1

Punj Lloyd Project report

On

“Working capital management and cash

flow analysis”

By

Arindam Mitra

(PGDM)

ITM Business school, Navi Mumbai

1

Summer Internship Project

(Batch 2009-11)

Preface

To start any business, First of all we need finance and the success of that business entirely depends on the proper management of day-to-day finance and the management of this short-term capital or finance of the business is called Working capital Management.

Working Capital is the money used to pay for the everyday trading activities carried out by the business - stationery needs, staff salaries and wages, rent, energy bills, payments for supplies and so on.

I have tried to put my best effort to complete this task on the basis of skill that I have achieved during the last one year study in the institute.

I have tried to put my maximum effort to get the accurate statistical data. However I would appreciate if any mistakes are brought to my consideration by the reader.

1

Acknowledgement

A work is never a work of an individual. The satisfaction and euphoria that accompanies the successful completion of any task would be incomplete without mentioning the names of the people who made it possible, whose constant guidance and encouragement crown all the efforts with success. I owe a sense of gratitude to the intelligence and co-operation of those people who had been so easy to let me understand what I needed from time to time for completion of this exclusive project.

I’m deeply indebted to all people who have guided, inspired and helped us in the successful completion of this project. I owe a debt of gratitude to all of them, who were so generous with their time and expertise.

I would like to thank my guides Dr. C S Adhikari, project guide (summer internship), ITM Business School, Navi Mumbai, Mrs. Preeti Bakshi, finance professor, ITM Business School, Navi Mumbai & Mr. Parag Nerurkar, Manager - Accounts, KAEFER Punj Lloyd limited, Navi Mumbai, for their constant guidance, advice and help which enabled me to finish this project report properly in time .

Last but not the least, I would like to forward my gratitude to my friends & other faculty members who always endured me and stood with me and without whom I could not have completed the project.

Arindam Mitra

1

Declaration

I do hereby declare that this piece of project report entitled “A Study on Working capital Management and cash flow analysis in KAEFER Punj Lloyd” for partial fulfillment of the requirements for the award of the degree of “POST GRADUATE DIPLOMA IN MANAGEMENT” is a record of original work done by me under the supervision and guidance of Dr. C S Adhikari, ITM Business School, Navi Mumbai. This project work is my own and has neither been submitted nor published elsewhere.

Place: Arindam Mitra

Date:

1

1.Executive summary

The major objective of the study is to properly understanding the working capital of KAEFER Punj Lloyd & to suggest measures to overcome the shortfalls if any.

Funds needed for short term needs for the purpose like raw materials, payment of wages and other day to day expenses are known as working capital. Decisions relating to working capital (Current assets-Current liabilities) and short term financing are known as working capital management. It involves the relationship between a firm’s short-term assets and its short term liabilities. By definition, working capital management entails short-term definitions, generally relating to the next one year period.

The goal of working capital management is to ensure that the firm is able to continue its operation and that it has sufficient cash flow to satisfy both maturing short term debt and upcoming operational expenses.

Working capital is primarily concerned with inventories management, Receivable management, cash management & Payable management.

Inventories management at Punj Lloyd:

Punj Lloyd is a large scale construction &engineering company involved in refractories, insulation, in oil & gas, petrochemicals, power and civil engineering. Therefore, it has to maintain large quantity of inventories at production units for its smooth running and functioning.

Cash management at Punj Lloyd:

Punj Lloyd has been accumulating huge cash surpluses over last several years, which enables the organization to maintain adequate cash reserves and to generate required amount of cash.

Receivables management at Punj Lloyd:

1

Punj Lloyd has set up its marketing office at all metro cities in India i.e. Mumbai, New Delhi. This marketing office obtains job orders in India as well as globally. On the basis of order received for different jobs it marks production planning.

2.Introduction

Working Capital:

The life blood of business, as is evident, signified funds required for day-to-day operations of the firm. The management of working capital assumes great importance because shortage of working capital funds is perhaps the biggest possible cause of failure of many business units in recent times. There it is of great importance on the part of management to pay particular attention to the planning and control for working capital.

Decisions relating to working capital and short term financing are referred to as working capital management. These involve managing the relationship between a firm's short-term assets and its short-term liabilities. The goal of Working capital management is to ensure that the firm is able to continue its operations and that it has sufficient money flow to satisfy both maturing short-term debt and upcoming operational expenses.

2.1 Objective of the study:

The following are the main objective which has been undertaken in the present study:

1. To determine the amount of working capital requirement and to calculate various ratios relating to working capital.

2. To make an item wise study of the components of the working capital.

3. To suggest the steps to be taken to increase the efficiency in management of working capital.

Place of study:

The project study is carried out at the Finance Department of Punj Lloyd office situated at Belapur, Navi Mumbai. The study is undertaken as a part of the PGDM curriculum from 10 th

May 2010 to 02nd July 2010 in the form of summer placement.

1

2.2 Study design and methodology:

Two types of data are collected, one is primary data and second one is secondary data. The primary data were collected from the Department of finance, Punj Lloyd. The secondary data were collected from the Annual Report of Punj Lloyd, Punj Lloyd website, etc.

2.3 Limitations:

There may be limitations to this study because the study duration (summer placement) is very short and it’s not possible to observe every aspect of working capital management practices.

2.4 Deliverables:

This project on “working capital management and cash flow analysis” will help the company to identify its working capital requirements and the discrepancies in cash flows, between projected and actual expenses and incomes. It will also aid the company in finding out the ways for financing its working capital requirements through short term or long term financing and help in identifying the various resources available in doing so.

1

3.Introduction

Indian Industry overview

3.1 Oil & Gas

The oil and gas industry has been instrumental in fuelling the rapid growth of the Indian economy. India has total reserves of 775 million metric tonnes (MT) of crude oil and 1074 billion cubic metres (BCM) of natural gas as on April 1, 2009, according to the Ministry of Petroleum.

Petroleum exports during 2008-09 were US$ 26.2 billion according to the Ministry of Petroleum.

Under New Exploration Licensing Policy (NELP VIII), 1.62 sq km of area comprising 70 blocks was put up for bidding.

The Cabinet Committee on Economic Affairs (CCEA) has approved award of 33 out of 36 oil and gas blocks that were bid for in New Exploration Licensing Policy (NELP-VIII), for which bidding closed on October 12, 2009.

Production

By the end of the Eleventh Plan the refinery capacity is expected to reach 240.96 MMTPA.

Crude oil production during 2009-10 was 33.68 MT, compared to 33.50 MT in 2008-09.

Refinery production in terms of crude throughput was 160.03 MT in 2009-10.

The production of natural gas went up to 47.57 billion cubic metres tonnes (BCM) in 2009-10 from 32.84 BCM in 2008-09.

Consumption

1

The sales/consumption of petroleum products during 2008-09 were 133.40 MT (including sales through private imports), an increase of 3.45 per cent over sales of 128.94 MT during 2007-08, according to the Ministry of Petroleum.

India's domestic demand for oil and gas is on the rise. As per the Ministry of Petroleum, demand for oil and gas is likely to increase from 186.54 million tonnes of oil equivalent (mmtoe) in 2009-10 to 233.58 mmtoe in 2011-12.

The refining capacity in the country increased to 177.97 million tonnes per annum (MTPA) as on April 1, 2009 as compared to 148.968 MTPA as on April 1, 2008.

Gas

India's natural gas demand is expected to nearly double to 320 million standard cubic meters per day by 2015, according to a report released by global consultancy firm McKinsey at the VI Asia Gas Partnership Summit.

According to the report, the current demand of 166 million standard cubic metres per day (mscmd)—made up of nearly 132 mscmd supplies from domestic fields and the rest from imported LNG-- is likely to rise to at least a minimum of 230 mscmd and a maximum of 320 mscmd by 2015.

In January 2010, Gas Authority of India Ltd (GAIL) said that gas availability in India is expected to grow at 23 per cent compounded annual growth rate (CAGR) to 312 mscmd by FY14, buoyed by trebling of domestic production to 254 mscmd and doubling of regasified liquefied natural gas imports to 58 mscmd.

To capture the opportunity presented by the impending gas surge in India, GAIL is investing significantly in its pipeline network. Over the next three years, it will invest US$ 660.7 million –US$ 770.8 million, expanding its transmission capacity from the current 150 mscmd to 300 mscmd.

State-owned Oil and Natural Gas Corp (ONGC) has added 83 million tonnes of oil and gas reserves in the 2009-10 fiscal, the highest in two decades.

The ultimate reserve accretion of ONGC including its joint ventures (with firms like Cairn India) in domestic fields in 2009-10 has been 87.37 million tonnes of oil and oil equivalent gas against the target of 76.28 million tonnes.

ONGC on a standalone basis added 82.98 million tonnes of oil and oil equivalent gas reserves.

1

Investments and Acquisitions

Indian Oil Corp aims to expand the capacity of its Panipat plant by 25 per cent to 300,000 barrels per day (bpd) by October 2010 to meet growing fuel demand. The refinery expansion will cost US$ 224.8 million.

Mahanagar Gas Ltd (MGL) will invest over US$ 3.37 billion in a span of 5-6- years to lay infrastructure for the supply of both Compressed Natural Gas (CNG) and Piped Natural Gas (PNG)

The Ruias of Essar Group have injected US$ 293 million in Essar Oil by subscribing to global depository shares (GDS) to part finance its US$ 1.7-billion expansion plans. The proposed expansion plan includes scaling up of the Jamnagar refinery capacity by 25 per cent to 375,000 barrels.

State-owned gas firm GAIL India will invest about US$ 3.37 billion over the next 2-3 years in laying pipelines to connect consumption centres in North India to fuel sources.

Energy major Reliance Industries gained an overseas foothold by agreeing to pay US$ 1.7 billion to form a joint venture with U.S.-based Atlas Energy

Gujarat State Petroleum Corporation (GSPC) has inked an agreement with government of Egypt for oil and gas exploration in the African nation where the Indian firm has been alloted blocks.

Templeton Strategic Emerging Markets Fund (TSEMF) has invested US$ 20.6 million investment in Shiv-Vani Oil & Gas Exploration Services.

Indian state-run Oil & Natural Gas Corp will invest US$ 7.11 billion for the first phase development of three marginal fields located in Mumbai offshore on the western coast.

Government Initiatives

The government has been taking many progressive measures to create a conducive policy and regulatory framework for attracting investments.

FDI up to 100 per cent under the automatic route is permitted in exploration activities of oil and natural gas fields, infrastructure related to marketing of petroleum products, actual trading and marketing of petroleum products, petroleum product pipelines, natural gas and LNG pipelines, market study and formulation and petroleum refining in the private sector.

1

FDI up to 49 per cent is permitted under the government route in petroleum refining by the public sector undertakings.

Vision-2015 approved in 2009, for the oil sector which will focus on expanding the marketing network as well as quality of the products and services to customers covering four broad areas of LPG (liquefied petroleum gas), kerosene, auto fuels and compressed natural gas/piped natural gas.

In 2009, the government announced a seven-year tax holiday for commercial production of gas in respect of contract to be signed under NELP VIII & Coal Bed Methane (CBM) IV with a view to give a boost to exploration and production.

India will complete building its first strategic crude oil storage by October 2011 in an effort to insulate itself from supply disruptions.

The country is building underground storages at Visakhapatnam in Andhra Pradesh and Mangalore and Padur in Karnataka to store about 5.33 million tonnes of crude oil. This is enough to meet nation's oil requirement of 13-14 days.

The storage at Visakhapatnam will have capacity to store 1.33 million tonnes of crude oil in underground rock caverns and will be completed by 2011, while the Mangalore facility will be able to store 1.55 million tonnes and would be completed by November 2012. A 2.5-million tonnes storage at Padur, near Mangalore, would be completed by December 2012.

3.2 Civil & Engineering

The country’s core sector, comprising six key infrastructure industries, accelerated by 5.1 per cent year-on-year in April 2010, compared with 3.7 per cent in April 2009, according to the data released by the Union Ministry of Commerce and Industry. The growth was primarily led by an increase in the production of cement, which stood at 18.87 million tonnes (MT), compared to 17.36 MT during April 2009.

Electricity production grew by 6 per cent in April 2010, as against 6.7 per cent in the same month of the previous fiscal. Finished steel production registered a growth of 4.7 per cent during the month, against a decline of 1.3 per cent in the corresponding period of 2009. Among other industries, production of crude petroleum rose by 5.2 per cent, as against minus 3.1 per cent, while production of petro-products registered an increase of 5.3 per cent, as compared to a contraction of 4.5 per cent during April 2009.

Infrastructure investment in India is set to grow dramatically. As per Union Minister for Finance, Mr Pranab Mukherjee, India would require to develop a rupee-denominated long-term bond

1

market for funding the infrastructure sector that requires an investment of around US$ 459 to US$ 500 billion by 2012.

Further, investment in the infrastructure sector is expected to be around US$ 425.2 billion during the Eleventh Five Year Plan (2007-12), as against US$ 191.3 billion during the Tenth Plan. Meanwhile, private investment into the sector is also projected to increase to US$ 157.3 billion in the Eleventh Plan, as compared to US$ 47.84 billion in the Tenth Plan. This investment is likely to be fulfilled through public-private-partnership (PPP) projects that are based on long-term concessions.

Clearance has been given to nine new investment proposals of around US$ 1.05 billion by the State Level Single Window Clearance Authority (SLSWCA). Out of these nine proposals, five were from the cement sector, two for setting up aluminium conductor units, and one each for developing a petroleum coke plant and a maize processing unit.

Meanwhile, a committee on infrastructure under Prime Minister Dr Manmohan Singh will conduct quarterly review of development of power, road, ports, civil aviation and railways sectors, announced the Planning Commission of India recently. Further, the cabinet committee on infrastructure (CCI) will handle specific infrastructure cases that may require necessary policy correction or solving issues affecting projects.

Notably, truck sales, a key indicator of goods movement, registered a growth of 74 per cent during May 2010, as per the data released by the Indian Foundation for Transport Research and Training (IFTRT). The increase in the demand for cargo transportation from the agricultural and manufacturing sectors was one of the contributing factors in the increase in the truck sales.

In order to develop eco-friendly infrastructure for new cities in the Delhi-Mumbai Industrial Corridor (DMIC), Japan-based consultants such as Nikken Sekkei, Mitsubishi and IBM Japan would work along with DMIDC and three state governments. The project, expected to be completed by 2018, as per Mr Anand Sharma, Union Minister for Commerce and Industry is “by far the world’s biggest infrastructure project.”

Ports

The major ports in India handled 45.8 million tonnes cargo in February 2010, as compared to 45.2 million tonnes in February 2009. The cargo growth during April-February 2010 registered an increase of 5.5 per cent as compared to the corresponding period in the 2009 fiscal, as per data released by the Indian Ports Association (IPA).

1

The annual combined capacity of the major and non-major ports in the country will be 1.5 billion tonnes by 2012, stated by Minister of Shipping, Mr G K Vasan, while speaking at the Logistics Outsourcing Summit organised by the Confederation of Indian Industry (CII).

The Union Cabinet has given the approval to the Shipping Ministry for declaring Andaman and Nicobar ports as major port, stated Union Minister of Shipping, Mr G K Vasan.

The Cabinet Committee on Infrastructure (CCI) has approved a proposal to develop the fourth container terminal at the Jawaharlal Nehru Port (JNPT), the country's busiest port, at an estimated cost of US$ 1.44 billion. The government also cleared a proposal to build standalone container handling facility at Mumbai port at a cost of US$ 129.6 million. The project would be implemented within two years from the date of the award of the project.

Airports

The domestic airlines flew about 4.78 million passengers in May 2010, an increase of almost 22 per cent over the number carried in the same period in the previous year.

The Union Minister of State for Civil Aviation, Mr Praful Patel, stated that the country will become the top-five civil aviation markets in the world in the next five years. India is the ninth largest civil aviation market in the world at present.

The Airports Authority of India (AAI), the agency responsible for civil aviation infrastructure, is likely to spend over US$ 1.01 billion on the modernisation of non-metro airports in the current year.

Aircraft manufacturing companies, Boeing and Airbus, remain upbeat over India's aviation growth potential. Airbus has forecast that India will need 1,032 new aircraft worth US$ 138 billion by 2028, while Boeing has forecast that the country will require 1,000 aircraft worth US$ 100 billion over the next two decades.

Mumbai Airport posted its highest ever monthly passenger traffic in its history in December 2009. According to Mumbai International Airport (MIAL), the Chhatrapati Shivaji International Airport (CSIA) saw a record 2.53 million passengers in December 2009. This number is the highest-ever passenger volume handled by the airport in its history, with the previous high standing at 2.38 million passengers in January 2008.

The government has mandated MIAL with the task of upgrading and modernising CSIA, which is a joint venture between the Airports Authority of India and the GVK-SA consortium.

1

Railroads

During the first month of the 2010-11 fiscal, the Railways reported an increase of 9.69 per cent in its total earnings at US$ 1.62 billion, as compared to US$ 1.5 billion in the same month last fiscal. The Railways garnered US$ 459 million in total passenger earnings in April 2010, compared to US$ 411.6 million in April 2009.

According to the Department of Industrial Policy and Promotion (DIPP), the foreign direct investment (FDI) inflow into railways related components has been US$ 109.56 million from April 2000 to March 2010.

Roads

An in-principal approval for converting 10,000 km of state roads to national highways has been given by the Empowered Group of Ministers (EGoM). It is estimated that around US$ 3.3 billion would be required over the next five years to undertake this project.

Further, the Cabinet Committee on Infrastructure (CCI) has approved four highway projects of about US$ 543.8 million on June 10, 2010. These projects would cover states such as Gujarat, West Bengal, Bihar, Uttar Pradesh and Madhya Pradesh.

Anil Dhirubhai Ambani Group (ADAG)’s flagship company Reliance Infrastructure Ltd (R-Infra) won a US$ 197.3 million project from the National Highways Authority of India (NHAI). It is the tenth road project it won from the NHAI.

Earlier, R-Infra won a US$ 218.3 million road project from the Gujarat government, within a week after winning the US$ 380 million Pune-Satara Road project from the National Highway Authority of India (NHAI). The project is to execute a 71 kilometre four-six lane corridor connecting the ports of Mundra and Kandla in Gujarat.

Recently, the elevated expressway between Silk Board junction and Electronic City junction, built for US$ 165.5 million, was opened to public use. A consortium comprising Soma Enterprise Ltd, Nagarjuna Construction Company and Maytas Infra Ltd constructed the 9.985 km long elevated road project. The project, executed through a special purpose vehicle, Bangalore Elevated Tollway Ltd, was built on a build operate transfer basis for the NHAI.

Investments

The infrastructure sector seems to have emerged as a favourite for the private equity (PE) in 2010. According to Venture Intelligence data, so far in 2010, there have been 19 deals in this sector at an approximate investment of US$ 1.1 billion, as compared to 14 deals with an investment of US$ 257.5 million during the same period last year.

1

JSW Energy (Bengal) Limited, a special purpose vehicle (SPV) for the Bengal power and coal project, plans to invest around US$ 423.6 million in coal mine development.

Sembcorp Utilities, a Singapore-based company, has bought 49 per cent stake in Thermal Powertech Corporation India Ltd, a SPV and subsidiary of Gayatri Projects Ltd, for US$ 235.1 million.

An investment of around US$ 425 million has been made by a consortium of investors led by Morgan Stanley Infrastructure Partners along with Goldman Sachs Investment Management, General Atlantic LLC (GA), Everstone Capital, Norwest Venture Partners and others in Asian Genco Pte (AGPL), an infrastructure company.

Larsen & Toubro (L&T), the country’s largest engineering company, will invest around US$ 5.46 billion to build its thermal power business in the next five years. L&T Power, the wholly-owned subsidiary of L&T, will have a generation capacity of 5,500 MW, including hydro power, by 2015. Larsen and Toubro Ltd also formed a joint venture with Malaysia-based SapuraCrest Petroleum to install pipelines and construct offshore rigs and platforms in India, the Middle East and South East Asia.

Tata Power has lined up investments of US$ 5.19 billion for its upcoming plants in Mundra, Maithon and Jojobera over the next three years. Tata Power and Reliance Power are coming up with UMPPs with a combined generation capacity of close to 16,000 MW. Jindal Steel & Power, which has a production capacity of 1,000 MW, plans to add another 4,380 MW thermal power and 6,100 MW hydro power capacity in the next five years.

Government Initiatives

The infrastructure finance companies (IFC) are being included in the category of non-banking finance company (NBFC) by the Reserve Bank of India (RBI). The IFCs would require a capital adequacy ratio of 15 per cent and the similar criteria of NBFCs would be applied to IFCs as well. Further, RBI stated that at least 75 per cent of the assets of these institutions should be used in infrastructure and their net owned funds should be US$ 64.6 million or more.

While presenting the Union Budget this year, the Finance Minister has announced the allocation of US$ 37.7 billion, around 46 per cent of the total plan outlay of US$ 81 billion for 2010-11 to infrastructure sectors. In the last fiscal, this proportion was about 30 per cent.

The Government of India has envisaged capacity addition of 100,000 MW by 2012 to meet its mission of power to all. Recently, a ministerial group discussing large power plants with a capacity to generate 4,000 MW of power has approved, in principle, a proviso requiring such plants that will be awarded in the future to use local power generation equipment. The move is

1

expected to provide a fillip to domestic manufacturing. The decision on so-called ultra mega power plants, or UMPPs, will also benefit domestic power generation equipment manufacturers such as state-owned Bharat Heavy Electricals Ltd (Bhel) and Larsen and Toubro Ltd (L&T), which has a joint venture with Mitsubishi Heavy Industries Ltd (MHI) of Japan. At least three joint ventures, between Toshiba Corp. of Japan and JSW Group; Ansaldo Caldaie SpA of Italy and GB Engineering Enterprises Pvt. Ltd; and Alstom SA of France and Bharat Forge Ltd are looking to start manufacturing power equipment in India.

Further, the government is also implementing the National Solar Mission, aimed at setting up 20,000 MW of solar power capacity by 2020.

The Asian Development Bank (ADB) has approved a financial assistance for US$ 200 million under the Assam Power Sector Enhancement Investment Programme. The project has some innovative features like franchisee-based distribution, off-grid electrification with renewable energy, reduction in CHG emissions through efficiency gains.

The road transport and highways ministry has proposed priority sector status for road development, allowing private highway developers more funds from banks.

3.3 Petrochemicals

Petrochemicals are chemicals made from petroleum (crude oil) and natural gas. The petrochemical industry of today is an indispensable part of the manufacturing and consuming sectors, churning out products which include paint, plastic, rubber, detergents, dyes, fertilizers and textiles. "Primary Petrochemicals" include olefins (ethylene, propylene and butadiene) aromatics (benzene, toluene, and xylenes); and methanol. Olefins and aromatics are the building blocks for a wide range of materials such as solvents, detergents, and adhesives. Olefins are the basis for polymers and oligomers used in plastics, resins, fibers, elastomers, lubricants, and gels. Notwithstanding the wide range of products derived from this sector, it consumes only ~5% of annual oil and gas production.

Over the past 10 years, despite the traditional dominance American and Western European players, there has been a paradigm shift from West to East, with the Middle East emerging as global production hub with natural advantages of low cost feedstock and Asia becoming a major consumption centers.

A job in the petrochemical industry offers lucrative income, employee welfare facilities and career development opportunities. Career opportunities for educated, highly skilled and motivated workers include jobs as engineers, operating technicians, lab technicians, electricians, environmental, health and safety technicians and managers and supervisors.

1

Undoubtedly, there is a very strong emphasis on technical proficiency, efficiency and being a team player.

Performance

The global petrochemicals sector was ravaged by a huge drop in demand for its products due to the global economic slowdown in 2008-2009, exacerbated by increasing input costs with oil prices skyrocketing to $110. That said, most of the big players still made a profit, just not as big as the profits they made over the past two or three boom years. The largest global petrochemicals companies (by 2008 revenue) are BASF (Germany), Dow Chemical (USA), ExxonMobil Chemical (USA), LyondellBasell Industries (Netherlands), INEOS (UK) and Saudi Basic Industries Corporation (Saudi Arabia).

The Indian petrochemical industry has been one of India’s fastest growing domestic industries, comprising both small and large scale enterprises. Due to its linkages with various domestic manufacturing industries such as pharmaceuticals, construction, agriculture, and textiles etc it is undoubtedly an integral part of the energy value chain. In recent years, India has experienced significant industrial and economic development and as a result has become a net exporter of chemicals leveraging the tremendous growth in overseas sales of dyes, intermediates and specialty chemicals. In addition, the government’s decision to revamp eight public sector fertilizer units has helped buoy the domestic market demand. Also, the strong demand for end products such as plastics has ensured that the industry top line remained robust.

The leading players in India are Reliance Industries, Gujarat State Fertilizer and Chemicals, Tata Chemicals, Haldia Petrochemicals and Hindustan Organic chemicals. Like their global counterparts, these players too suffered a subdued 2 years. It is important for players to remain aware of the lessons learnt from this period, which acted as a rude wake-up call for all the euphoric predictors of sustained double digit growth.

The sector reeled under the pressure of escalating crude oil prices, lowered domestic and export demand, resulting in compressed bottom lines. With more balanced predictions, and the economic gloom slowly lifting, optimism is returning once again.

Future Prospects

The aggregate demand of all the key segments in the petrochemical industry is likely to regain a sharp positive trajectory over the next 12 months, with key players aiming to ramp up scale and

1

increase recruitment. Hence, those graduates with a strong technical and/ or engineering background should remain confident of being able to find decent employment opportunities. This is not an industry suitable for the initiated, and freshers with general degrees would be best advised to seek alternate options elsewhere.

Petrochemicals Production

The petrochemicals industry primarily consists of synthetic fibres, polymers, elastomers, synthetic detergents, intermediates and performance plastics. Presently, petrochemical products span the entire spectrum of daily use items, from housing, clothing, construction, packaging, medical appliances etc.

Table: production of selected major chemicals (In ‘000 MT)

Year Alkali chemicals

Inorganic chemicals

Organic chemicals

Pesticides (Tech)

Dyes & Dyestuffs

Total Major Chemicals

2004-05 4792 404 1353 70 26 6645

2005-06 5070 441 1474 85 26 7096

2006-07 5272 508 1506 94 28 7408

2007-08 5475 544 1545 82 30 7676

2008-09 5269 602 1545 85 33 7534

1

The industrial units of the petrochemical industry are located mainly in 18 states covering 30-35 districts within them. The industry is concentrated in the states of Gujarat and Maharashtra on account of the easy availability of raw materials, infrastructure etc. Gujarat alone accounted for more than 50% of the total production of major chemicals in FY09.

Industrial Investment

Proposed investments in the chemicals & petrochemicals industry was almost 10% of the total proposed investment between the periods, Aug 1991 to Oct 2009. Of the actual investment during this period, around 17% investments of total investments belonged to the petrochemicals industry.

Table: Proposed and Actual Implementation of Industrial Investment

(Aug 1991 to Oct 2009)

1

Sector Proposed Investment (Rs

mn)

%age of Grand Total

Actual investment (Rs mn)

%age of grand total

Chemicals & Petrochemicals

3049780 9.66 436760 16.80

Fertilizers 260350 0.82 37050 1.43

3.4 Power

As per leading market research firm RNCOS (2008) report on “Indian Power Sector Analysis” more than 64% of India’s total installed capacity is contributed by thermal power. Significant jump in unit size and steam parameters will result in higher efficiencies and better economics for the Indian power sector.

Western region accounts for largest share (30.09%) of the installed power in India followed by Southern region with 27.76%.

Unbalanced growth remains the cause of concern for the Indian power sector. Only about 56% of households have access to electricity, with the rural access being 44% and urban access about 82%.

Southern region remains the dominant region in renewable energy source accounting for more than 57% of the total renewable energy installed capacity.

Key players currently operating in the Indian power sector are National Thermal Power Corporation Limited, Nuclear Power Corporation of India Limited, North Eastern Electric Power Corporation Limited, Power Grid Corporation of India, Tata Power, etc.

Size

The total installed capacity in India is calculated to be 145,554.97 mega watt, out of which 75,837.93 mega watt (52.5%) is from State, 48,470.99 mega watt (34%) from Centre, and 21,246.05 mega watt (13.5%) is from Private sector initiative.

Generation capacity of 141 GW; 663 billion units produced (1 unit = 1kwh)-January 2008. CAGR of 5% over the last 5 years

India has the fifth largest electricity generation capacity in the world. Low per capita consumption at 631 units; less than half of China

1

Transmission & Distribution network of 6.6 million circuit km - the third largest in the world

Coal fired plants constitute 54% of the installed generation capacity, followed by 25% from hydel power, 10% gas based, 3% from nuclear energy and 8% from renewable sources

Structure

Majority of Generation, Transmission and Distribution capacities are with either public sector companies or with State Electricity Boards (SEBs)

Private sector participation is increasing especially in Generation and Distribution

Distribution licenses for several cities are already with the private sector

Three large ultra-mega power projects of 4000MW each have been recently awarded to the private sector on the basis of global tenders.

Policy

100% FDI permitted in Generation, Transmission & Distribution - the Government is keen to draw private investment into the sector

Policy framework: Electricity Act 2003 and National Electricity Policy 2005

Incentives: Income tax holiday for a block of 10 years in the first 15 years of operation; waiver of capital goods' import duties on mega power projects (above 1,000 MW generation capacity)

Independent Regulators: Central Electricity Regulatory Commission for central PSUs and inter-state issues. Each state has its own Electricity Regulatory Commission

Blueprint of ministry

The Ministry of Power has set a goal - Mission 2012: Power for All.

A comprehensive Blueprint for Power Sector development has been prepared encompassing an integrated strategy for the sector development with following objectives:-

Sufficient power to achieve GDP growth rate of 8%

Reliable of power

1

Quality power

Optimum power cost

Commercial viability of power industry

Power for all

Strategies to Achieve The Objectives:

Power Generation Strategy with focus on low cost generation, optimization of capacity utilization, controlling the input cost, optimisation of fuel mix, Technology upgradation and utilization of Non Conventional energy sources

Transmission Strategy with focus on development of National Grid including Interstate connections, Technology upgradation & optimization of transmission cost.

Distribution strategy to achieve Distribution Reforms with focus on System upgradation, loss reduction, theft control, consumer service orientation, quality power supply commercialization, Decentralized distributed generation and supply for rural areas

Regulation Strategy aimed at protecting Consumer interests and making the sector commercially viable

Financing Strategy to generate resources for required growth of the power sectorConservation Strategy to optimise the utilization of .electricity with focus on Demand Side management, Load management and Technology upgradation to provide energy efficient equipment / gadgets.

Communication Strategy for political consensus with media support to enhance the general public awareness.

Power Sector at a glance - all India - as on February 28, 2009

1

4.Economic and business overview

India

The official GDP growth numbers released on 29 May 2009 is 6.8% for 2008-09, with Q4 GDP growth at 5.8%. But that is just one part of the problem. At the time of writing this Management Discussion and Analysis, India is facing two conflicting situations. The first is a hugely positive uplift in sentiments, with the Congress winning 206 seats in the recent elections for the 15th Lok Sabha and the United Progressive Alliance (UPA) comfortably securing a majority. The fact that Dr. Manmohan Singh will be again leading his team — this time unfettered by the compulsions of meeting the demands of the Left parties — has created a universally positive milieu throughout India. But there are disquieting trends. Industrial growth has been falling sharply. While there seems to be no dearth of liquidity in the financial system, banks are still not lending enough, and there doesn’t seem to be an adequate credit uptick. The consolidated fiscal deficit for 2008-09 is estimated at 11% of GDP; and, given the government’s objective of increasing spends on education, health, social infrastructure and support for families below the poverty line, there is little likelihood of the consolidated deficit reducing sharply in 2009-10. Thus, there are concerns of interest rates hardening in the second half of 2009-10. Equally, with the rise in crude oil prices — it is now at US$ 70 per barrel — there is a scope of rising inflation during the second half of the year.

Thus, as far as India goes 2009-10 may be an unpredictable year. The baseline GDP growth forecast remains at around 6% to 6.5%. However, if the new government shows speed and

1

determination — as people think it will — we could see a significant upsurge in investment demand and, with it, a rise in growth rate to the 7% to 7.5% range. We will have to wait and see.

5.Introduction

Company Profile

5.1 Punj Lloyd group

Punj Lloyd Group is a diversified global conglomerate providing Engineering & Construction services in Oil & Gas, Infrastructure and Petrochemicals, and with interests in Defence, Aviation, Marine and Upstream sectors.

With a turnover of US $2.6 billion, the Group’s three brands - Punj Lloyd headquartered in India, Sembawang Engineers & Constructors in Singapore, and Simon Carves in the United Kingdom, each with its own subsidiaries and joint ventures, converge to offer complementary services, rich experiences and the best practices from across the globe. 16 international offices and entities across the Middle East, the Caspian, Asia Pacific, Africa, South Asia, China and Europe, have established Punj Lloyd as a proven and reputable Group.

Having built projects across the world, the Group continues to provide integrated design, engineering, procurement, construction and project management services for the energy, infrastructure and petrochemical sectors. From pipelines, tanks and terminals to refineries, power plants to renewables, airports, rail transit systems to expressways, the Group can offer EPC solutions across a wide spectrum of businesses.

1

A dynamic enterprise, the Group explores and pursues the enormous opportunity in markets globally. Partnering with the best in their own arenas, Punj Lloyd brings technology and quality to clients worldwide and reiterates its belief of delivering the best, in services and manufacturing. An excellent track record for successful completion of projects within tight schedules, lends credibility to the Group, encouraging clients to trust it with repeat orders.

The skilled multicultural workforce has the experience of working in different geographies and diverse terrain, empowering the Group to aggressively pursue its vigorous plans.

The Group’s key strengths are its varied experience, rich knowledge of local conditions, high standards of health, safety, quality and environment, accolades and recognitions from industry bodies and clients, its ability to manage operations in diverse industries and economies, long-term relationships with world-class clients and ability to mobilise financial resources. The huge fleet of equipment Punj Lloyd owns gives the company an edge over its competitors.

5.2 The business segments of Punj Lloyd

As shown in Table 1, Punj Lloyd Ltd. (‘Punj Lloyd’ or ‘the Company’) operates in four major segments: Oil and Gas, Civil and Infrastructure, Petrochemicals and Power. Table 1 gives the figures.

1 REVENUES AND ORDER BACKLOG: BY BUSINESS SEGMENT IN RS CRORE

Segments

Total Revenue

(2008-09)

Percentage Share

Of which, Top 15 revenue earners

Percentage

Share Order

Backlog

Oil & Gas

7,233.76

61%

4,118.83

58%

10,514.67

51%

Civil & Infrastructure

3,007.37

26%

1,624.72

23%

6,425.99

31%

Petrochemicals

1,017.64

9%

1,003.24

14%

2,525.83

12%

Power

457.13

4%

352.81

5%

1,218.72

6%

Total

11,715.90

100%

7,099.60

100%

20,685.21

100%

5.3 Oil & Gas

The oil & gas business contributes to 61% of Punj Lloyd’s total revenues and about 58% of Punj Lloyd’s top 15 revenue earning projects in 2008-09. This business offers services in process engineering, pipelines, both onshore and offshore, and tankages. The segment earned revenues of Rs. 7,234 crore during the year and as on 31 March 2009, has an order backlog of Rs. 10,515

1

crore. In 2008-09, Punj Lloyd won the Strategic Gas Transmission Project for Qatar Petroleum, valued at Rs. 3,636 crore and involved laying two new 36” dia pipelines and 24 Core FOC laying. This is the largest project that the Company has undertaken in the oil & gas business till date. The Company’s capabilities in the oil & gas sector are also well recognised in India. In 2008-09, the Company has won big ticket projects both for the refineries as well as for pipelines. Some of the projects that Punj Lloyd has been awarded are highlighted in Table 2 below.

2 MAJOR PROJECTS: A W ARDED AND UNDER EXECUTION FOR 2008-09: OIL & GAS IN RS CRORE

Project Client Contract Value

Delayed Coker Unit IOCL, Vadodara 590

Sulphur Block for Bina Refinery Project Bharat Oman Refinery, Bina 590

Motor Spirit Quality Upgradation IOCL, Barauni 649

EPC Contract for Pipeline Gujarat State Petronet Ltd. 239

Heated and Insulated Gas Pipeline: Three Sections Cairn India Ltd. 141

Dense Phase Ethylene and Butane Pipelines between Ras Laffan and Mesaieed

Ras Laffan Olefins Company Ltd, Qatar

191

EPC for 21 Storage Tanks Eastern Bechtel Co. Ltd., Abu Dhabi 140

Offsite and Utilities Yemen LNG, Yemen 322

Construction of Two Gas Pipelines in Libya Sirte Oil Company of Libya 1,349

In tankage, the Company has the expertise to execute a complete EPC project for tank farms and terminals, including cryogenic storage. Punj Lloyd is one of the few companies in the world having its own design capabilities and construction expertise for cryogenic and floating roof tanks.

Among the projects under execution during the year, the ‘EPCC 8 packages’ for IOCL Panipat is worth separate mention. The Rs. 350 crore project is for the design and construction of offsites and storage facilities for the naphtha cracker project at IOCL’s Panipat refinery. Unlike other projects, here all kinds of storage equipment are being manufactured at site, including spheres, moulded bullets, atmospheric tanks and propylene and ethylene cryogenic tanks.

Some of the other major projects that have been executed are detailed below:

Two orders for New Doha International Airport fuel system; contract value Rs. 608 crore.

Two order for mechanical work, including steel, equipment and pipeline fabrication and erection for Abu Dhabi Polymers Company (Borouge); contract value Rs. 762 crore.

Offshore Projects in Oil & Gas

During 2008-09, this business unit (in association with our wholly owned subsidiary, PT Sempec of Indonesia) was executing an offshore EPC project, with a contract value of Rs. 1,289 crore,

1

involving four well head platforms, pipelines, flexibles, cable laying and SBM, etc, for ONGC at Heera. Subsequently, in April 2009, Punj Lloyd has successfully commissioned and handed over the first of the four offshore wellhead platforms to ONGC for it to commence drilling and production operations. Heera is the first of Punj Lloyd’s offshore platform projects in India and the successful technical execution of the project has established the Company’s credentials in offshore.

It also completed the Uran Trombay Gas Pipeline (the UTG pipeline), where a substantial part of the project was offshore. The project scope included 24 km of 20” dia pipeline and terminal work and was completed before time.

During 2008-09, Punj Lloyd bid for a US$ 130 million project in Thailand, as well as for the ZADCO block in Abu Dhabi. It has also submitted bids to ONGC with a combined value of more than US$ 2.5 billion. In the offshore business, Punj Lloyd identifies two issues critical to success: equipment and the skills to effectively deploy them. Punj Lloyd has acquired sophisticated equipment and machinery over the past few years, especially during 2008-09. Pipe-laying barges are used to lay sections of the pipeline at various water depths; the Company has acquired two such barges, one operating in depths up to 60 metres; the other can lay pipes in depths of 150 metres. Punj Lloyd is one of the few companies in the world that has such sophisticated equipment. In 2008-09, the Company also acquired an accommodation and crane barge. Punj Lloyd has a long term growth objective of being able to graduate to deep water offshore work, both in India and abroad, especially in the gulf region.

5.4 Civil, Infrastructure & Power

The Civil, Infrastructure & Power business of Punj Lloyd comprises two elements (Civil Engineering, Building & Power, and Roads & Other Infrastructure). Together, they have contributed Rs. 3,465 crore of topline to Punj Lloyd during the year ended 31 March 2009, with a residual order book of Rs. 7,645 crore as on that date (Table 4). Civil & Infrastructure work is executed through three entities: Punj Lloyd Ltd. (which mainly executes projects in India), Sembawang Engineers and Constructors Pte Ltd. (SEC) and Sembawang UAE.

Power

There are two parts to the power business: thermal and conventional and nuclear power. During the year, the power business segment of Punj Lloyd generated revenues of Rs. 457 crore, with an order backlog of Rs. 1,219 crore as on 31 March 2009.

Thermal and Conventional Power

1

During the year, Punj Lloyd is executing the complete EPC, including civil work of balance of plant (BOP) package for 2 x 250 MW Chhabra Thermal Power Project in Rajasthan; the order value of the project is Rs. 823 crore. The first unit was synchronised on 16 April 2009 and the project is expected to be completed by July 2009. Punj Lloyd has also been awarded the EPC for BOP at the 2 x 270 MW Govindwal Sahib Power project in the Tarn Taran district of Punjab. Punj Lloyd has already started the engineering work for the project, which is valued at Rs. 1,005 crore.

On the business development front, the power segment has entered into an agreement with General Electric (GE) to work together in Indian and international markets, with Punj Lloyd as

the EPC contractor for the entire plant (including turbine) and GE as the equipment and technology supplier. Over the next few years, Punj Lloyd wishes to migrate from being an EPC player of BOP in power plants to a full EPC player.

Nuclear Power

India will need to develop its nuclear power generation capability if it is to meet its growing demand for power. The power shortage for 2008-09 is estimated at 11.0%8. Currently, only 4,120 MW (2.8%) of India’s total generation is met through nuclear power. The country proposes to add another 3,380 MW of generation capacity by the end of the 11th Plan period9; have 20,000 MW of nuclear power by 2020 and targets 25% of its electricity supply to come from nuclear power by 205010. This will not be possible without Private Public Partnerships (PPPs); though, currently, the sole authority supervising India’s civil nuclear programme is the Nuclear Power Corporation of India Ltd (NPCIL). Punj Lloyd recognises that this area offers long term growth opportunities for its engineering and construction businesses. Punj Lloyd envisages that, over a period of time, the following business opportunities will arise for the Company in the nuclear power generation business:

In EPC.

Decommissioning of Nuclear Power Plants and nuclear waste management; using the experience of Simon Carves Ltd (UK), which has 3.5 million man hours of experience in nuclear de-commissioning, spent-fuel management and engineering advisory services.

In Nuclear Fuel and Consultancy.

In Components.

In Operations & Maintenance.

1

The team is establishing relationships with leading global nuclear technology providers for EPC jobs, as well as exploring qualification opportunities jointly with the appropriate international EPC majors. Punj Lloyd has also been issued the pre-qualification (PQ) documents for civil work contract for the Pressurised Heavy Water Reactors (PHWR) of 700 MW each, worth Rs. 650 crore at Kakarpara in Gujarat.

5.5 Petrochemicals

In 2008-09, the petrochemicals segment generated revenues of Rs, 1,018 crore, with an order backlog of Rs. 2,526 crore as on 31 March 2009 (Table 6).

Simon Carves

Simon Carves Limited, UK (SC)

Simon Carves Limited provides comprehensive Engineering, Procurement, Construction and Commissioning (EPCC) services the across the global process industry sector, focusing on petrochemicals and renewables, especially bio- fuel manufacture. Its expertise lies in the following areas:

Polymers and Petrochemicals, which have been designed and supplied over 80 manufacturing facilities to its customers worldwide.

Chemicals, with its own acid technology and through strategic licensor relationships for other technologies: SCL has built over 350 chemical manufacturing facilities worldwide; the company has extensive experience in the Pharmaceutical and Agro chemical markets particularly in Europe having worked closely in partnership with AstraZeneca over a long period of time.

Nuclear Power, where it has been involved in the design and build of new installations in the UK particularly fuel fabrication, waste treatment and processing.

In 2008-09, Simon Carves generated revenues of £169 million (2007-08: £177 million).

At 31 March 2009, the Punj Lloyd Group reorganised its holding structure of Simon Carves Limited. Simon Carves Singapore Pte. Ltd. is now the parent company. There will be no effect on Simon Carves Limited, and is a reflection of the Group wide focus on projects in Asia and the Middle East. The Abu Dhabi office becoming the global headquarters of Simon Carves will allow it to exploit opportunities in the Middle East and Asia.

1

6.Working Capital

Introduction

Every business needs investment to procure fixed assets, which remain in use for a longer period. Money invested in these assets is called ‘Long term Funds’ or ‘Fixed Capital’.

Business also needs funds for short-term purposes to finance current operations. Investment in short term assets like cash, inventories, debtors etc., is called ‘Short- term Funds’ or ‘Working Capital’. The ‘Working Capital’ can be categorized, as funds needed for carrying out day-to-day operations of the business smoothly. The management of the working capital is equally important as the management of long-term financial investment.

Every running business needs working capital. Even a business which is fully equipped with all types of fixed assets required is bound to collapse without

adequate supply of raw materials for processing;

cash to pay for wages, power and other costs;

creating a stock of finished goods to feed the market demand regularly; and,

the ability to grant credit to its customers.

1

All these require working capital. Working capital is thus like the lifeblood of a business. The business will not be able to carry on day-to-day activities without the availability of adequate working capital.

Working capital cycle involves conversions and rotation of various constituents Components of the working capital. Initially ‘cash’ is converted into raw materials.

Subsequently, with the usage of fixed assets resulting in value additions, the raw materials get converted into work in process and then into finished goods. When sold on credit, the finished goods assume the form of debtors who give the business cash on due date. Thus ‘cash’ assumes its original form again at the end of one such working capital cycle but in the course it passes through various other forms of current assets too. This is how various components of current assets keep on changing their forms due to value addition. As a result, they rotate and business operations continue. Thus, the working capital cycle involves rotation of various constituents of the working capital.

While managing the working capital, two characteristics of current assets should be kept in mind viz. (i) short life span, and (ii) swift transformation into other form of current asset.

Each constituent of current asset has comparatively very short life span. Investment remains in a particular form of current asset for a short period. The life span of current assets depends upon the time required in the activities of procurement; production, sales and collection and degree of synchronization among them. A very short life span of current assets results into swift transformation into other form of current assets for a running business.

These characteristics have certain implications:

Decision regarding management of the working capital has to be taken frequently and on a repeat basis. The various components of the working capital are closely related and mismanagement of any one component adversely affects the other components too.

The difference between the present value and the book value of profit is not significant. The working capital has the following components, which are in several forms of current assets:

Stock of Cash

Stock of Raw Material

Stock of Finished Goods

Value of Debtors

1

Miscellaneous current assets like short term investment loans & Advances

A number of definitions have been formulated: perhaps the most widely acceptable would be;

“WORKING CAPITAL represents the excess of CURRENT ASSETS over CURRENT LIABILITIES “

The same may be designated in the following equation:

Working capital= current assets – current liabilities: Funds thus invested in current assets keep revolving fast and are being constantly converted in to cash and this cash flows out again in exchange for other current assets. Thus it is known as revolving or circulating capital or short term capital.

These are two concepts of working capital:

a. Gross Working Capital.

b. Net Working Capital.

Gross working capital is the total of all current assets. Net working capital is the difference between current assets and current liabilities. Though the later concept of working capital is commonly used it is an accounting concept with little sense to say that a firm manages its net working capital. What a firm really does is to take decisions with respect to various current assets and current liabilities. The constituents of current assets and current liabilities are shown in table A.

6.1 Constituents of Current Assets and Current Liabilities

Current Assets

Inventories – Raw materials and components, Work in progress, Finished goods, other.

Trade Debtors.

Loans and Advances.

Investments.

Cash and Bank balance.

Current Liabilities

1

Sundry Creditors.

Trade Advances.

Borrowings.

Provisions.

The working capital needs of a business are influenced by numerous factors. The important ones are discussed in brief as given below:

Nature of Enterprise

The nature and the working capital requirements of an enterprise are interlinked. While a manufacturing industry has a long cycle of operation of the working capital, the same would be short in an enterprise involved in providing services. The amount required also varies as per the nature; an enterprise involved in production would require more working capital than a service sector enterprise.

Manufacturing/Production Policy

Each enterprise in the manufacturing sector has its own production policy, some follow the policy of uniform production even if the demand varies from time to time, and others may follow the principle of 'demand-based production' in which production is based on the demand during that particular phase of time. Accordingly, the working capital requirements vary for both of them.

Working Capital Cycle

In manufacturing concern, working capital cycle starts with the purchase of raw materials and ends with realization of cash from the sale of finished goods. The cycle involves the purchase of raw materials and ends with the realization of cash from the sale of finished products. The cycle involves purchase of raw materials and stores, its conversion in to stock of finished goods through work in progress with progressive increment of labor and service cost, conversion of finished stick in to sales and receivables and ultimately realization of cash and this cycle continuous again from cash to purchase of raw materials and so on.

Operations

The requirement of working capital fluctuates for seasonal business. The working capital needs of such businesses may increase considerably during the busy season and decrease during the

1

slack season. Ice creams and cold drinks have a great demand during summers, while in winters the sales are negligible.

Market Condition

If there is high competition in the chosen product category, then one shall need to offer sops like credit, immediate delivery of goods etc. for which the working capital requirement will be high. Otherwise, if there is no competition or less competition in the market then the working capital requirements will be low.

Credit Policy

The credit policy is concerned in its dealings with debtors and creditors influence considerably the requirements of the working capital. A concern that purchases its requirements on credit and sells its products/services on cash requires lesser amount of working capital. On the other hand a concern buying its requirements for cash and allowing credit to its customers, shall need larger amount of funds are bound to be tied up in debtors or bills receivables.

Business Cycle

Business Cycle refers to alternate expansion and contraction in general business activities. In a period of born i.e. when the business is prosperous there is a need for larger amount of working capital due to increase in sales, rise in prices, optimistic expansion of business etc. On the country at the time of depression i.e. when there is a down swing of the cycle, business contracts, sales decline, difficulties are faced in collections from debtors and firms may have a large amount of working capital lying ideal.

Availability of Raw Material

If raw material is readily available then one need not maintain a large stock of the same, thereby reducing the working capital investment in raw material stock. On the other hand, if raw material is not readily available then a large inventory/stock needs to be maintained, thereby calling for substantial investment in the same.

Growth and Expansion

Growth and expansion in the volume of business result in enhancement of the working capital requirement. As business grows and expands, it needs a larger amount of working capital. Normally, the need for increased working capital funds precedes growth in business activities.

1

Earning capacity and Dividend Policy

Some firms have more earning capacity than others due to the quality of their products, monopoly conditions etc. Such firms with high earning capacity may generate cash profits from operations and contribute to their capital. The dividend policy of a concern also influences the requirements of the working capital. A firm that maintains steady high rate of cash dividend irrespective of its generation of profits needs more capital than the firm retains larger part of its profits and does not pay high rate of cash dividend.

Price Level Changes

Generally, rising price level requires a higher investment in the working capital. With increasing prices, the same level of current assets needs enhanced investment.

Manufacturing Cycle

The manufacturing cycle starts with the purchase of raw material and is completed with the production of finished goods. If the manufacturing cycle involves a longer period, the need for working capital would be more. At times, business needs to estimate the requirement of working capital in advance for proper control and management. The factors discussed above influence the quantum of working capital in the business. The assessment of working capital requirement is made keeping these factors in view. Each constituent of working capital retains its form for a certain period and that holding period is determined by the factors discussed above. So for correct assessment of the working capital requirement, the duration at various stages of the working capital cycle is estimated. Thereafter, proper value is assigned to the respective current assets, depending on its level of completion.

Other Factors

Certain other factors such as operating efficiency, management ability, irregularities a supply, import policy, asset structure, importance of labor, banking facilities etc. also influences the requirement of working capital.

Component of Working Capital

Basis of Valuation

Stock of raw material Purchase cost of raw materials

Stock of work in process at cost or market value, whichever is lower

Stock of finished goods Cost of production

1

Debtors Cost of sales or sales value

Cash working expenses.

Each constituent of the working capital is valued on the basis of valuation Enumerated above for the holding period estimated. The total of all such valuation becomes the total estimated working capital requirement.

The assessment of the working capital should be accurate even in the case of small and micro enterprises where business operation is not very large. We know that working capital has a very close relationship with day-to-day operations of a business. Negligence in proper assessment of the working capital, therefore, can affect the day-to-day operations severely. It may lead to cash crisis and ultimately to liquidation. An inaccurate assessment of the working capital may cause either under-assessment or over-assessment of the working capital and both of them are dangerous.

7.Working capital management

Introduction

Working Capital Management refers to management of current assets and current liabilities. The major thrust of course is on the management of current assets .This is understandable because current liabilities arise in the context of current assets. Working Capital Management is a significant fact of financial management. Its importance stems from two reasons:-

Investment in current assets represents a substantial portion of total investment.

Investment in current assets and the level of current liabilities have to be geared quickly to change in sales. To be sure, fixed asset investment and long term financing are responsive to variation in sales. However, this relationship is not as close and direct as it is in the case of working capital components.

The importance of working capital management is effected in the fact that financial manages spend a great deal of time in managing current assets and current liabilities. Arranging short term financing, negotiating favorable credit terms, controlling the movement of cash, administering the accounts receivable, and monitoring the inventories consume a great deal of time of financial managers.

1

The problem of working capital management is one of the “best” utilization of a scarce resource. Thus the job of efficient working capital management is a formidable one, since it depends upon several variables such as character of the business, the lengths of the merchandising cycle, rapidity of turnover, scale of operations, volume and terms of purchase & sales and seasonal and other variations.

Consequences of under assessment of working capital

Growth may be stunted. It may become difficult for the enterprise to undertake profitable projects due to non-availability of working capital.

Implementation of operating plans may become difficult and consequently the profit goals may not be achieved.

Cash crisis may emerge due to paucity of working funds.

Optimum capacity utilization of fixed assets may not be achieved due to non availability of the working capital.

The business may fail to honor its commitment in time, thereby adversely affecting its credibility. This situation may lead to business closure.

The business may be compelled to buy raw materials on credit and sell finished goods on cash. In the process it may end up with increasing cost of purchases and reducing selling prices by offering discounts. Both these situations would affect profitability adversely.

Non-availability of stocks due to non-availability of funds may result in production stoppage.

While underassessment of working capital has disastrous implications on business, over assessment of working capital also has its own dangers.

Consequences of over assessment of working capital

Excess of working capital may result in unnecessary accumulation of inventories.

It may lead to offer too liberal credit terms to buyers and very poor recovery system and cash management.

It may make management complacent leading to its inefficiency.

1

Over-investment in working capital makes capital less productive and may reduce return on investment. Working capital is very essential for success of a business and, therefore, needs efficient management and control. Each of the components of the working capital needs proper management to optimize profit.

The working capital in certain enterprise may be classified into the following kinds.

1. Initial working capital. The capital, which is required at the time of the commencement of business, is called initial working capital. These are the promotion expenses incurred at the earliest stage of formation of the enterprise which include the incorporation fees, attorney's fees, office expenses and other expenses.

2. Regular working capital. This type of working capital remains always in the enterprise for the successful operation. It supplies the funds necessary to meet the current working expenses i.e. for purchasing raw material and supplies, payment of wages, salaries and other sundry expenses.

3. Fluctuating working capital. This capital is needed to meet the seasonal requirements of the business. It is used to raise the volume of production by improvement or extension of machinery. It may be secured from any financial institution which can, of course, be met with short term capital. It is also called variable working capital.

4. Reserve margin working capital. It represents the amount utilized at the time of contingencies. These unpleasant events may occur at any time in the running life of the business such as inflation, depression, slump, flood, fire, earthquakes, strike, lay off and unavoidable competition etc. In this case greater amount of capital is required for maintenance of the business.

7.1 Financing Working Capital

Now let us understand the means to finance the working capital. Working capital or current assets are those assets, which unlike fixed assets change their forms rapidly. Due to this nature, they need to be financed through short-term funds. Short-term funds are also called current liabilities. The following are the major sources of raising short-term funds:

I. Supplier’s Credit

At times, business gets raw material on credit from the suppliers. The cost of raw material is paid after some time, i.e. upon completion of the credit period. Thus, without having an outflow of cash the business is in a position to use raw material and continue the activities. The credit given by the suppliers of raw materials is for a short period and is considered current

1

liabilities. These funds should be used for creating current assets like stock of raw material, work in process, finished goods, etc.

ii. Bank Loan for Working Capital

This is a major source for raising short-term funds. Banks extend loans to businesses to help them create necessary current assets so as to achieve the required business level. The loans are available for creating the following current

Assets:

Stock of Raw Materials

Stock of Work in Process

Stock of Finished Goods

Debtors

Banks give short-term loans against these assets, keeping some security margin. The advances given by banks against current assets are short-term in nature and banks have the right to ask for immediate repayment if they consider doing so. Thus bank loans for creation of current assets are also current liabilities.

iii. Promoter’s Fund

It is advisable to finance a portion of current assets from the promoter’s funds. They are long-term funds and, therefore do not require immediate repayment. These funds increase the liquidity of the business.

Important Terms

7.2 Working Capital Cycle

Cash flows in a cycle into, around and out of a business. It is the business's life blood and every manager's primary task is to help keep it flowing and to use the cash flow to generate profits. If a business is operating profitably, then it should, in theory, generate cash surpluses. If it doesn't generate surpluses, the business will eventually run out of cash and expire.

The faster a business expands the more cash it will need for working capital and investment. The cheapest and best sources of cash exist as working capital right within business. Good management of working capital will generate cash will help improve profits and reduce risks.

1

Bear in mind that the cost of providing credit to customers and holding stocks can represent a substantial proportion of a firm's total profits.

There are two elements in the business cycle that absorb cash - Inventory (stocks and work-in-progress) and Receivables (debtors owing you money). The main sources of cash are Payables (your creditors) and Equity and Loans. Each component of working capital (namely inventory, receivables and payables) has two dimensions ........TIME ......... and MONEY. When it comes to managing working capital - TIME IS MONEY. If you can get money to move faster around the cycle (e.g. collect monies due from debtors more quickly) or reduce the amount of money tied up (e.g. reduce inventory levels relative to sales), the business will generate more cash or it will need to borrow less money to fund working capital.

As a consequence, you could reduce the cost of bank interest or you'll have additional free money available to support additional sales growth or investment. Similarly, if you can negotiate improved terms with suppliers e.g. get longer credit r an increased credit limit; you effectively create free finance to help fund future sales.

If you....... Then......

Collect receivables (debtors) faster, you release cash from the cycle

Collect receivables (debtors) slower, your receivables soak up cash

Get better credit (in terms of duration or amount) from suppliers, you increase your cash resources

Shift inventory (stocks) faster, you free up cash

Move inventory (stocks) slower, you consume more cash

It can be tempting to pay cash, if available, for fixed assets e.g. computers, plant, vehicles etc. If you do pay cash, remember that this is now longer available for working capital. Therefore, if cash is tight, consider other ways of financing capital investment - loans, equity, leasing etc. Similarly, if you pay dividends or increase drawings, these are cash outflows and, like water flowing downs a plug hole, they remove liquidity from the business.

More businesses fail for lack of cash than for want of profit.

7.3 Sources of Additional Working Capital

Sources of additional working capital include the following:

Existing cash reserves

1

Profits (when you secure it as cash!)

Payables (credit from suppliers)

New equity or loans from shareholders

Bank overdrafts or lines of credit

Long-term loans

If you have insufficient working capital and try to increase sales, you can easily over-stretch the financial resources of the business.

This is called overtrading. Early warning signs include:

Pressure on existing cash

Exceptional cash generating activities e.g. offering high discounts for early cash payment

Bank overdraft exceeds authorized limit

Seeking greater overdrafts or lines of credit

Part-paying suppliers or other creditors

Paying bills in cash to secure additional supplies

Management pre-occupation with surviving rather than managing frequent short-term emergency requests to the bank (to help pay wages, pending receipt of a cheque).

7.4 Estimating working capital needs

1. Liquidity vs. Profitability: Risk Return Trade Off.

The firm would make just enough investment in current assets if it were possible to estimate working capital needs exactly. Under perfect certainty, current assets holdings would be at the minimum level. A larger investment in current assets under certainty would mean a low rate of return of investment for the firm, as excess investment in current assets will not earn enough return. A small invest in current assets, on the other hand, would mean interrupted production and sales, because of frequent stock-cuts and inability to pay to creditors in time due to restrictive policy.

As it is not possible to estimate working capital needs accurately, the firm must decide about levels of current assets to be carried.

1

2. The Cost Trade Off:

A different way of looking into the risk return trade off is in terms of the cost of maintaining a particular level of current assets. There are two types of cost involved:-

I. Cost of liquidity

II. Cost of illiquidity

If the firm’s level of current assets is very high, it has excessive liquidity. Its return on assets will be low, as funds tied up in idle cash and stocks earn nothing and high levels of debtors reduce profitability. Thus, the cost of liquidity increases with the level of current assets.

The cost of illiquidity is the cost of holding insufficient current assets. The firm will not be in a position to honor its obligations if it carries to little cash. This may force the firm to borrow at high rates of interests. This will also adversely affect the credit-worthiness of the firm and it will face difficulties in obtaining funds in the future. All this may force the firm into insolvency. Similarly, the low levels of stock will result in loss of sales and customers may shift to competitors. Also, low level of debtors may be due to right credit policy which would impair sales further. Thus the low level of current assets involves cost that increase as this level falls.

1

7.5 Policies for financing current assets

The following policies for financing current assets in Punj Lloyd:-

Long term financing: The sources of long term financing include ordinary shares capital, preference share capital debentures, long term borrowings from financial institutions and reserves and surplus. It manages its long term financing from capital reserve, share premium A/C, foreign project reserve, bonds redemption reserve and general reserve.

Short term financing: The short term financing is obtained for a period less than one year. It is arranged in advance from banks and other suppliers of short term finance include working capital funds from banks, public deposits, commercial paper, factoring of receivables etc.

Punj Lloyd manages secured loans as:-

1) Loans and advances from banks

2) Other loans and advances:

(i) Debentures/bonds

1

(ii) Loans from State Govt.

(iii) Loans from financial institutions(secured by pledge of PSU bonds and bills accepted guaranteed by banks)

3) Interest accrued and due on loans

(a) From State Govt.

(b) From financial institutions bonds and other

(c) packing credit

Punj Lloyd manages unsecured loans as:-

1) Public deposits

2) Short term loans and advances:

(1) From banks

(a) Commercial papers

(2) From others

(a) From companies

(b) From financial institutions

3) Other loans and advances

(a) From banks

(b) From others

(i) from govt. of India

(ii) from state govt.

(iii) from financial institutions

(iv) from foreign financial institution

(v) post shipment credit exim bank

(vi) credit for assets taken on lease

1

4) Interest accrued and due on

(a) Post shipment credit

(b) Govt. credit

(c) State Govt. loans

(d) Credits for assets taken on lease

(e) Financial institutions and others

(f) Foreign financial institutions

(g) Public deposits

Spontaneous financing:-

Spontaneous financing refers to the automatic sources of short term funds arising in the normal course of a business. Trade Credit and outstanding expenses are examples of spontaneous financing.

A firm is expected to utilize these sources of finances to the fullest extent. The real choice of financing current assets, once the spontaneous sources of financing have been fully utilized, is between the long term and short term sources of finances.

What should be the mix of short and long term sources in financing current assets?

Depending on the mix of short and long term financing, the approach followed by a company may be referred to as:

1. matching approach

2. conservative approach

3. aggressive approach

Matching approach

The firm can adopt a financial plan which matches the expected life of assets with the expected life of the source of funds raised to finance assets. Thus, a ten year loan may be raised to finance a plant with an expected life of ten year; stock of goods to be sold in thirty days may be financed with a thirty day commercial paper or a bank loan. The justification for the exact

1

matching is that, since the purpose of financing is to pay for assets, the source of financing and the asset should be relinquished simultaneously. Using long term financing for short term assets is expensive as funds will not be utilized for the full period. Similarly, financing long term assets with short term financing is costly as well as inconvenient as arrangement for the new short term financing will have to be made on a continuing basis.

When the firm follows matching approach (also known as hedging approach) long term financing will be used to finance fixed assets and permanent current assets and short term financing to finance temporary or variable current assets. However, it should be realized that exact matching is not possible because of the uncertainty about the expected lives of assets.

The firm fixed assets and permanent current assets are financed with long term funds and as the level of these assets in increases, the long term financing level also increases. The temporary or variable current assets are financed with short term funds and as their level increases, the level of short term financing also increases. Under matching plan, no short term financing will be used if the firm has a fixed current assets need only.

Conservative approach

A firm in practice may adopt a conservative approach in financing its current and fixed assets. The financing policy of the firm is said to be conservative when it depends more on long term funds for financing needs. Under a conservative plan, the firm finances its permanent assets and also a part of temporary current assets with long term financing. In the period when the

1

firm has no need for temporary current assets, the idle long term funds can be invested in the tradable securities to conserve liquidity. The conservative plan relies heavily on long term financing and, therefore, the firm has less risk of facing the problem of shortage of funds. The conservative financing policy is shown below. Note that when the firm has no temporary current assets, the long term funds released can be invested in marketable securities to build up the liquidity position of the firm.

Aggressive Approach

A firm may be aggressive in financing its assets. An aggressive policy is said to be followed by the firm when it uses more short term financing than warranted by the matching plan. Under an aggressive policy, the firm finances a part of its permanent current assets with short term financing. Some extremely aggressive firms may even finance a part of their fixed assets with

1

short term financing. The relatively more use of short term financing makes the firm more risky. The aggressive financing is illustrated in fig below.

Short term vs long term financing: A Risk Return Trade off

A firm should decide whether or not it should use short term financing. If short term financing has to be used, the firm must determine its position in total financing. This decision of the firm will be guided by the risk return trade off. Short term financing may be preferred over long term financing. For two reasons:

1. The cost advantage

2. Flexibility

But short term financing is more risky than long term financing.

Cost: short term financing should generally be less costly than long term financing. It has been found in developed countries like USA, the rate of interest is related to the maturity of debt. The relationship between the maturity of debt and its cost is called the term structure of

1

interest rates. The curve, relating to maturity of debt and interest rates, is called the yield curve. The yield curve may assume any shape, but it is generally upward sloping.

The justification for the higher cost of long term financing can be found in the liquidity preference theory. This theory says that since lenders are risk averse, and risk generally increases with the length of lending time (because it is more difficult to forecast the more distant future), most lenders would prefer to make short term loans. The only way to induce these lenders to lend for longer periods is to offer them higher rates of interest.

The cost of financing has an impact on the firm’s return. Both short and long term financing have a leveraging effect on shareholders’ return. But the short term financing ought to cost less than the long term financing; therefore, it gives relatively higher return to shareholders.

It is noticeable that in India short term loans cost more than the long term loans. Banks are the major suppliers of the working capital finance in India. Their rates of interest on working capital finance are quite high. The main sources of long term loans are financial institutions which till recently were not charging interest at differential rates. The prime rate of interest rate charged by financial institutions is lower than the rate charged by banks.

Flexibility: it is relatively easy to refund short term funds when the need for funds diminishes. Long term funds such as debenture loan or preference capital cannot be refunded before time. Thus, if a firm anticipates that its requirement for funds will diminish in near future, it would choose short term funds.

Risk: although short term financing may involve less cost, it is more risky than long term financing. If the firm uses short term financing to finance its current assets, it runs the risk of renewing borrowing again and again. This is particularly so in the case of permanent assets. As discussed earlier, permanent current assets refer to the minimum level of current assets which a firm should always maintain. If the firm finances it permanent current assets with short term debt, it will have to raise new short term funds as debt matures. This continued financing exposes the firm to certain risks. It may be difficult for the firm to borrow during stringent credit periods. At times, the firm may be unable to raise any funds and consequently, it operating activities may be disrupted. In order to avoid failure, the firm may have to borrow at most inconvenient terms. These problems are much less when the firm finances with long term funds. There is less risk of failure when the long term financing is used.

Risk returned trade-off: Thus, there is conflict between long term and short term financing. Short term financing is less expensive than long term financing, but, at the same time, short term financing involves greater risk than long term financing. The choice between long term and short term financing involves a trade-off between risk and return.

1

Handling Receivables (Debtors)

Cash flow can be significantly enhanced if the amounts owing to a business are collected faster. Every business needs to know, who owes them money, how much is owed, how long it owes, for what it is owed etc.

Late payments erode profits and can lead to bad debts.

Slow payment has a crippling effect on business; in particular on small businesses who can least afford it. If you don't manage debtors, they will begin to manage your business as you will gradually lose control due to reduced cash flow and, of course, you could experience an increased incidence of bad debt.

The following measures will help manage your debtors:

1. Have the right mental attitude to the control of credit and make sure that it gets the priority it deserves.

2. Establish clear credit practices as a matter of company policy.

3. Make sure that these practices are clearly understood by staff, suppliers and customers.

4. Be professional when accepting new accounts, and especially larger ones.

5. Check out each customer thoroughly before you offer credit. Use credit agencies, bank references, industry sources etc.

6. Establish credit limits for each customer... and stick to them.

7. Continuously review these limits when you suspect tough times are coming or if operating in a volatile sector.

8. Keep very close to your larger customers.

9. Invoice promptly and clearly.

10. Consider charging penalties on overdue accounts.

11. Consider accepting credit /debit cards as a payment option.

12. Monitor your debtor balances and ageing schedules, and don't let any debts get too large or too old.

1

Recognize that the longer someone owes you, the greater the chance you will never get paid. If the average age of your debtors is getting longer, or is already very long, you may need to look for the following possible defects:

weak credit judgement

poor collection procedures

lax enforcement of credit terms

slow issue of invoices or statements

errors in invoices or statements

Customer dissatisfaction.

Debtors due over 90 days (unless within agreed credit terms) should generally demand immediate attention. Look for the warning signs of a future bad debt. For example,

longer credit terms taken with approval, particularly for smaller orders

use of post-dated checks by debtors who normally settle within agreed terms

evidence of customers switching to additional suppliers for the same goods

new customers who are reluctant to give credit references

Receiving part payments from debtors.

Profits only come from paid sales.

The act of collecting money is one which most people dislike for many reasons and therefore put on the long finger because they convince themselves there is something more urgent or important that demands their attention now. There is nothing more important than getting paid for your product or service. A customer who does not pay is not a customer.

Managing Payables (Creditors) Creditors are a vital part of effective cash management and should be managed carefully to enhance the cash position. Purchasing initiates cash outflows and an over-zealous purchasing function can create liquidity problems. Consider the following:

Who authorizes purchasing in your company - is it tightly managed or spread among a number of (junior) people?

Are purchase quantities geared to demand forecasts?

1

Do you use order quantities which take account of stock-holding and purchasing costs?

Do you know the cost to the company of carrying stock?

Do you have alternative sources of supply? If not, get quotes from major suppliers and shop around for the best discounts, credit terms, and reduce dependence on a single supplier.

How many of your suppliers have a returns policy?

Are you in a position to pass on cost increases quickly through price increases to your customers?

If a supplier of goods or services lets you down can you charge back the cost of the delay?

Can you arrange (with confidence!) to have delivery of supplies staggered or on a just-in-time basis?

There is an old adage in business that if you can buy well then you can sell well. Management of your creditors and suppliers is just as important as the management of your debtors. It is important to look after your creditors - slow payment by you may create ill-feeling and can signal that your company is inefficient (or in trouble!).

7.6 Management of Inventory

Inventories constitute the most significant part of current assets of a large majority of companies in India. On an average, inventories are approximately 60 % of current assets in public limited companies in India. Because of the large size of inventories maintained by firms maintained by firms, a considerable amount of funds is required to be committed to them. It is, therefore very necessary to manage inventories efficiently and effectively in order to avoid unnecessary investments. A firm neglecting a firm the management of inventories will be jeopardizing its long run profitability and may fail ultimately. The purpose of inventory management is to ensure availability of materials in sufficient quantity as and when required and also to minimize investment in inventories at considerable degrees, without any adverse effect on production and sales, by using simple inventory planning and control techniques.

Needs to hold inventories:-

There are three general motives for holding inventories:-

1

Transaction motive emphasizes the need to maintain inventories to facilitate smooth production and sales operation.

Precautionary motive necessities holding of inventories to guard against the risk of unpredictable changes in demand and supply forces and other factors.

Speculative motive influences the decision to increases or reduce inventory levels to take advantage of price fluctuations and also for saving in reordering costs and quantity discounts etc.

Objective of Inventory Management:-

The main objectives of inventory management are operational and financial. The operational mean that means that the materials and spares should be available in sufficient quantity so that work is not disrupted for want of inventory. The financial objective means that investments in inventories should not remain ideal and minimum working capital should be locked in it.

The following are the objectives of inventory management:-

To ensure continuous supply of materials, spares and finished goods.

To avoid both over-stocking of inventory.

To maintain investments in inventories at the optimum level as required by the operational and sale activities.

To keep material cost under control so that they contribute in reducing cost of production and overall purchases.

To eliminate duplication in ordering or replenishing stocks. This is possible with the help of centralizing purchases.

To minimize losses through deterioration, pilferage, wastages and damages.

To design proper organization for inventory control so that management. Clear cut account ability should be fixed at various levels of the organization.

To ensure perpetual inventory control so that materials shown in stock ledgers should be actually lying in the stores.

To ensure right quality of goods at reasonable prices.

To facilitate furnishing of data for short-term and long term planning and control of inventory

1

7.7 Management of cash

Cash is the important current asset for the operation of the business. Cash is the basic input needed to keep the business running in the continuous basis, it is also the ultimate output expected to be realized by selling or product manufactured by the firm. The firm should keep sufficient cash neither more nor less. Cash shortage will disrupt the firm’s manufacturing operations while excessive cash will simply remain ideal without contributing anything towards the firm’s profitability. Thus a major function of the financial manager is to maintain a sound cash position. Cash is the money, which a firm can disburse immediately without any restriction. The term cash includes coins, currency and cheques held by the firm and balances in its bank account. Sometimes near cash items such as marketing securities or bank term deposits are also included in cash. Generally when a firm has excess cash, it invests it is marketable securities. This kind of investment contributes some profit to the firm.

Need to hold cash

The firm’s need to hold cash may be attributed to the following three motives:-

The Transaction Motive: The transaction motive requires a firm to hold cash to conduct its business in the ordinary course. The firm needs cash primarily to make payments for purchases, wages and salaries, other operating expenses, taxes, dividends, etc.

The Precautionary Motive: A firm is required to keep cash for meeting various contingencies. Though cash inflows and outflows are anticipated but there may be variations in these estimates. For example a debtor who pays after 7 days may inform of his inability to pay, on the other hand a supplier who used to give credit for 15 days may not have the stock to supply or he may not be in opposition to give credit at present.

Speculative Motive: - The speculative motive relates to the holding of cash for investing in profit making opportunities as and when they arise. The opportunities to make profit changes. The firm will hold cash, when it is expected that interest rates will rise and security price will fall.

Components of working capital are calculated as follows:

1) Raw Materials Storage Period=Average stock of raw materials/Average cost of raw material consumption per day.

2) W-I-P Holding period=Average w-i-p in inventory/Average cost of production per day.

3) Stores and spares conversion period= Average stock of Stores and spares/ Average consumption per day.

1

4) Finished goods conversion period= Average stock of finished goods/Average cost of goods sold per day.

5) Debtors collection period=Average book debts/Average credit sales per day.

6) Credit period availed=Average trade creditors/Average credit purchase per day.

7.8 Management of Receivables

A sound managerial control requires proper management of liquid assets and inventory. These assets are a part of working capital of the business. An efficient use of financial resources is necessary to avoid financial distress. Receivables result from credit sales. A concern is required to allow credit sales in order to expand its sales volume. It is not always possible to sell goods on cash basis only. Sometimes other concern in that line might have established a practice of selling goods on credit basis. Under these circumstances, it is not possible to avoid credit sales without adversely affecting sales.

The increase in sales is also essential to increases profitability. After a certain level of sales the increase in sales will not proportionately increase production costs. The increase in sales will bring in more profits. Thus, receivables constitute a significant portion of current assets of a firm. But for investment in receivables, a firm has to insure certain costs. Further, there is a risk of bad debts also. It is therefore, very necessary to have a proper control and management of receivables.

Needs to hold cash:

Receivables management is the process of making decisions relating to investment in trade debtors. Certain investments in receivables are necessary to increase the sales and the profits of a firm. But at the same time investment in this asset involves cost consideration also. Further, there is always a risk of bad debts too. Thus, the objective of receivable management is to take a sound decision as regards investments in debtors. In the words of Bolton, S.E., the need of receivables management is “to promote sales and profits until that point is reached where the return of investment in further funding of receivables is less than the cost of funds raised to finance that additional credit.”

8.Financials of Punj Lloyd ltd

8.1 Income Statement

1

31-Mar-09(12)

  31-Mar-08(12)

  31-Mar-07(12)

 

Profit / Loss A/C Rs mn %OI Rs mn %OI Rs mn %OI

   Net Sales (OI) 68879.50 100.00

44885.68 100.00

22388.47 100.00

   Material Cost 23817.61 34.58 16253.63 36.21 5873.55 26.23

   Increase Decrease Inventories

0.00 0.00 0.00 0.00 4.97 0.02

   Personnel Expenses 5701.88 8.28 3475.74 7.74 2365.63 10.57

   Manufacturing Expenses

23901.47 34.70 15043.77 33.52 8805.23 39.33

Gross Profit 15458.54 22.44 10112.54 22.53 5339.09 23.85

   Administration Selling and Distribution Expenses

8049.85 11.69 4968.23 11.07 3186.30 14.23

EBITDA 7408.69 10.76 5144.31 11.46 2152.79 9.62

   Depreciation Depletion and Amortisation

1194.81 1.73 1133.87 2.53 844.61 3.77

EBIT 6213.88 9.02 4010.44 8.93 1308.18 5.84

   Interest Expense 1942.80 2.82 1132.81 2.52 1001.16 4.47

   Other Income 676.67 0.98 531.88 1.18 666.31 2.98

Pretax Income 4947.75 7.18 3409.51 7.60 973.33 4.35

   Provision for Tax 1736.79 2.52 1195.08 2.66 357.49 1.60

   Extra Ordinary and Prior Period Items Net

0.00 0.00 0.00 0.00 0.00 0.00

Net Profit 3210.98 4.66 2214.43 4.93 615.85 2.75

1

Adjusted Net Profit 3210.98 4.66 2214.43 4.93 615.85 2.75

Dividend - Preference 0.00 0.00 0.00 0.00 0.00 0.00

Dividend - Equity 91.05 0.13 121.38 0.27 78.38 0.35

8.2 Balance Sheet

31-Mar-09

%BT 31-Mar-08

%BT 31-Mar-07

%BT

    Equity Capital 606.96 0.74 606.89 1.14 522.52 1.34

    Preference Capital 0.00 0.00 0.00 0.00 0.00 0.00

Share Capital 606.96 0.74 606.89 1.14 522.52 1.34

Reserves and Surplus 25482.63 31.03 23538.82 44.24 10519.67 26.95

Loan Funds 29378.54 35.78 13676.48 25.71 15186.40 38.91

    Current Liabilities 24006.21 29.23 13635.10 25.63 11895.09 30.48

    Provisions 1463.05 1.78 726.78 1.37 297.40 0.76

Current Liabilities and Provisions

25469.26 31.02 14361.89 27.00 12192.48 31.24

Total Liabilities and Stockholders Equity (BT)

82117.61 100.00

53201.63 100.00

39027.15 100.00

    Tangible Assets Net 0.00 0.00 0.00 0.00 8312.98 21.30

    Intangible Assets Net 0.00 0.00 0.00 0.00 199.23 0.51

  Net Block 10722.77 13.06 9894.34 18.60 8512.21 21.81

  Capital Work In Progress Net

1236.54 1.51 928.48 1.75 40.34 0.10

Fixed Assets 11959.31 14.56 10822.82 20.34 8552.55 21.91

1

Investments 9933.47 12.10 7277.56 13.68 3177.97 8.14

  Inventories 29502.87 35.93 15051.48 28.29 11628.36 29.80

  Accounts Receivable 15235.62 18.55 9639.67 18.12 5615.05 14.39

  Cash and Cash Equivalents

3589.26 4.37 2144.23 4.03 3379.01 8.66

  Other Current Assets 924.05 1.13 812.47 1.53 590.42 1.51

Current Assets 49251.81 59.98 27647.86 51.97 21212.84 54.35

Loans & Advances 10973.02 13.36 7452.31 14.01 6083.67 15.59

Miscellaneous Expenditure Other Assets

0.00 0.00 0.00 0.00 0.00 0.00

Total Assets (BT) 82117.61 100.00

53201.63 100.00

39027.15 100.00

9.Ratio Analysis

1

As on 31-Mar-09

31-Mar-08 31-Mar-07

Working Capital

Working Capital to Sales (x) 0.40 0.30 0.40

Working Capital Days (days gross sales) 133.80 113.90 151.90

Receivables (days gross sales) 80.70 78.40 91.50

Creditors (days cost of sales) -- 70.20 86.50

FG Inventory (days cost of sales) -- 0.10 0.10

RM Inventory (days consumption) -- -- --

Cash Flow Indicator

Operating Cash Flow/Sales (%) -9.40 -5.20 -8.20

Following steps have been taken to control inventory:

An inventory monitoring cell is constituted at the corporate office.

The purchases were controlled by the materials management group reporting to the Director of Finance.

The company provided for weekly meetings between material planning, production control and purchase departments for better matched material availability.

Monthly review of total inventory at the level of chief executives of plants and corporate management is introduced.

Inventory control is dovetailed with the budgeting system. Top 100 inventory items are identified for closer scrutiny and control

Key Working Capital Ratios

The following, easily calculated, ratios are important measures of working capital utilization.

1

Ratio Formula Result Interpretation

Stock Turnover (in days)

Average Stock * 365/ Cost of Goods Sold

= x days On average, you turnover the value of your entire stock every x days. You may need to break this down into product groups for effective stock

management. Obsolete stock, slow moving lines will extend overall stock turnover days. Faster production, fewer product lines, just in time ordering will reduce average days.

Receivables Ratio (in days)

Debtors * 365/ Sales

= x days It takes you on average x days to collect monies due to you. If you’re official credit terms are 45 day and it takes you 65 days... why? One or more large or slow debts can drag out the average days. Effective debtor management will minimize the days.

Payables Ratio (in days)

Creditors * 365/ Cost of Sales (or Purchases)

= x days On average, you pay your suppliers every x days. If you negotiate better credit terms this will increase. If you pay earlier, say, to get a discount this will decline. If you simply defer paying your suppliers (without agreement) this will also increase - but your reputation, the quality of service and any flexibility provided by your suppliers may suffer.

Current Ratio

Total Current Assets/ Total Current Liabilities

= x times Current Assets are assets that you can readily turn in to cash or will do so within 2 months in the course of business. Current Liabilities are amount you are due to pay within the coming 12 months. For example, 1.5 times means that you should be able to lay your hands on $1.50 for every $1.00 you owe. Less than 1 time e.g. 0.75 means that you could have liquidity problems and be under pressure to generate sufficient cash to meet oncoming demands.

Quick Ratio (Total Current Assets -

= x times Similar to the Current Ratio but takes account of the fact that it may take time to convert inventory

1

Inventory)/ Total Current Liabilities

into cash.

Working Capital Ratio

(Inventory + Receivables - Payables)/ Sales

As % Sales A high percentage means that working capital needs are high relative to your sales.

Other working capital measures include the following:

Bad debts expressed as a percentage of sales.

Cost of bank loans, lines of credit, invoice discounting etc.

Debtor concentration - degree of dependency on a limited number of customers.

Once ratios have been established for your business, it is important to track them over time and to compare them with ratios for other comparable businesses or industry sectors. When planning the development of a business, it is critical that the impact of working capital be fully assessed when making cash flow forecasts.

Calculation of current assets to fixed asset ratio

A firm needs current and fixed assets to support a particular level of output. However, to support the same level of output the firm can have different levels of current assets. As the firm’s output and sales increases, the need for current asset increases. Generally the current assets do not increase in direct proportion to output; current assets may increase at a decreasing rate with input. This relationship is based upon the notion that it takes a greater proportional investment in current assets when only a few units of output are produced than it does later on when the firm can use its current assets more efficiently.

The level of the current assets can be measured by relating current assets to fixed assets.

There are three policies:-

1) conservative current assets policy:

CA/FA is higher. It implies greater liquidity and lower risk.

1

2) aggressive current assets policy:

CA/FA is lower; it implies higher risk and poor liquidity.

3) moderate current assets policy:

CA/FA ratio falls in the middle of conservative and aggressive policies.

In case of Punj Lloyd, the ratio of current assets to fixed assets is:

2008-09 (Rs mn) 2007-08 (Rs mn) 2006-07 (Rs mn)

Current Assets 49251.81 27647.86 21212.84

Fixed Assets 11959.31 10822.82 8552.55

CA/FA 4.12 2.55 2.48

1

10.Cash Flow Analysis

Cash flow analysis is a method of analyzing the financing, investing, and operating activities of a company. The primary goal of cash flow analysis is to identify, in a timely manner, cash flow problems as well as cash flow opportunities. The primary document used in cash flow analysis is the cash flow statement. Since 1988, the Securities and Exchange Commission (SEC) has required every company that files reports to include a cash flow statement with its quarterly and annual reports. The cash flow statement is useful to managers, lenders, and investors because it translates the earnings reported on the income statement—which are subject to reporting regulations and accounting decisions—into a simple summary of how much cash the company has generated during the period in question. "Cash flow measures real money flowing into, or out of, a company's bank account," Harry Domash notes on his Web site, WinningInvesting.com. "Unlike reported earnings, there is little a company can do to overstate its bank balance."

The cash flow statement

A typical cash flow statement is divided into three parts: cash from operations (from daily business activities like collecting payments from customers or making payments to suppliers and employees); cash from investment activities (the purchase or sale of assets); and cash from financing activities (the issuing of stock or borrowing of funds). The final total shows the net increase or decrease in cash for the period.

Cash flow statements facilitate decision making by providing a basis for judgments concerning the profitability, financial condition, and financial management of a company. While historical cash flow statements facilitate the systematic evaluation of past cash flows, projected (or pro forma) cash flow statements provide insights regarding future cash flows. Projected cash flow statements are typically developed using historical cash flow data modified for anticipated changes in price, volume, interest rates, and so on.

To enhance evaluation, a properly-prepared cash flow statement distinguishes between recurring and nonrecurring cash flows. For example, collection of cash from customers is a recurring activity in the normal course of operations, whereas collections of cash proceeds from secured bank loans (or issuances of stock, or transfers of personal assets to the company) is typically not considered a recurring activity. Similarly, cash payments to vendors is a recurring activity, whereas repayments of secured bank loans (or the purchase of certain investments or capital assets) is typically not considered a recurring activity in the normal course of operations.

In contrast to nonrecurring cash inflows or outflows, most recurring cash inflows or outflows occur (often frequently) within each cash cycle (i.e., within the average time horizon of the cash

1

cycle). The cash cycle (also known as the operating cycle or the earnings cycle) is the series of transactions or economic events in a given company whereby:

1. Cash is converted into goods and services.

2. Goods and services are sold to customers.

3. Cash is collected from customers.

Reasons for Creating a Cash Flow Budget

Think of cash as the ingredient that makes the business operate smoothly just as grease is the ingredient that makes a machine function smoothly. Without adequate cash a business cannot function because many of the transactions require cash to complete them.

By creating a cash flow budget you can project your sources and applications of funds for the upcoming time periods. You will identify any cash deficit periods in advance so you can take corrective actions now to alleviate the deficit. This may involve shifting the timing of certain transactions. It may also determine when money will be borrowed. If borrowing is involved, it will also determine the amount of cash that needs to be borrowed.

Periods of excess cash can also be identified. This information can be used to direct excess cash into interest bearing assets where additional revenue can be generated or to scheduled loan payments.

Cash Flow is not Profitability

People often mistakenly believe that a cash flow statement will show the profitability of a business or project. Although closely related, cash flow and profitability are different. A cash flow statement lists cash inflows and cash outflows while the income statement lists income and expenses. A cash flow statement shows liquidity while an income statement shows profitability.

Many income items are also cash inflows. The sales of crops and livestock are usually both income and cash inflows. The timing is also usually the same as long as a check is received and deposited in your account at the time of the sale. Many expense items are also cash outflow items. The purchase of livestock feed (cash method of accounting) is both an expense and a cash outflow item. The timing is also the same if a check is written at the time of purchase.

However, there are many cash items that are not income and expense items, and vice versa. For example, the purchase of a tractor is a cash outflow if you pay cash at the time of purchase. If money is borrowed for the purchase using a term loan, the down payment is a cash outflow

1

at the time of purchase and the annual principal and interest payments are cash outflows each year.

10.1 Cash Flow Statement of Punj Lloyd

Cash Flows used in Operating ActivitiesNet Profit before Taxation

Year ended March 31, 2009

13,356

Year ended March 31, 2008

4,834,834

Adjustments for -Depreciation/Amortization 1,770,765 1,462,386Loss / (Profit) on Sale / Discard of Fixed Assets (Net) (402,479) 30,163Loss / (Profit) on Sale of Non Trade Long Term Investments 95,320 (363,901)Loss / (Profit) on Liquidation of Subsidiaries & ISP Business (Net) 118,810 -Interest Income (98,322) (276,689)Dividend on Long Term Investments (2) (345)Unrealised Foreign Exchange Fluctuation (Net) 503,313 277,499Interest Expenses 2,207,606 1,292,129Amortisation of Foreign Currency Monetary Items Translation (346,902) -Bad Debts/ Advances Written Off - 76,481Unspent Liabilities and Provisions Written Back (189,719) (132,684)Provision for Doubtful Receivable 80,181 52,882Operating Profit before Working Capital Changes 3,751,927 7,252,755Movements in Working Capital:(Increase) in Inventories (16,093,979) (3,729,198)(Increase) in Sundry Debtors (5,692,411) (8,720,340)(Increase) / Decrease in Other Current Assets 337,988 (314,941)(Increase) in Margin Money Deposits (578,904) (479,708)(Increase) in Loans and Advances (3,389,536) (2,420,500)Increase in Current Liabilities and Provisions 15,198,031 4,052,425Cash Used in Operations (6,466,884) (4,359,507)Direct Taxes Paid (1,227,020) (823,518)Net Cash Used in Operating Activities (7,693,903) (5,183,025)Cash Flows Used in Investing ActivitiesPurchase of Fixed Assets (Including Capital Work in Progress) (7,945,806) (4,995,765)Purchase of Investments (1,499,010) (3,832,746)Cash Outflow on Acquisition of Subsidiaries (150,814) -Proceeds from Sale of Investments 203,155 404,186Proceeds from Sale of Fixed Assets 1,581,986 787,558Outflow for Misc. Expenses - (1)Dividend Received 2 345Interest Received 109,873 288,615Net Cash Used in Investing Activities (7,700,614) (7,347,808)Cash Flows from Financing ActivitiesInflow in Share Capital 72 338,371Share Issue Expenses - (106,475)Increase in Premium on Issue of Share Capital 6,972 11,068,258Increase in Short-Term Working Capital Loans 9,372,124 2,124,550Repayment of Long-Term Borrowings (1,965,863) (7,424,358)Proceeds from Long-Term Borrowings 12,114,172 4,379,446Interest Paid (2,152,226) (1,270,907)Dividend Paid (121,372) (78,378)Tax on Dividend Paid (20,628) (13,320)Net Cash from Financing Activities 17,233,251 9,017,187Net Increase / (Decrease) in Cash and Cash Equivalents (A+B+C)

1,838,734 (3,513,646)Exchange Fluctuation Translation Difference (1,152,203) (94,755)Total 686,531 (3,608,401)Cash and Cash Equivalents at the Beginning of the Year 6,347,013 9,955,414Cash Outflow due to Disposal of a Branch and a Subsidiary (66,270) -Cash Inflow due to Acquisition of Subsidiaries 24,762 -Cash and Cash Equivalents at the End of the YearComponents of Cash and Cash Equivalents

6,992,036 6,347,013

Cash on Hand (Including Cheque on Hand Rs. Nil) 109,388 77,115Balance with Banks

On Current Accounts 3,359,582 2,506,307On Cash Credit Accounts 98,771 52,264On EEFC Accounts 25,082 400,279On Fixed Deposits 4,529,206 3,862,137Less : Margin Money Deposits (1,129,993) (551,089)

Total 6,992,036 6,347,013

1

10.2 Cash Flow of Jobs

10.2.1 Monthly cash flow of a Job

PARTICULARS Last period Apr-10

Actual Budgeted Actual BudgetedCASH OUTFLOWS

CHARGED WAGES Charged wages 3844065 4200000 555395 420000SOCIAL COST ON WAGES Employer Cont EPF- wages 76623 588000 58800SALARIES OF HIRED EMPLOYEES INTER-DIVISION COSTS (FROM TWO DIVISIONS)

INTRA-DIVISION COSTS (FROM TWO DEPARTMENTS)

TEMPORARY WORKERS SUB CONTRACTORS AND CONSULTANTS Sub contractors and consultants 780224 1595833 159583.3COSTS AFFILIATED COMPANIES MATERIAL Consumables 3598385 52727 CENTRAL SALES TAX CST- MH CST- CG CST- GJ CST- RJ CST- HR CST- PJ CST- JK CST- TN CST- WB CST- AP CST- MP CST- OR CST- UP CST- BH RENTAL COST OF SCAFFOLDING CHARGED RENTAL COSTS CHARGED INTEREST EXPENSES SITE COST Accommodation 352030 450000 45000Conveyance 22764 41666.7 4166.67

1

LC/BG bank charges 61941.94 20833.3 16846.85 2083.33Site consumables and safety gadgets 3500000 350000Equipment hired 942741 1578333 157833.3Food and site allowance 86029 50000 5000Fuel and services 83817 958333.3 95833.33Insurance cost workmen compensation 30312 2756 Local taxes 20833.3 2083.33IT costs 700 Medical services 4714 83333.3 274 8333.33Printing and stationery 16346 41666.7 130 4166.67Vehicle hired 180651 408333.3 40833.33Telephone and internet 26805 41666.7 4166.67Temporary shed/ warehouse 41666.7 4166.67 TRAVELLING Hotel cost- domestic 101087 83333.3 8333.33Ticket cost- domestic 150453.7 83333.3 13713 8333.33Other cost- domestic 36923 41666.7 4166.67Other site costs 25051 100 Courier and postage 4609 20833.3 110 2083.33Transportation and octroi 4500 83333.3 8333.33Engineering services 811257 666666.7 66666.67Testing and inspection 9484 133333.3 13333.33Repair and maintenance 11105 125000 12500Training and seminar expenses Uniform and Dress Power and water 2197 112500 11250Charity and donation 26655 83333.3 8333.33Client entertainment 17413 41666.7 4166.67Commission and brokerage 300 CHARGED SALARY INCLUDING SOCIAL COST CHARGED SALARY Charged salary 1094348 1458333 97201 145833.3 SOCIAL COST ON SALARY Employer Cont EPF- salary 45463 240000 24000Employer Cont ESIC- salary MISCELLANEOUS PROJECT COST 208333.3 20833.33OUTPUT TAX CHARGED OTHER COST  

TOTAL CASH OUTFLOW 12448993 17002166 739252.9 1679383 

CASH INFLOWS

1

Cash payment received 5468330 24312500 2431250TOTAL CASH INFLOW 5468330 24312500 0 2431250

  NET CASH FLOW -6980663 7310334 -739253 751866.7

Projected Cash Flows from individual projects (in Rs.)  

Job no.

Job start date

Job completion

date

Cash Outflows Cash Inflows Budgeted Margin

(%)

Actual Margin

(%)Budgeted project expenses

Actual Project cost

Estimated value of job

Actual revenue earned

47 Jun-09 May-10 20402600 12448993.4 29175000 8972765.21 30 -38.7420

10.3 Job Cash flow Analysis & Interpretation

The monthly cash flows from this project show varied results as cash inflows occur only in the months of October, December, January and March. The other months do not show any cash inflows as no payment is received on these months from the client. As there is no cash inflow these months show negative net cash flows. In spite of payment being received march shows a negative net cash flow as the inflows are not enough to cover the cash outflows.

Barring few expenses it can be seen that the budgeted costs for most of the listed expenses are extremely high. This shows that funds are not optimally utilized as most of the funds are lying idle. Some expenses are projected at extremely high expected rates as they are more than thrice or four times of the actual costs. The cash position of the project is mostly negative even if the actual costs are well within the limits of the budgeted costs.

Though the net monthly cash flows are mostly negative it does not mean that the company is in immediate need of cash which can be funded by short term borrowings as the budgeted costs are quite higher and the company’s financial position assures that it can meet the expenses at the stipulated time as and when required.

The budgeted costs that are set aside by the company are quite high and it can be reduced by carefully considering certain costs, like, power and fuel costs, repairs and maintenance costs etc. which are projected at four to five times their actual expenses made.

Overall this project was a failure as we see that the company incurred a heavy loss of around 38% though the budgeted margin was expected around 30%. This tells us the budgets made for

1

this project were highly inflated. The job order might have looked lucrative but it yielded unfavorable results due to poor forecasts made in this regard.

11.Conclusion

Let us summarize our discussion on the structure and financing of current assets. The relative liquidity of the firm’s assets structure is measured by current to fixed assets or current asset to total asset ratio. The greater this ratio, the less risky as well as the less profitable will be the

1

firm and vice versa. Similarly, the relative liquidity of the firm’s financial structure can be measured by short-term financing to total financing ratio. The lower this ratio the less risky as well as profitable will be the firm and vice-versa. In shaping its working capital policy, the firm should keep in mind these two dimensions: relative asset liquidity (level of current assets) and relative financing liquidity (level of short term financing) of the working capital management. A firm will be following a very conservative working capital policy if it combines a high level of current assets with a high level of long term financing (or low level of short term financing). Such a policy will not be risky at all but would be less profitable. An aggressive firm on the other hand would combine low level of current assets with a low level of long term financing (or high level of short term financing). This firm will have high profitability and high risk. In fact, the firm the firm may follow a conservative financing policy to counter its relatively liquid asset structure in practice. The conclusion of all this is that the considerations of assets and financing mix are crucial to the working capital management.

12.Recommendations

There is a great need for effective management of working capital in any firm. There is no precise way to determine the exact amount of gross or net working capital for any firm. The data and problems of each company should be analyzed to determine the working capital.

1

There is no specific rule as to how current assets should be financed. It is not feasible in practice to finance current assets by short-term sources only. Keeping in view the constraints of the company, a judicious mix of short and long term finances should be invested in current assets. Since current assets involve cost of funds, they should be put to productive use.

13.Bibliography

1. Financial Management by Khan & Jain

2. Financial Management by Prasanna Chandra

1

3. Financial Management by I.M.Pandey

4. Annual Reports of Punj Lloyd

5. Auditor’s report, Director’s report & Investor’s report

6. www.punjlloydgroup.com

7. www.google.com