been incorporated under the companies Act 1956 on
21.10.1975 and is wholly owned by the Government of India. The company is
chiefly in to the business of coal mining, coal based products and mining
consultancy.
The wholly owned subsidiaries of the company are as follows:
1. Eastern Coalfields Limited.
2. Bharat Coking Coal Limited
3. Central Coalfields Limited
4. Northern Coalfields Limited
5. Western Coalfields Limited
6. Southeastern Coalfields Limited
7. Mahanadi Coalfields Limited.
8. Central Mine Planning and Design Institute Limited.
North Eastern Coalfields is directly under control of Coal India Limited.
Registered office of the Company is Coal Bhawan, 10 Netaji Subhas Road,
Kolkata700 001, West Bengal, India.
India is the 3rd largest coal producing country in the world and Coal India
Limited produces 85% of total coal production in India. It is the largest company
in the world in terms of coal production. It employs around 404744 people and is
the largest corporate employer in the country.
The objectives of the company are as follows:
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1) To promote the development and utilization of the coal reserves in the country
for meeting the present and likely future requirement of the nation with due
regard to need for conservation of non-renewable resources and safety of mine
workers.
2) To raise the productivity of coal mining and related activities through
introduction of improved technology, streamlining of organization, management
and improving the skills, motivation of the work-forces.
3) Efficiency of operations and adopting appropriate cost reduction and cost
control methods.
4) To make efficient arrangements for marketing and supply of coal so that coal,
coke and other similar derivatives are available to consumers throughout the
country conveniently and at reasonable prices.
5) To promote research and development activities on a continuing basis in the
areas of coal mining, beneficiation development of new coal based products or
by-products, fuel technology or any other area having a bearing on conservation,
development for utilization of the coal reserves of the country.
2. EVOLUTION OF CIL
Coalthe mainstay of Indias Energy Security.
Strategic Role of Coal in Indias Economy
Coal the dominant energy source in India meets 55% of countrysprimary commercial energy supply.
In India, 84% of hard coal is produced by Coal India Limited (CIL), aMaharatna Coal Mining PSU and 7% by Singareni Collieries Company
Limited (SCCL)-under Ministry of Coal.
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Coal prices in India are deeply discounted compared to internationalprices even in the face of Global Economic meltdown.
Coal Sector in India thus plays an extremely important strategic role inmaking the end user industry globally competitive.
The benefit granted without creating any burden on Government of Indiaor on the producing company.
CIL contributes more than Rs 5000 Crores to per annum to the exchequeron account of Dividend and corporate taxes alone and meets its
investment requirement entirely from internally generated funds.
3. COAL RESERVES IN INDIA
As a result of exploration carried out up to the depth of 1200m by the GSI,CMPDI and MECL, a cumulative total of 267.21 Billion tonnes of Geological
Resources of Coal have so far been estimated in the country as on 1.4.2009. The
state-wise distribution of coal resources and its categorisation are as follows:
State
Geological Resources of Coal
Proved Indicated Inferred Total
Andhra Pradesh 9194 6748 2985 18927
Arunachal Pradesh 31 40 19 90
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2039.98
3132.79
4679.12
4894.05
100000
8602.47
8738.46
5744.1
13964.93
0 20000 40000 60000 80000 100000 120000
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
2009-10
Y
E
A
R
FINANCIAL POSITION Rs in crores
Assam 348 36 3 387
Bihar 0 0 160 160
Chhattisgarh 10910 29192 4381 44483
Jharkhand 39480 30894 6338 76712
Madhya Pradesh 8041 10295 2645 20981
Maharashtra 5255 2907 1992 10154
Meghalaya 89 17 471 577
Nagaland 9 0 13 22
Orissa 19944 31484 13799 65227
Sikkim 0 58 43 101
Uttar Pradesh 866 196 0 1062
West Bengal 11653 11603 5071 28327
Total 105820 123470 37920 267210
4. FINANCIAL HIGHLIGHTS
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5. CORPORATE STRUCTURE
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0
2000
4000
6000
8000
10000
12000
2010-
11
2009-
10
2008-
09
2007-
08
2006-
07
2005-
06
Net Profit (Crs in INR) 10891.03 9632.78 2073.29 4916.64 5636.58 5852.81
AxisTitle
Net Profit (Crs in INR)
0
2000
4000
6000
8000
10000
12000
14000
16000
18000
20000
2010-
11
2009-
10
2008-
09
2007-
08
2006-
07
2005-
06
Gross Profit 18196.67 15355.88 7407.03 10268.41 9914.1 10103.9
Gross Profit (Crs in INR)
6. VIEW OF THE COMPANY AT A GLANCE
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0
10000
20000
30000
40000
50000
60000
70000
2010-11 2009-10 2008-09 2007-08 2006-05 2005-06
Gross Sales (Crs in
INR), 33997.19
AxisTitle
Axis Title
Gross Sales (Crs in INR)
0
10000
20000
30000
40000
50000
60000
2010-11 2009-10 2008-09 2007-08 2006-07 2005-06
Net Sales (Crs in INR)
Net Sales (Crs in INR)
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0
5000
10000
15000
20000
25000
30000
35000
2010-11 2009-10 2008-09 2007-08 2006-07 2005-06
Net Worth (Crs in INR)
Net Worth (Crs in INR)
0
500
1000
1500
2000
2500
3000
3500
Debtors Position (Crs in INR)
Debtors Position (Crs in INR)
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7. AIM AND OBJECTIVE OF STUDY
WORKING CAPITAL MANAGEMENT:
The financial statement is the depiction of companies growth and establishing its
available resources. The statements are prepared for a particular period. The
financial statements by nature are summaries of items recorded in the business
and these statements are prepared periodically. They are prepared for the purpose
of presenting a periodical review of reports on progress by the management and
deal with the status of investment in the business and the results achieved during
the period under review.
Two types of capital are needed in an enterprise Fixed Capital and Working
Capital.
Business operations demand few assets to be used in the business for a longer
period which are known as fixed assets. And capital invested in acquisition of
such assets is known as Fixed Capital. Capital is also needed for short-term
purpose, i.e., for the meeting of the day-to-day operations. Capital invested for
this purpose is known as Current Capital or Working Capital. Thus, Working
Capital refers to concerns investment in short-term assets like cash, short-term
securities, debtors and investors of all types. It can also be regarded as the
position of companys total capital which is employed in short-term operations. In
other words, Working Capital is the investment needed for carrying out day-to-
day operations of the business smoothly.
Working capital is the amount of funds necessary to cover the cost of operating
the enterprise. -Shubin
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, receivables into cash. Genestenberg
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8. CONCEPT OF WORKING CAPITAL
There are two major concepts of working capital-
1. Balance sheet concept
2. Operating cycle concept
An Over view on Balance sheet Concept:-
Gross Working Capital: The capital which is needed for conductingthe day-to-day expenditures of the business is called Working Capital.
As the day-to-day expenditures of the business are met by the current
assets, economists like Mead, Malott, Baker, Field etc. consider that the
sum total of current assets employed in the business is the Gross Working
Capital. According to this concept, the amount of working capital
increases as the amount of current assets increases and vice-versa. Current
assets refer to those assets which are needed in the ordinary course of
business and can be converted into cash within a short period (generally,
within one year) without disrupting the operations of the business.
Stock-in-trade, Sundry Debtors, Bills Receivable, Marketable securities,
prepaid expenses, Accrued income, Cash in hand; Cash at bank etc. are the
different components of current assets.
Gross Working Capital = Current Assets
Net Working Capital: It refers to the difference between currentassets 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 an
outstanding expenses.
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Net Working Capital = Current Assets - Current
Liabilities
We can make the following three views about the Net Working Capital from this
equation:
Firstly, if the value of total current assets is equal to the value of total current
liabilities, then the amount of working capital is zero i.e., if Current Assets =
Current Liabilities, Working Capital = Current Assets - Current
Liabilities = 0.
Secondly, if the value of total current assets is more than the value of total
current liabilities i.e., if Current Assets > Current Liabilities, then the net
working capital is positive.
Thirdly, if the value of total current assets is less than the value of total current
liabilities, i.e., if Current Assets < Current Liabilities, then the net working
capital is negative.
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9. DIFFERENT TYPES OF WORKING CAPITAL
10. TIME BASE WORKING CAPITAL:
Gerstenberg has conveniently classified the working capital into;
Regular or permanent working capital Temporary or variable working capital
Kinds of Working Capital
On the Basis of Concept On the Basis of Time
Gross Working
Capital
Net Working
Capital
Permanent or
Fixed Working
Capital
Temporary or
Variable
Working Capital
Regular Working
Reserve Working
Seasonal
Working
Special
Workin
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The variable working capital is again bifurcated in seasonal and special working
capital.
Regular or permanent working capital: it is the minimum investment kept in
the form of:
Inventory of raw materials Work in process Finished goods Stores and spares & Book debt
to facilitate uninterrupted operation in a firm. Though this investment is stable in
short run, it certainly varies in long run depending upon the expansion programs
undertaken by a firm. It may increase or decrease over a period of time. The
minimum level of current assets maintained in a firm is usually known as
permanent or regular working capital.
Temporary Working Capital:
A firm is required to maintain an additional current asset temporarily over and
above permanent working capital to satisfy cyclical demands. Any additional
working capital apart from permanent working capital required to support the
changing production and sales activities is refer to as temporary or variable
working capital. At times, additional working capital is required to meet the
unforeseen events like floods, strikes, fire & price hike tendencies and
contingencies.
11. COMPONENTS OF WORKING CAPITAL
According to the gross working capital concept, all the current assets are the
components of the working capital. On the other hand, according to the net
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working capital concept, all the current assets and the current liabilities are the
components of the working. These components are discussed below:
1. CURRENT ASSETS: Current assets refer to those assets which in the
ordinary course of business can be converted into cash within a short
period (generally, within one year) without disrupting the operations of the
business.
E.g. Sundry Debtors, Stock-in-trade, Bills Receivable, short-term loan and
advance, short term investment, prepaid expenses, accrued income, cash in
hand, cash at bank etc.
2. CURRENT LIABILITIES: Current liabilities refer to those liabilities
which are repaid, generally, within one year by using the current assets or
earnings of the business.
E.g. Sundry creditors, Bills Payable, Short-term loan, Outstanding
expenses, Provision for taxation, Proposed dividend, Bank overdraft etc.
are the current liabilities.
12. IMPORTANCE OF WORKING CAPITAL
Importance of working capital in any type1 of business is unlimited. The day-to-
day activities of the business are conducted with the help of this working capital.
So, the working capital is called life-blood and controlling nerve center of the
business. The importance of working capital is discussed below:
Solvency: The short term solvency of the business depends on the amountof working capital. If there is sufficient amount of working capital in the
business, then it is possible to repay the claims of the creditors on demand.
On the other hand, the shortage of working capital indicates incapability of
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repayment of short-term liabilities. So, every business should have
sufficient amount of working capital in order to maintain the short-term
solvency.
Maintenance of Goodwill: It is possible to repay the claim of creditors intime, then the credibility of the concern increases and as a result of it, the
goodwill of the business increases. If there is sufficient amount of working
capital in the business, then only it is possible to repay the claim of the
creditors in time. So, every business should have sufficient amount of
working capital so that the goodwill of the firm remains intact.
Possibility of getting loans: Sufficient amount of working capitalexpresses solvency of the business and indicates satisfactory debt-
settlement capacity. So, the concerns which have sufficient amount of
working capital can easily get loan from the market at favorable terms.
Regular supply of raw materials: It is possible to repay the claim ofsuppliers of raw materials in time if there remains sufficient amount of
working capital in the business. As a result of it, the raw materials are
available from the suppliers on demand. Besides this, for smooth supply of
raw material throughout the year in case of seasonal industry, sufficient
amount of working capital is needed for storing of raw material at theseason.
Regular payment of day-to-day expenditure: It is possible for theconcerns, which have sufficient amount of working capital, to pay wages to
the workers and to meet day-to-day overheads regularly. Thus, the
reliability of the workers increases and also the amount of cost reduces as
wastages are reduced. As a result of it, the amount of profit also increases
with increasing in quality and quantity of the product.
Credit sales: It is possible to sale goods on credit if there is sufficientworking capital in the business. As a result of it, the amount of sales as well
as the amount of profits increases.
Increase in profitability: Wastages are reduced to minimum, productionand sales are increased and opportunity of cash discount can be taken as a
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result of quick turnover and efficient management of working capital. As a
result of this, the profit earnings capacity of the business increases.
13. FACTORS DETERMINING WORKING CAPITAL
Whatever be the size of the business, every business requires working capital.
Because, it is not possible to conduct a business without working capital. But if
the amount of working capital is more than the actual need, then capital remains
blocked unnecessarily. As a result of it, the rate of profit reduces. Again, if the
amount of working capital is less than the actual need, the production is hamperedand hindrance takes place in the normal activities of the business. So, every
business should have needed appropriate amount of working capital. They are
discussed below:
Nature of business: The requirement of working capital of a businessprimarily depends on the nature of that business. Public utility concerns,
such as, water, electricity, gas etc. supply concerns generally render
services in cash and working capital of these concerns never blocked on
account of unsold stock or trade debtors. So, they do not require a very
large amount of working capital as their liquid cash is rotated very rapidly.
On the other hand, the working capital remains blocked in various stages
of production and buying and selling in the manufacturing and trading
concerns. So, they need large amount of working capital.
Size of the business: The amount of working capital of a business directlydepends on the size of the business. For instance, the large scale
businesses require a large amount of working capital because the amount
of production and buying and selling of them is very large. On the other
hand, the small scale businesses require comparatively less amount of
working capital.
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Production process: The stages through which the production of aproduct is completed are called production process. The industrial
undertakings which have a numbers of production process, requires much
time to complete finished goods and need large amount of working capital.
As for instance, Oil refinery, or Chemical industries requirehuge amount
of working capital for having long production process. On the other hand
the production process of making bread or biscuit can be completed within
a short period. So, not much amount of working capital is required for
their production.
Seasonal variation: There are certain products, the demand for which isseasonal in nature. There are on seasons (when the demand is very high)
and off seasons (when the demand is very less). During the on-seasons
the demand will be high and the production level has also required to be
high to meet this high demand level and thus the working capital
requirement would be more.
Business cycle: The requirement of working capital is also affected by therise and fall of the business cycle. When there is boom in the market, the
amount of sales increases. Price of goods increases and the way of
expansion of the business is easily accessible. So, a huge amount of
working capital is needed at that time. On the other hand, the amount of
investment in current assets is less at the time of depression as the amount
of production and sales reduces due to decrease in demand at that time.
Credit policy: The requirement of working capital of a firm also dependson its credit policy. For instance, the less the period of credit allowed to
debtors and the more the period of credit allowed by creditors, the less will
be the requirement of the working capital.
Expansion and growth: If the expansion and growth takes place in abusiness, then the amount of working capital is required to be increased in
order to keep the production process unhindered. Though it is very
difficult to determine the relationship between the growth in the volume of
business and the growth of its working capital, but it can be said
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undoubtedly that if a firm does not make proper arrangement for required
working capital for expansion and new project, then investment in fixed
assets does not become effective due to lack of working capital.
Change in price level: The requirement of working capital changes alongwith the change in price level. For instance, if price level raises upward,
then more amount of working capital is needed for maintaining the
previous level of activity due to increase in price of raw materials and
other factors.
14. OBJECTIVES OF WORKING CAPITAL
MANAGEMENT
The objectives of working capital management could be stated as:
To ensure optimum investment in current assets. To strike a balance between the twin objectives of liquidity and
profitability in the use of funds.
To ensure adequate flow of funds for current operations. To speed up the flow of funds or to minimize the stagnation of funds.
15. MANAGEMENT OF WORKING CAPITAL:
Management will use a combination of policy and techniques for the management
of working capital. These require managing the current assets generally cash
and cash equivalents, inventories and debtors. There are also varieties of short
term financing options which are considered. The various steps in the
management of working capital involve:
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CASH MANAGEMENT- To identify the cash balance which allows forthe business to meet day to day expenses, but reduces cash holding cost.
INVENTORY MANAGEMENT- To identify the level of inventorywhich allows for uninterrupted production but reduces the investment in
raw materials and hence increases cash flow; the techniques like JUST IN
TIME (JIT) and ECONOMIC ORDER QUANTITY (EOQ) are used for
this.
DEBTORS MANAGEMENT- To identify the appropriate credit policy,i.e., credit terms which will attract customers, such that any impact on
cash flow and the cash conversion cycle will be offset by increased
revenue and hence return on capital (or vice-versa). The TOOLS like
DISCOUNTS and ALLOWENCES are used for this.
SHORT TERM FINANCING- Inventory is ideally financed by creditgranted by the supplier; dependent on the cash conversion cycle, it may
however, be necessary to utilize a bank loan (or overdraft), or to convert
debtors to cash through factoring in order to finance working capital
requirements.
16. CONSTRAINTS OF WORKING CAPITAL
MANAGEMENT:
Non-realization of the importance of working capital. Continuous inflation in the economy The existence of sellers market or monopoly conditions; and
High profitability
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17. ASPECTS OF WORKING CAPITAL
MANAGEMENT:
There are many aspects of working capital management which makes it important
function of financial management.
TIME: working capital management requires much of the finance managers
time.
INVESTMENT: working capital represents a large portion of the total
investment in assets.
CREDIBILITY: working capital management has great significance for all firms
but it is very critical for small firms.
GROWTH:the need for working capital is directly related to the firms growth.
It is advisable that the finance manager should take precautionary measures for
effective and efficient management of working capital.
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18. DEDUCE FROM BALANCE SHEET HOW
WORKING CAPITAL MOVES
WORKING CAPITAL POSITION AND ANALYSIS OF INFORMATION
RELATED TO CURRENT ASSETS AND CURRENT LIABILITIES
OF COAL INDIA LIMITED.
(Rs. in Crores)
Year ending
31st
March2010-11 2009-10 2008-09 2007-08 2006-07 2005-06 2004-05
Current Assets (A)(1) (i) Inventory of
Coal, Coke etc.
(ii) Inventory of
Stores & Spares
etc.
(iii) Other Inventories
(2) Sundry Debtors
(3) Cash & Bank
Balances
(4) Loans & Advances
& Spares etc.
Total Current Assets (A)
4439.82
1038.97
106.85
3025.86
45862.28
9922.84
64396.02
3186.49
1087.54
127.74
2168.65
39077.76
8676.20
54324.38
2514.98
1055.51
112.39
1826.14
29695.01
11244.51
46448.54
2381.24
909.36
93.36
1657.06
20961.48
10304.29
36306.79
2137.04
900.67
82.76
1586.41
15929.27
8191.88
28828.03
1889.50
921.92
90.40
1804.47
13427.24
6278.10
24411.63
1405.72
915.7
95.7
2072.1
7986.9
5059.7
17535.99
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The above table highlights the improved growth of
Working Capital from its negative trend to positive trend
as depicted in Graph.
2010-11 2009-10 2008-09 2007-08 2006-07 2005-06 2004-05
Net Working Capital 17902.12 11415.3 5942.74 6611.61 6007.06 2670.38 -805.41
Current Assets 64396.02 54324.38 46448.54 36306.79 28828.03 24411.63 17535.99
Current Liabilities 46493.9 42909.08 40505.8 29695.18 22820.97 21741.25 18341.4
-10000
0
10000
20000
30000
40000
50000
60000
70000
ValuesinINRCrs
Working Capital
Less: Current Liabilities
& Provision (B)
NET WORKING
CAPITAL
(AB)
46493.9
17902.12
42909.08
11415.30
40505.81
5942.74
29695.18
6611.61
22820.97
6007.06
21741.25
2670.38
18341.4
-- 805.41
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19. ANALYZING THE EFFICIENCY OF WORKING
CAPITAL THROUGH VARIOUS RATIOS
1. Working Capital Turnover ratio = Total Net Sales/ Average NetWorking Capital
The ratio indicated the rate of working capital utilization in the firm.
From the above table we can see that the ratio has increased from 2004-05 to
2005-06. But it has further decreased recently. It is therefore will not be proper to
conclude anything from this ratio.
Year ending
31st
March2010-2011 2009-10 2008-09 2007-08 2006-07 2005-06 2004-05
TOTAL NET
SALES50233.59 44615.25 39123.48 32633.86 29602.19 28701.83 25862.8
WORKING
CAPITAL17902.92
11415.305942.74 6611.61 6007.06 2670.38 -805.41
WORKING
CAPITAL
TURNOVER
RATIO
2.81 3.91 6.58 4.94 4.93 10.75 -32.11
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2010-11 2009-10 2008-09 2007-08 2006-07 2005-06
Working Capital Turnover
Ratios2.8 3.91 6.58 4.94 4.93 10.74
0
2
4
6
8
10
12
Times
Working Capital Turnover Ratios
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2010-
11
2009-
10
2008-
09
2007-
08
2006-
07
2005-
06
2004-
05
Current Aseets Turnover
Ratio0.78 0.82 0.84 0.9 1.03 1.18 1.47
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
Times
Current Aseets Turnover Ratio
2. Current Asset Turnover Ratio = Total Net Sales / Average CurrentAsset
Year ending
31st
March2010-11 2009-10 2008-09 2007-08 2006-07 2005-06 2004-05
TOTAL
NET SALES50233.59 44615.25 39123.48 32633.86 29602.19 28701.83 25862.86
CURRENT
ASSETS64396.02 54324.38 46448.54 36306.79 28828.03 24411.63 17535.99
CURRENT
ASSETS
TURNOVER
RATIO
0.78 0.82 0.84 0.90 1.03 1.18 1.47
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20. AN OVERVIEW ON OPERATING CYCLE
CONCEPT OF WORKING CAPITAL
According to this concept, the sum total of the expenditures which are incurred in
order to perform the operational activities is the working capital. Operational
costs refer to the cost of raw materials, labor costs and overheads. Raw materials
are purchased out of cash which is invested at the initial stage of the business;
finished goods are produced by converting the raw materials with the help of
labor and overheads. Debtors are created through the sale of finished goods on
credit and again cash is generated when debts are realized from debtors. The
process is rotated repeatedly. Thus the sum total of the operating costs which are
required to be incurred in order to perform an operating cycle is the working
capital. An operating cycle is shown in the following diagram:
In the form of an equation, the operating cycle process can be expressed as
follows:
OPERATING CYCLE= R+W+F+D-C
WHERE,
R= RAW MATERIAL CONVERSION PERIOD
W= WORK- IN- PROGRESS CONVERSION PERIOD
F= FINISHED GOOD CONVERSION PERIOD
D= DEBTORS COLLECTION PERIOD
C= CREDIT DEFERRAL PERIOD
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WORKING CAPITAL BASED ON OPERATING
CYCLE:
One of the methods for forecasting working capital requirement is based on the
concept of operating cycle. The calculation of operating cycle and the formula for
estimating working capital on its basis has been demonstrated with the help of
following illustration.
ILLUSTRATION:
From the following information of XYZ ltd., you are required to calculate:
Gross Operating Cycle
Net Operating Cycle
(Figures in Rs. Lakhs)
PARTICULARS 2010 2011
1. Raw materials purchased 4653 60912.
Opening Raw material Inventory 523 827
3. Closing Raw material Inventory 827 9864. Raw materials consumed 4349 59325. Depreciation 82 906. Other Manufacturing Expenses 553 7047. Direct Labor 368 4988. Total Works Cost 5352 72249. Opening W.I.P. Inventory 185 32510.Closing W.I.P. Inventory 325 49811.Cost of Production 5212 705112.Opening Finished Goods Inventory 317 52613.Closing Finished Goods Inventory 526 995
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14.Cost Of Goods Sold 5003 658215.Selling Expenses 304 45716.Cost of Sales 5307 703917.Sales 6087 800718.Debtors (closing) 735 100419.Creditors (closing) 454 642
SOLUTION:
OPERATING CYCLE CALCULATION
PARTICULARS 2010 2011
A. Raw Material Conversion Period
(i) Raw material consumption 4349 5932(ii) Raw material consumption per day
= [ Raw material consumption / 360]12.1 16.5
(iii) Raw material Inventory (closing) 827 986(iv) Raw material Inventory Holding
(Days)
= [ Raw material Inventory / Raw material
consumption per day]
68 60
B. W.I.P. Conversion Period
(i) Cost of Production 5212 7051(ii) Cost of Production per Day 14.5 19.6
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= [ Cost of Production / 360]
(iii) W.I.P. Inventory (closing) 325 498(iv) W.I.P. Inventory Holding (Days)
= [ W.I.P. Inventory / Cost of
Production per day]22 25
C. Finished Goods Conversion Period
(i) Cost Of Goods Sold 5003 6582(ii) Cost Of Goods Sold per Day
= [ Cost Of Goods Sold / 360]13.9 18.3
(iii) Finished Goods Inventory (closing) 526 995(iv) Finished Goods Inventory Holding
(Days) =[Finished Goods Inventory /
COGS per day] 38 54
D. Debtors Collection Period
(i) Credit Sales 6087 8007(ii) Credit Sales per Day
= [ Credit Sales / 360]16.9 22.2
(iii) Debtors (closing) 735 1004(iv) Debtors Outstanding (Days)
= [ Debtors / Credit Sales per day]43 45
E. Creditors Deferral Period
(i) Credit Purchases 4653 6091(ii) Credit Purchase per day
= [ Credit Purchases / 360]12.9 16.9
(iii) Creditors (closing) 454 642(iv) Creditors Outstanding (Days)
= [ Creditors / Credit Purchase per
day]
35 38
Therefore;
GROSS OPERATING CYCLE (for 2009) = (68+ 22+ 38+ 43) = 171 Days
(for2010) = (60+ 25+ 54+ 45) = 184 Days
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NET OPERATING CYCLE (for 2009) = (68+ 22+ 38+ 43- 35) = 136 Days
(for2010) = (60+ 25+ 54+ 45- 38) = 146 Days
20. ANALYSING THE EFFICIENCY OF
WORKING CAPITAL ELEMENTS
1. Turnover Ratios - Turnover ratios also referred to as activity ratios orasset management ratios, measure how efficiently the assets are employed
by a firm. The important turnover ratios are:-
Inventory Turnover Ratio=Cost of goods sold / Average InventoryWhere, Cost of goods sold= Total Net SalesGross Profit
Year ending 31st
March2010-11 2009-10 2008-09 2007-08 2006-07 2005-06
Cost of goods sold 33730.36 30650.32 33379.38 23895.4 20999.72 19913.37
Average Inventory4993.71 4154.55 3761.26 3478.6 3235.04 2811.42
Inventory Turnover
Ratio
6.75 7.17 9.35 7.26 6.91 7.08
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2010-11 2009-10 2008-09 2007-08 2006-07 2005-06
Inventory Turnover Ratio 6.75 7.17 9.35 7.26 6.91 7.08
0
1
2
3
4
5
6
7
8
9
10
Times
Inventory Turnover Ratio
Debtors Turnover Ratio= Net Credit Sales / Average Sundry Debtors
As the figure of net credit sales is not available, one may have to takethe net sales figure in place of net credit sales in the numerator.
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If we look at the trend of the debtors turnover rat io for the last six years we see it has
increased substantially from 16. 97 to 22.34 last year and again it decreased to 19.34 in
the current year, which would indicate that the organizations efficiency in handling the
credit management has increased and that is a positive aspect with regard to solvency of
the firms in general. To get some additional insight into the managerial aspect of
receivables we may also consider Average collection period.
2010-11 2009-10 2008-09 2007-08 2006-07 2005-06
Debtors Turnover Ratios 19.34 22.34 22.46 19.55 16.6 16.97
0
5
10
15
20
25
Times
Debtors Turnover Ratios
Year ending 31st March 2011-10 2009-10 2008-09 2007-08 2006-07 2005-06
NET SALES 50233.59 44615.25 39123.48 32633.86 29602.19 28701.83
AVERAGE SUNDRY
DEBTORS
2597.11 1997.4 1741.6 1669.65 1783.14 1690.93
DEBTOR'S TURNOVER 19.34 22.34 22.46 19.55 16.60 16.97
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Average Collection Period= 360 / Debtors Turnover
From the average collection period data for the last 6 years we find that the
number of days for which receivables remain uncollected has considerably
decreased from 21.21 days in 2005-06 to 18.61 days in 2010-11. It therefore
indicates that the system and procedure of collection has been streamlined and
improved over this period.
2010-11 2009-10 2008-09 2007-08 2006-07 2005-06
Debtors Collection Period 18.61 16.11 16.02 18.41 21.69 21.21
0
5
10
15
20
25
Days
Debtors Collection Period
Year ending 31st
March2010-11 2009-10 2008-09 2007-08 2006-07 2005-06
AVERAGECOLLECTION
PERIOD
18.61 16.11 16.02 18.41 21.69 21.21
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Next we will consider the set of ratios required to analyze Liquidity of
Working Capital Elements:
The liquidity of working capital is an important aspect, which needs to be
analyzed by the management for maintaining proper liquid resources to meet both
operational requirements as well as financing commitment of repayment of
borrowed funds.
We will mainly consider two ratios like Current Ratio and Acid test ratio or Quick ratio.
1. Current Ratio= Current Assets / Current LiabilitiesThis ratio is known as current or working capital ratio. It gives the relationship
between current assets and current liabilities of the concern. A high current ratio
is considered to be sign of financial strength. Bankers in India have used a norm
of 1.33. Internationally, the norm is 2.0.
2. Acid-test Ratio = (Current Assets-Loans and Advances-Inventories) /Current Liabilities
Year ending 31st
March
2010-11 2009-10 2008-09 2007-08 2006-07 2005-06
CURRENT RATIO 1.39 1.27 1.15 1.22 1.26 1.12
ACID-TEST RATIO 1.05 0.96 0.78 0.75 0.76 0.7
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2010-11 2009-10 2008-09 2007-08 2006-07 2005-06
Current Ratio 1.39 1.27 1.15 1.22 1.26 1.12
Acid Test Ratio 1.05 0.96 0.78 0.75 0.76 0.7
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
Times
Liquidity Ratios
First of all if we analyze the current ratio for the last 6 years it has increase from
1.12 in 2005-06 to 1.39 in 2010-11 and as we all know the industry average is
1.22 means it is satisfactorily. So if the value of current assets depreciates, the
company may face difficulty to pay off its debts and loans on time.
Similarly in the case of Acid-test ratio it has increased from 0.7 in 2005-06 to
1.05 in 2010-11, as the industry average is 0.69 so for Coal India Limited it is far
better than the industry average.
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We will state other positive features, which emerged out of studying the
balance sheet, in terms of the following ratios:
Year ending 31st March 20010-11 2009-10 2008-09 2007-08 2006-07 2005-06
a) Profitability Ratios
1) As % Net Sales
Net Profit 32.77 31.3 14.68 26.78 29.06 30.62 Gross Profit 32.90 31.61 15.08 27.24 29.35 30.94
b) Turnover Ratios
Capital Turnover Ratios
(Net Sales / Capital
Employed)
1.63 1.9 2.31 1.91 1.82 2.25
2010-11 2009-10 2008-09 2007-08 2006-07 2005-0
Gross Profit Ratio 32.77 31.3 14.68 26.78 29.06 30.62
Net Profit 32.9 31.61 15.08 27.24 29.35 30.94
Captal Turnover Ratio(Times) 1.63 1.9 2.31 1.91 1.82 2.25
0
5
10
15
20
25
30
35
AxisTitle
Profitabilty Ratios
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2010-11 2009-10 2008-09 2007-08 2006-07 2005-06
Debt:Equity 0.24 0.26 0.31 0.27 0.29 0.33
Debt:Net Worth 0.05 0.06 0.1 0.09 0.1 0.15
Net Worth:Equity 5.27 4.08 3.03 3.06 2.83 2.23
Net Fixed Assets:Net Worth 0.39 0.47 0.58 0.54 0.57 0.72
0
1
2
3
4
5
6
Times
Stuctural Ratios
We also present below other important financial ratios those would substantiate
the above claims regarding the financial health of the company.
Year ending 31st March 2010-11 2009-10 2008-09 2007-08 2006-07 2005-06
STRUCTURAL RATIOS
Debt: Equity 0.24 0.26 0.31 0.27 0.29 0.33
Debt: Net Worth 0.05 0.06 0.10 0.09 0.10 0.15
Net Worth: Equity 5.27 4.08 3.03 3.06 2.83 2.23
Net Fixed Assets: Net Worth 0.39 0.47 0.58 0.54 0.57 0.72
SHAREHOLDERS
INTEREST
Book value of shares 52.74 40.84 3034.19 3062.26 2832.21 2234.64
Dividend per share 3.90 3.50 270.00 270.00 237.50 200.00
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It is important to mention that it is a profit making PSU who regularly pays
royalty and tax to Government of India and continues to generate healthy revenue
earning for the Union Government.
FINANCING OF WORKING CAPITAL
After determining the amount of working capital required, the next time to be
taken by the FINANCE MANAGER is to arrange the funds.as discussed earlier, it
is advisable that the FINANCE MANGER bifurcates the working capital
requirement between the following:
PERMENANT WORKING CAPITAL TEMPERORY WORKING CAPITAL
0
500
1000
1500
2000
2500
3000
3500
2010-11 2009-10 2008-07 2006-07 2005-06 2004-05
Book Value Of Shares (INR)
Dividend Per Share (INR)
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PERMANENT WORKING CAPITAL: It is always needed irrespective of
sales fluctuations, hence should be financed by the LONG TERM sources such as
DEBT and EQUITY
TEMPERORY WORKING CAPITAL: It is financed by the SHORT TERM
sources of finance.
Broadly Speaking, The Working Capital Finance May Be Classified Between The
Two Categories:
SPONTANEOUS SOURCE NEGOTIABLESOURCE
SPONTANEOUS SOURCE: the spontaneous sources of finance are those which
naturally arise in the course of business operations. Trade Credit, Credit from
Employees, Credit from Suppliers of Services, etc. are some of the examples
which may be quoted in this respect.
NEGOTIABLE SOURCE: On the other hand the negotiated sources, as the
name implies, are those which have to be specifically negotiated with lenders say,
Commercial Banks, Financial Institutions, General Public etc.
The following parameters should be kept in mind while a finance manager is
selecting a particular source or a combination thereof for financing of working
capital:
COST FACTOR
IMPACT ON CREDIT RATING
FEASEBILITY
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RELIABILITY
RESTRICTIONS
HEDGING APPROACHOR MATCHING APPROACH i.e., FINANCING OF
ASSETS WITH THE SAME MATURITY AS OF ASSETS
21. WORKING CAPITAL LOANS IN TWO
LEVELS
Working Capital is primarily financed through loans from bank and financial
institution. There is therefore an element of interest associated with such loans for
working capital.
It is always the Endeavour of organization to bring down the interest amount to
the maximum extent possible. A common strategy adopted by organization with a
view to minimize the interest burden is to take the working capital loan in two
levels.
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T
O
T
A
L
W
O
RK
I
N
G
C
A
P
I
T
A
L
B
A
S
E
L
E
V
E
L
V
A
R
Y
IN
G
L
E
V
EL
TIME
W
O
R
K
I
N
G
C
A
P
I
T
A
L
R
E
Q
U
I
R
E
M
E
N
T
It would be evident from the above figure that the working capital requirement of
an organization would vary over a period of time keeping the trend of variation in
view the financing of working capital can be done in two levels.
Base LevelThis level of loan that is taken on a long term basis. This fund is available
to the organization on a continuous basis and therefore the interest burden
of this has to be borne continuously over the entire period of time.
Varying LevelThere might be certain points of time when the actual working capital
requirement may be more than the present base level in such periods an
additional loan over and above the base level is taken to bridge the gap.
This amount of loan is taken only for the period of actual requirement
once the requirement is over this amount of loan is repaid.
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22. SOURCES OF FINANCE Trade credit: It is a spontaneous source of finance which is normally
extended to the purchaser organization by the seller or service providers.
This source is more important since it contributes to about one third of
the total short term requirements .It has lesser cost of finance as compared
with other sources. Trade credit is guaranteed when a company acquires
supplies, merchandise or materials and does not pay immediately. If a
buyer is able to get the credit without completing many formalities, it is
termed as open account trade credit.
Bills Payable: In this the purchaser will have to give a written promise topay the amount of the bill / invoice either on demand or at a fixed future
date to the seller or the bearer of the note.
Inter-Corporate Loans and Deposits: Sometimes, organizations havingsurplus funds invest for short term period with other organizations. The
rate of interest will be higher than the bank rate of interest and depending
on the financial soundness of the borrower company. This source of
finance reduces dependence on bank financing.
Commercial Papers: Commercial Paper (CP) is an unsecured promissorynote issued by a firm to raise funds for a short period. This is an
instrument that enables highly rated corporate borrowers for short- term
borrowings and provides an additional financial instrument to investors
with a freely negotiable interest rate. The maturity period ranges from
minimum 7 days to less than 1 year.
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Benefits of Commercial Paper:
1. CP sold on an unsecured basis and does not contain any restrictive
condition so liquidity is assured.
2. Liability on maturity can be discharged by selling new CP and thus flow
of fund can be maintained.
3. Maturity of CP can be tailored to suit the requirement of the issuing firm.
4. CP can be issued as a source of fund even when money market is tight.
5. Generally, CP is preferred by the issuing firm since debt servicing is
cheaper than commercial banks.
Limitations of Commercial Paper:
1. Only hefty credit rating firms can use it. New and moderately rated firm
generally are not in a position to issue CP.
2. CP can never be redeemed before maturity nor can be extended beyond
maturity.
23. WORKING CAPITAL ADVANCE BY
COMMERCIAL BANKS
Regulation of Bank Finance
Traditionally industrial borrowers enjoyed a relatively easy access to bank finance
for meeting their working capital needs. Further the cash-credit management the
principle device through which such finance has been provided is quite
advantageous from the point of view of borrowers. Ready availability of finance
in a fairly convenient form led to in the opinion of many informed observers of
the Indian banking scene over-borrowing by industry and deprivation of other
sectors.
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The Reserve Bank of India (RBI) particularly from mid 1960s onwards has been
trying to bring a discipline among industrial borrowers and to redirect credit to the
priority sectors of the economy. For these committees have been formed and they
have provided some guidelines and directives regarding the issue of working
capital financing from banks. The committees are Tandon Committee, Chore
Committee, Dahejia Committee and Marathe Committee.
From the mid-1970s the regulation of bank finance for working capital was based
mainly on the recommendations of Tandon Committee. But after 1990s in the
wake of financial liberalization the RBI has given freedom to the boards of
individual banks in all matters relating to working capital requirements.
Assessment of Working Capital
Projected Balance Sheet Method: The working capital requirements are assessed
on the basis of the projected values of assets and liabilities.
Cash Budget Method: The working capital requirements are assessed on the basis
of the projected cash flows.
Turnover Method: The working capital requirements are assessed on the basis of
the projected annual turnover.
Current Ratio Norms
Under the Tandon Committee the minimal current ratio of 1.33 was required. At
present 1.33 is regarded only as a benchmark and depending on circumstances
banks do accept a lower current ratio. Presently banks follow a more flexible
approach in determining the Assessed Bank Finance.
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24. FACTORS DETERMINING CREDIT
POLICY
The bank credit will generally be in the following forms:
Cash Credit: the facility will be given by the bankers to the customers by giving
certain amount of credit facility on continuous basis. The borrower will not be
allowed to exceed the limit sanctioned by the bank.
Bank Overdraft: it is a short-term borrowing facility made available to the
companies in case of urgent need of funds. The banks will impose limit on the
amount they can lend. When the borrowed funds are no longer required they can
quickly and easily be repaid. The banks issue overdrafts with a right to call them
in at short notice.
Bills Discounting: the company which sells goods on credit will normally draw a
bill on the buyer who will accept it and sends it to the seller of goods. The seller,in turn discounts the bill with his banker. The banker will generally earmark the
discounting bills limit.
Bills Acceptance: to obtain finance under this type of arrangement a company
draws a bill of exchange on bank. The bank accepts the bill thereby promising to
pay out the amount of the bill at some specified future date.
Line Of Credit: line of credit is the commitment by a bank to lend a certain
amount of funds on demands specifying the maximum amount.
Letter Of Credit: it is an arrangement by which the issuing bank on the
instructions of a customer or on its own behalf undertakes to pay or accept or
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negotiates or authorizes another bank to do so against stipulated documents
subject to compliance with specified terms and condition.
Bank Guarantees: it is one of the facilities that the commercial banks extend on
behalf of their clients in favor of third parties who will be beneficiaries of the
guarantees.
25. STRUCTURAL ANALYSIS OFCURRENTASSETS AND CURRENT LIABILITIES
Concept of Current Assets and Current Liabilities and its components and the
volume variance in terms of amount shall put a major swing in the working
capital management. Determination of affordable liability burden and the future
avenues to discharge the debt burden is identified by liquidity analysis. Future
discharge of debt burden is based on the Time Frame Analysis and available fund
from Liquidity Analysis. Component wise analysis of Current Assets:-
1. Inventory wise Analysis both in (Quantity and Amount) locked up is amajor thrush on liquidity analysis.
2. Debtors position and age wise analysis of debtors is also a major thrush infund availability.
(Rs in crores)
COMPONENTS 2010-11 2009-10 2008-09 2007-08 2006-07 2005-0
Inventory of Coal and Coke 4439.82 3186.49 2514.98 2381.24 2137.04 1889.
Inventory of Stores& Spares 1038.97 1087.54 1055.51 909.36 900.67 921.9
Other Inventories 106.85 127.74 112.39 93.36 82.76 90.4
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Sundry Debtors 3025.56 2168.65 1826.14 1657.06 1586.41 1804.4
Cash& Bank Balances 45862.28 39077.76 29695.01 20961.48 15929.27 13427.
Loans& Advances& Spares 9922.54 8676.2 11244.51 10304.29 8191.88 6278.
TOTAL OF CURRENTASSETS
64396.02 54324.38 46448.54 36306.79 28828.03 24411.
The sample analysis given below of the accumulation of cash and bank balances
as a component of current assets commencing from 2004-05 to 2009-10 shall put
an adverse effect on Return on Investment.
COMPONENTS%/CA 2010-11 2009-10 2008-09 2007-08 2006-07 2005-06
Inventory / C.A (%) 6.89 5.86 5.41 6.55 7.41 7.74
Inventory, Stores &
Spares/CA(%)1.61 2 2.27 2.50 3.12 3.77
Other Inventory / CA (%) 0.17 0.23 0.24 0.25 0.28 0.37
Sundry debtors / CA (%) 4.7 3.99 3.93 4.56 5.50 7.39
Cash & Bank / CA (%) 71.21 71.93 63.93 57.73 55.25 55
Loans & Advances & Spares /
CA(%)15.42 15.97 24.22 28.38 28.41 25.72
Total Current Asset 100% 100.00% 100.00% 100.00% 100.00% 100.00%
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8%
4%0%
7%
55%
26%
Distribition of Current Assets(2005-06)
Inventory
Stores and Spares
Other Inventory
Sundry Debtors
Cash & Bank
Loans & Advances & Spares
Trend of working capital shows improvement in load bearing capacity and its
positive growth is registered from 2005-06. Chronological improvement in ratios
has firmed up its liquidity strength.
From the Pie Chart below it is identified that accumulation of Cash & Bank
Balance is the major player in CA .So the overall change in the Working Capital
has registered its prime role and there is a decrease in sundry debtors from 2005-
06. The Firm Can also Invest its Excess Cash & Bank for non-operating Incomes
and Gains. Its Substantially increased in last 6 years.
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7%
2% 0%5%
71%
15%
Distribution of Current Assets (2010-11)
Inventory
Stores & Spares
Other Inventory
Sundry Debtors
Cash & Bank
Loans & Advances & Spares
Activity Analysis:
YEARCURRENT
ASSETS
CURRENT
LIABILITIESWORKING CAPITAL CA:CL
2005-06 24411.63 21741.25 2670.38 1.12
2006-07 28828.03 22820.97 6007.06 1.26
2007-08 36306.79 29695.18 6611.61 1.22
2008-09 46448.54 40505.81 5942.74 1.15
2009-10 54324.38 42909.08 11415.3 1.27
2010-11 64396.02 46493.90 17902.12 1.39
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1.39
1.27
1.151.22
1.26
1.12
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
2010-11 2009-10 2008-09 2007-08 2006-07 2005-06
CA:CL
CA:CL
Improved pattern of Current Asset to Current Liability is depicted from the Ratio
which indicates on the accumulation of more current assets. From the above
component-wise analysis it is identified that the sole reason of such accumulation
is due to cash pile up.
Unutilized cash resources. More managerial skill is to be exerted for better
investment plan.
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26. ROI-ROE ANALYSIS
For e.g. a firm, AGE Limited, which requires an investment outlay of Rs 100
million, is considering two capital structures:
Capital Structure A (Rs Millions) Capital Structure B (Rs Millions)
Equity 100 50
Debt 0 50
While the average cost of the debt is fixed at 10%, the ROI may vary widely. The
tax rate of the firm is 50%.
Based on the above information, the relationship between ROI-ROE under the
two capital structures A and B would be as shown below.
Capital Structure A Capital Structure B
ROI 5% 10% 15% 20% 25% 5% 10% 15% 20% 25%
EBIT 5 10 15 20 25 5 10 15 20 25
Interest 0 0 0 0 0 5 5 5 5 5
PBT 5 10 15 20 25 0 5 10 15 20
Tax 2.5 5 7.5 10 12.5 0 2.5 5 7.5 10
PAT 2.5 5 7.5 10 12.5 0 2.5 5 7.5 10
ROE 2.5% 5% 7.5% 10% 12.5% 0% 5% 10% 15% 20%
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1 2 3 4 5
ROE of Capital Structure B 0 5 10 15 20
ROE of Capital Structure A 2.5 5 7.5 10 12.5
ROI 5 10 15 20 25
0
10
20
30
40
50
60
70
Percentage(%)
ROI-ROE Analysis
Looking at the above figure, the relationship between ROI-ROE we find
that:-
The ROE under capital structure A is higher than the ROE under capitalstructure B when ROI is less than the cost of debt.
The ROE under the two capital structures is the same when ROI is equalto the cost of debt.
The ROE under capital structure B is higher than the ROE under capitalstructure A when ROI is more than the cost of debt.
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2010-11 2009-10 2008-09 2007-08 2006-07 2005-06
ROE(%) 32.62 37.31 10.85 27.11 31.91 41.74
ROI(%) 20.21 19.72 9.16 17.08 20.06 22.58
0
10
20
30
40
50
60
70
Percentage(%)
ROI-ROE Analysis of CIL
27. ROI-ROE ANALYSIS OF COAL INDIA LIMITED
YEARS EBIT TOTAL ASSETS ROI (%) PAT NET WORTH ROE (%
2005-06 8788.46 38916.87 22.58 5891.52 14114.82 41.74
2006-07 8602.47 42879.35 20.06 5708.73 17889.3 31.91
2007-08 8738.46 51152.7 17.08 5243.27 19342.36 27.11
2008-09 5744.1 62693.03 9.16 2078.69 19165.04 10.85
2009-10 13964.93 70814.75 19.72 9622.45 25793.68 37.31
2010-11 16463.23 81397.28 20.21 10867.35 33313.82 32.62
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Looking at the above figure, the relationship between ROI-ROE we find
that:-
ROI and ROE has gradually decreased from 2005-06 to 2008-09 and againits vastly increased in the last 2 financial years.
Both ROI and ROE were maximum during 2005-06 and it was minimumduring 2008-09.
28. ASSOCIATION OF LEVERAGE WITH
WORKING CAPITAL MANAGEMENT
LEVERAGE is the most important mathematical tool to identify the extent of
fixed cost in an attempt to increase the level of profitability.
To run the operation at every level some parts of working capital is engaged.
Therefore, it is essential to compute the leverage gain (if any) so that fixed cost
can be minimized and no amount of working capital is being misused.
29. LEVERAGE
Leverage means that a percentage change in one amount causes a relatively larger
percentage change in other amounts. This phenomenon is a result of certain
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expenses being fixed in nature. it means either fixed cost is incorporated in the
operating cost structure of a firm and / or financial expenses i.e., fixed interest
bearing capital is incorporated in the capital structure of the firm.
According to VAN HORN- Leverage refers to the use of fixed costs in an
attempt to increase (or, Lever up) profitability.
According to EZRA SOLOMANLeverage is the ratio of net returns on share
holders equity and the net rate of return on the total capitalization.
According to S.C. KUCHHAL- The term leverage is used to describe a firms
ability to use fixed cost assets or funds to magnify the return to its owners.
On the basis of the above definitions, it can be said that the process of increasing
the earning per share to the equity shareholders by charging the fixed
operating cost and fixed financial cost with respect to change in sales is called
LEVERAGE.
Leverages are of three types:-
Financial Leverage Operating Leverage Combined Leverage
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29A. FINANCIAL LEVERAGE
Definition: The process of increasing the earning per share to the equity
shareholders by increasing the amount of debt capital is called FinancialLeverage. The financial leverage may be of two
Positive or Favorable Financial LeverageOR
Negative Unfavorable Financial LeverageWhen there is greater dependence on debt capital and as a result the earning
per share to the equity shareholders is increased at a faster rate, it is called
Positive or Favourable Financial Leverage. On the other hand, when there
is low dependence on the debt capital and as a result it is quite impossible to
increase the rate of earning per share to the equity shareholders, it is called
Negative or Unfavourable Financial Leverage.
POSITIVE or FAVOURABLE FINANCIAL LEVERAGE
ILLUSTRATION:
Capital Structure Firm A
Firm B
Equity Share Capital 6,00,000
10,00,000
(Rs. 10 per share)
9% Debentures 4,00,000
NIL------------------------
-------------
Total Capital Employed 10,00,000
10,00,000
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------------------------
-------------
Earnings Before Interest and Tax (EBIT) 20% of Capital
20% of Capital
Employed
Employed
Income Tax Rate 40%
40%
SOLUTION:
PARTICULARS Firm A
Firm B
(Rs) (Rs)
EBIT 2,00,000
2,00,000
Less: Interest (36,000)
NIL
--------------------------
---------------
Earnings Before Tax (EBT) 1,64,000
2,00,000
Less: Income Tax @ 40% (65,600)
(80,000)
--------------------------
---------------
Earnings After Tax (EAT) 98,400
1,20,000Less: Preference Dividend NIL
NIL
--------------------------
---------------
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Earnings Available for Equity Share Holders 98,400
1,20,000
--------------------------
---------------
Number of Shares 60,000
1,00,000
Earning per Share (EPS) 1.64
1.2
= Earnings Available to Equity Shareholders/ Number of Shares
It would be evident from the above figures that the debt proportion in the overall
capital structure is higher in Firm A as compared to Firm B and as such the EPS
of Firm A (Rs 1.64) Is greater than that of Firm B (Rs 1.2) this is Favourable
Financial Leverage.
Financial Leverage is concerned with the effect of changes in the EBIT on EPS. It
may be defined as the ability of a fir to use fixed financial charges to magnify the
effect of changes in EBIT on EPS.
NEGATIVE or UNFAVOURABLE FINANCIAL LEVERAGE
ILLUSTRATION:
Capital Structure Firm A
Firm B
(Rs)
(Rs)
Equity Share Capital 6,00,000
10,00,000
(Rs 10 per Share)
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9% Debentures 4,00,000
NIL
Total Capital Employed 10,00,000
10,00,000
EBIT 6% of Capital
6% of Capital
Employed
Employed
Income Tax Rate 40%
40%
SOLUTION:
PARTICULARS Firm A
Firm B
EBIT 60,000
60,000
Less: Interest (36,000)
NIL
--------------------------
---------------
EBT 24,000
60,000
Less: Income Tax @ 40% (9,600)
(24,000)
--------------------------
---------------
EAT 14,400
36,000
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Less: Preference Dividend NIL
NIL
--------------------------
---------------
Earnings Available for Equity Shareholders 14,400
36,000
--------------------------
---------------
Number of Equity Shares 60,000
1,00,000
EPS 0.24
0.36
It would be evident from the above figures that Firm A with a higher debt
proportion has a lower EPS (0.24) compared to the Firm B which has a lower debt
proportion (0.36)this is Negative orUnfavourable Financial Leverage .
It may be noted in this context that a Firm will have a favourable financial
leverage as long as its ROI is greater than the rate of interest. In a situation where
the ROI falls below the rate of interest the financial leverage would be negative.
DEGREE OF FINANCIAL LEVERAGE (DFL):
The percentage change in earning per share (EPS) due to one percent change in
earnings before interest and tax (EBIT), is called Degree of Financial Leverage
(DFL).
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DFL can be calculated in the following ways:
DFL = % Change in EPS/% Change in EBIT
If there is no preference share capital in the Capital Structure:DFL = EBIT / EBT
If there is preference share capital in the capital structure in the capitalstructure:
DFL = EBIT / EBTPd / (1-t)
Where EPS = Earnings per share
EBIT = Earnings before interest and tax
Pd = Preference Dividend
t = Tax Rate
ILLUSTRATION:
(i) Calculate DFL from the given information.
(ii) Calculate EPS when EBIT is increased by 30%.
Capital Structure Rs.
10% Debentures 5,00,000
12% Preference Share 1,00,000
Equity Share capital 4,00,000
(Rs. 10 per share) ---------------
10,00,000
---------------
EBIT 1,60,000
Income Tax Rate = 50%
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SOLUTION:
PARTICULARS (Increased by 30%)
Rs. Rs.
EBIT 1,60,000
2,08,000
Less: Interest (50,000)
(50,000)
------------------------------------
-----
EBT 1,10,000
1,58,000
Less: Income Tax @ 50% (55,000)
(79,000)
------------------------------------
-----
EAT 55,000
79,000
Less: Preference Dividend (12,000)
(12,000)
------------------------------------
-------
Earnings for Equity Shareholders 43,000
67,000
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------------------------------------
-------
EPS 1.075
1.675
Earnings available for Equity Shareholders
= -----------------------------------------------------
Number of Equity Shares
DFL = EBIT / EBT - [Pd / 1-t)] 1.86
1.55
OR
DFL = % Change in EPS / % Change in EBIT
Where; % increase in EPS from 1.075 to 1.675
= 1.6751.075 / 1.075 * 100
= 55.81%
% change in EBIT = 30%
So, DFL = 55.81 / 30
= 1.86
MEASURES OF FINANCIAL LEVERAGE
The most commonly used measures of financial leverage are:
1. DEBT RATIO: The ratio of debt to capital, i.e.,
L1 = D / D+E = D / V
Where;
D = Value of debt;
E = Value of shareholders equity;
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V = Value of total Capital
2. DEBT-EQUITY RQTIO: The ratio of debt to equity, i.e.,
L2 = D / E
3. INTEREST COVERAGE RATIO: The ratio of net operating income
(or EBIT) to interest charges, i.e.,
L3 = EBIT / INTEREST
NOTE: There is no difference between the first two measures of financial
leverage in operational terms. They are related to each other in the
following manner.
L1 = L2/ 1+L2 = D/E / 1+D/E = D / V
L2 = L1 / 1-L1 = D/V / 1-D/V = D / E
Both the measures will rank the companies in the same order. However, the
first measure (D / V) is more specific as its value will range between zero to
one. The value of the second measure (D / E) may vary from zero to any
large number.
The first two measures of financial leverage are also measures of capital
gearing. They are static in nature as they show the borrowing position of the
company at a point of time. These measures, thus, fail to reflect the level of
financial risk, which is inherent in the possible failure of the company to pay
interest and repay debt.
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The third measure of financial leverage, commonly known as coverage
ratio, indicates the capacity of the company to meet the fixed financial
charges.
29B. OPERATING LEVERAGE
Definition: The tendency of disproportionately changes in operating profit
with a change in sales is called Operating Leverage. Every firm has to bear
fixed cost whatever may be its productions or sales. The operating leverage
takes place only at the time when a firm has to bear fixed cost. As every firm
has to bear fixed cost compulsorily, the percentage change in operating profit
accompanying a change in sales is greater than the percentage change in
sales. So, in the definition of the operating leverage, disproportionate change
of the sales and operating profit has been mentioned.
DEGREE OF OPERATING LEVERAGE (DOL):
The degree of operating leverage is defined as the percentage change in the
earnings before interest and taxes relative to a given percentage change is
sales.
DOL can be calculated in the following ways:
DOL = % change in EBIT / % change in Sales
DOL = Contribution / EBIT
ILLUSTRATION:
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(i) Calculate DOL from the following information
(ii) Calculate EBIT when Sales is increased by 20%
PARTICULARS Rs.
Sales 3,00,000
Fixed Cost 1,50,000
Variable Cost 25% of
Sales
SOLUTION:
PARTICULARS
(Increased by 20%)
Rs.
Rs.
Sales 3,00,000
3,60,000
Less: Variable Cost (75,000)
(90,000)
---------------------------------
-------------
Contribution 2,25,000
2,70,000
Less: Fixed Cost (1,50,000)
(1,50,000)
---------------------------------
-------------
EBIT 75,000
1,20,000
---------------------------------
-------------
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DOL = Contribution / EBIT 3
2.25
OR
DOL = % Change in EBIT / % Change in Sales
Where; % Change in EBIT = 1,20,00075,000 / 75,000 * 100
= 60%
% Change in Sales = 20%
So, DOL = 60% / 20%
= 3
FINANCIAL BREAKEVEN POINT
Definition: Operating break-even point or Financial break-even point is the
volume of sales at which the company neither earns any profit nor incurs any loss
i.e. , it is the volume of sales at which operating profit is nil.
At the Operating BEP, total contribution is just equal to operating fixed costs.
Total contribution = Fixed Costs
Units Sold = Fixed Costs / Contribution per unit
BEP (Units) = Fixed Costs / Contribution per unit
At the Operating BEP, DOL = Contribution / EBIT
OR, DOL = Contribution / Nil
= (infinity)
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MARGIN OF SAFETY
Definition: Margin Of Safety is the difference between actual sales value and
break-even sales value i.e., it is the sales value over and above the break-even
volume of sales . It indicates the financial soundness of the company.
If the Margin of Safety increases, the amount of profit increases and vice-
versa.
Mathematically, M/S = Actual SalesBreak-even Sales
Or, M/S = S - BES
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29C. COMBINED LEVERAGE
Definition: The combined effect of Operating and Financial Leverage is
called Combined Leverage. The leverage by which the percentage change in
earning per equity share due to one percent change in sales is measured is
called Combined Leverage.
For example, a combined leverage of 10 means that the earning per share will
be changed by 10% due to one percent change in sales.
DEGREE OF COMBINED LEVERAGE:
The percentage change in earnings per equity share (EPS) due to one percent
change in sales (Q), is called Degree of Combined leverage (DCL).
The degree of combined leverage is calculated as follows:
If there is no preference share in the Capital Structure: DCL = Contribution / EBIT
If there is preference share in the Capital Structure:DCL = Contribution / EBT - Pd / (1-t)
DCL = DFL * DOL
ILLUSTRATION:
(a)Calculate DOL, DFL and DCL from the following data under financial
plan A and
B.
Installed capacity 45,000 units
Actual production and sales 80% of the capacity
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Selling price Rs. 25 per unit
Variable cost Rs. 15 per unit
Fixed cost Rs. 1,60,000
Tax rate 50%
Capital Structure Financial Plan A Financial
Plan B
(Rs) (Rs)
Equity Share Capital of Rs. 10 each 5,00,00
2,50,000
10% Preference Share Capital of Rs. 100 each NIL
2,00,000
Debt 2,00,000
2,50,000
Cost of Debt
Up to Rs. 1,00,000 = 10%
Above Rs. 1,00,000 = 12%
Above Rs. 2,00,000 = 16%
(b)Verify whether DCL = DOL * DFL or not.
(c) What conclusion do you draw from the computed value of DCL?
(d)Calculate EPS.
SOLUTION:
(a) Statement showing computation of DOL, DFL, DCL and interpret the results:
Particulars Plan - A Plan
B
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(Rs)
(Rs)
Effective Production and Sales 36,000 units
36000 units
(45,000 * 80 / 100)
Sales (Rs. 25 * 36,000) 9,00,000
9,00,000
Less: Variable cost 5,40,000
5,40,000
(Rs 15 * 36,000 units)
------------------------------------
---------------
Contribution 3,60,000
3,60,000
Less: Fixed cost 1,60,000
1,60,000
-------------------------------------
-------------
EBIT 2,00,000
2,00,000
Less: Interest (W.Note-1) 22,000
30,000
-----------------------------------
-------------- EBT 1,78,000
1,70,000
Less: Tax @ 50% 89,000
85,000
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------------------------------------
------------- EAT 89,000
85,000
Less: Preference dividend NIL
20,000
----------------------------------
--------------
Earnings available to equity 89,000
65,000
Shareholders
----------------------------------
---------------
DOL = (Contribution / EBIT) 3,60,000 / 2,00,000
3,60,000/ 2,00,000
= 1.80
= 1.80
DFL = (EBIT / EBT) 2,00,000 / 1,78,000
--
= 1.1236
= [EBIT / EBT Pd / (1-t)] --
2,00,000
--------------------------
-----
1,70,000-
20,000/(1-0.50)
=
1.5385
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DCL = (Contribution / EBT) 3,60,000 / 1,78,000
--
= 2.0225
= [Contribution / EBT- Pd / (1-t) --
3,60,000
----------------------
----------
1,70,000-20,000/(1-
0.50)
=
2.7692
Interpretation of the results of PlanA:
(i) DOL = 1.80. This means, if sales revenue changes by 1%, the EBIT willchange by 1.80%.
(ii) DFL = 1.1236. This means, if EBIT changes by 1%, the EPS will change by1.1236.
(iii) DCL = 2.0225. This means, if the volume of sales changes by 1%, the EPS
will change
by 2.0225%.
Interpretation of the results of PlanB:
(i) DOL = 1.80. This means, if sales revenue changes by 1%, the EBITwill change by 1.80%.
(ii) DFL = 1.5385. This means, if EBIT changes by 1%, the EPS willchange by 1.5385.
(iii) DCL = 2.7692. This means, if the volume of sales changes by 1%,the EPS will change by 2.7692%.
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(b)DCL of PlanA = DOL of Plan-A * DFL of Plan - B
= 1.80 * 1.1236
= 2.0225
DCL of PlanB = DOL of PlanA * DFL of PlanB
= 1.80 * 1.5385
= 2.769
Hence, DCL = DOL * DFL (Proved)
(c)DCL of PlanA is 2.0225. This means if the volume of sales is changed
by 1%, the EPS will change by 2.0225%. Again, DCL of Plan B is
2.7692. So, if the volume of sale is increased by 1 %, the EPS will
change by 2.7692%.
(d)EPS of Plan A = Earnings available to Equity shareholders / No. of
Equity shares
= Rs. (89,000 / 50,000)
= Rs. 1.78
EPS of PlanB = Rs. (65,000 / 25,000)
= Rs. 2.60
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30. CONCLUDING REMARKSON WORKING
CAPITAL MANAGEMENT
Highlights of Working Capital
Working Capital is an important issue that needs to be managed properly by the
financial managers of the company. The progress and growth of the company
depends to a large extent on full and prompt use of working capital. So the
company needs to keep working capital according to its requirement and the
requirement can always vary from company to company.
From the study of the annual report of Coal India Limited, we come across certain
peculiar features, which do not adhere to the theoretical norms of managing
working capital.
First from the efficiency analysis of the working capital we are able to say that the
general trend of the ratios suggest that efficiency in working capital management
cannot be ascertained and the trend in the current asset turnover ratio has to
change or become higher to mark better efficiency in working capital
management.
During 2004-05 the working capital showed negative results amounting to Rs -
805.41 Crs. But from 2005-10 it gradually increases from Rs (2670.38 to
11415.30).So we can say that the working capital of Coal India Limited is good.
Moreover, the CA:CL ratio of CIL is 1.27 which is more from the industryaverage i.e. 1.26.
A positive W/C is, therefore, recommended and likely to be maintained to help
the organization grow in healthy liquidity position.
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Hence this study recommends that in the long run the company has to conform to
the maintenance of a positive working capital to allow growth in healthy liquidity
position although the current W/C position poses no threat to fund managers of
the organization in running day-to-day business.
The profitability position of the organization on the whole for last 6 years, as has
been depicted before, is following a healthy and rising trend because of improved
productivity, increased turnover and containing cost within single digit inflation.
31. A CASE STUD THE STORY OF REVIVAL OF A
SICK COMPANY (BCCL)
BHARAT COKING COAL LIMITED
Bharat coking coal limited (BCCL), the DHANBAD based coal India subsidiary,
rich in coking coal reserve in the forerunner of the Indian nationalized coal sector.
It was formed in 1971 through nationalization of coking coal mines and
subsequently with nationalization of non-coking coal mines BCCL become a unit
of Coal India Limited (CIL) on 1-11-1975
It operates 76 mines -74 arc in JHARIA COALFIELD
2 in RANIGUNJ COALFIELD
It has 41 underground mines 13 opencast mines 22 mixed mines
Besides, BCCL operates 6 coking coal washeries, 2 non-coking coal washeries
and various other units
PERFORMANCE PARAMETRES-:
Production23.3 mts during 05-06
Registering the growth of coal production of 1 mt over last year
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Profit reported during five year 05-06Rs 205.08 cr
Gross sales reported during five year 05-06- Rs 3467.04 cr
Net sales reported during five year 05-06- Rs 3112.28 cr Washeries loss till (03-
04)
It was managed to turn around in o4-05 with a profit of 58.38 cr and earned a
profit of Rs 293.40 cr in 2005-06
BCCL contributed an amount of Rs 458.05 cr to government exchange in the term
from Royalty, Cess, Sales tax, Stowing excise duty (SED) and Entry tax during
2005.
PAST SCENARIO AND MEASURES INITIATED FOR TURN AROUND -:
Owing to various reasons BCCL has been consistently incurring losses over the
years. Its turn- around in 2005-06 is the result of perseverance, dedication and
resolve to its employee. The company reported loss of Rs 569.85 cr and cash loss
of Rs 209 cr in 03-04.
The turn around in less than 2 years from a near bankruptcy
Situation has been made possible through dedicated and sustained pursuit of a
revival strategy focused on -:
Enhancing production of high value coking and washed coal
Internalizing premium on coal marketed to non-core sector through e marketing
Arresting / reversing the trend of persistent decline in coal production since 1999-
2000
Several decisive steps were taken towards the end of 03-04 and the order of
priorities was re adjusted to turn around. In order to procure production holding
items on a fast track and subsequent payment
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Worn out machines were surveyed off. Procurement of heavy earth moving
machinery (HEMM) was adjusted as a new major thrust area
To supplement the drive is to improve production from departmental mines by
revamping the existing capacity.
Efforts were made to obtain coal from isolated patches by deployment of hired
HEMM. A number of contracts were awarded in 05-06 for deployment of
HEMM.
In 03-04 on a production of 22.68 mts the company incurred a loss of Rs. 569.85
cr. This loss was equivalent to contribution of around 8 mts. In other words the
break-even level was 30.68mts achieving increase in production of such
magnitude was ruled out under the given circumstances it therefore became
imperative to focus on -:
-Increase in production of high value prime washed coking coal & unshakable the
constraints in value realization, wherever possible. Accordingly efforts were made
to reserve the steep decline in washed coal production witnessed during the earlier
year.
As a consequence of all the above measures, acting in Tandem. BCCL earned
profit slowly from operations, for the first time in its history of 05-06.
During 06-07 BCCL has also registered it performance in line with 05-06 & the
estimated profit is Rs.21crore.
FUTURE PLAN
Revamping departmental capacity
Deploying hired HEMM for coal production from isolated patches.
Long wall Mechanization is Moonidihi project
Developments of MANDRA Block in BARORA Area
Up gradation & modernization of washeries
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It is estimated that net worth will be positive by 2010-11 & production will tend
to 30mts by 2011-12.
32. RESULTS AND CONCLUSION
AIM: To analyze the Financial Statement of Coal India Limited for the past six
years.
COMMENT on OBJECTIVES:
1. To measure the efficiency of the Organization If we go through the ratio
analysis part we will see that during the analysis of liquidity ratio there is positive
growth from 2005-06 onwards. The liquidity position of the company is
improving significantly and the terminal year has registered its growth positively
and has established that current assets has exceeded over current liabilities. There
is also immense reduction of the percentage of debt during the years, which is the
company has low financial risk which is beneficiary to the shareholders. If we go
through the profitability ratios we will see that the company is making profit andits operating efficiency is sound.
2. To judge the profit earning capacity of the Organization The profitability
position of the organization on the whole for last six years as has been depicted
before is following a healthy and rising trend because of improved productivity,
increased turnover and containing cost between single digit inflation.
3. To know about the financial strength of the Organization The debt burden of
the company is drastically reducing, which is a good indication for the
shareholders that the company is able to withstand it financial needs from its own
generation and the siphoning of funds from outer sources is gradually in
decreasing order.
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From the information in the dissertation, it can be said that the company
is financially sound and it is identified that the company including its eight
subsidiaries has attained the stage of profitability and it is a remarkable
achievement in the arena of Financial Management.
4. Information about activities in the Organization - In addition to above, the
following jobs were also undertaken:
Revision of project reports/cost estimates.
Feasibility reports for coking/non-coking coal washeries.
Study on improvement/modernization of existing BCCL washeries.
Operational plans for large Open Cast mines.
Environmental Management Plan (EMP)
33. RECOMMENDATION
From the overall analysis of financial statements and component wisecost, the company is being looked from all the dimension and finally it can
be concluded that economic health is sufficiently strong with huge cash
reserve which can enable the company for diversification and many other
venture is being processed apart from the main business of coal mining.
Cost aspect is also registering that the price increase is contained withinthe level of inflation in spite of many other extraneous factors.
In my opinion it is a cash rich PSU and should go for diversificationmeeting all social commitment. In global context for its survival and
growth many other conditional ties to be complied.
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Under corporate governance more transparency should be maintained andmany other commitment to be achieved.
34. LIMITATIONS OF THE STUDY AND FUTURE
SCOPE OF THE WORK
After reviewing all sets of financial data as well as statistical information of the
company, an effort is taken to highlight the companys financial position along
with sufficient comment to diagnose the financial health from time to time. It is a
drive with time constraint so overall review of the company from several direction
cannot be viewed which can help the management to take concrete managerial
decision. Further to note that the structure of company is massive in nature with
manpower of 404744