working capital management 124
TRANSCRIPT
A
SUMMER TRAINING REPORT
ON
“financial analysis ”
IN
MICROQUAL TECHNO (P) LTD.
FOR THE PARTIAL FULFILLMENT OF DEGREE OF MASTER OF BUSINESS
ADMINISTRATION
SUBMITTED TO: SUBMITTED BY:
Mrs………………………… HITESH Lecturer KU ROLL NO…Department of management studies
AMRAPALI INSTITUTE OF MANAGEMENT AND COMPUTER APPLICATION
Shiksha Nagar, Lamachaur, Haldwani
(Affiliated to Uttarakhand Technical University) Dehradun
STUDENT DECLARATION
I hereby declare that I have undergone training at microqual techno pvt ltd. for a Period of weeks from 10 june to 4 aug. This report is being submitted
in partial fulfillment of MASTER OF BUSINESS ADMINISTRATION
under UTU.
This project has not been presented in any seminar or submitted elsewhere
for the award of any degree or diploma.
(…………………………….)
CONTENTS
Chapter 1
Introduction Objectives Methodology
Limitation Scope
Chapter 2
Industrial overview
Company profile
Chapter 3
Data analysis
Chapter 4
Finding
Suggestion Conclusion
Chapter 5
Bibliography
INTRODUCTION Working Capital Management
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 cash flow to satisfy both maturing short-
term debt and upcoming operational expenses.
DECISION CRITERIA By definition, working capital management entails short term decisions -
generally, relating to the next one year periods - which are "reversible".
These decisions are therefore not taken on the same basis as Capital
Investment Decisions (NPV or related, as above) rather they will be based
on cash flows and / or profitability.
One measure of cash flow is provided by the cash conversion cycle -
the net number of days from the outlay of cash for raw material to
receiving payment from the customer. As a management tool, this
metric makes explicit the inter-relatedness of decisions relating to
inventories, accounts receivable and payable, and cash. Because this
number effectively corresponds to the time that the firm's cash is tied
up in operations and unavailable for other activities, management
generally aims at a low net count.
In this context, the most useful measure of profitability is Return on
capital (ROC). The result is shown as a percentage, determined by
dividing relevant income for the 12 months by capital employed;
Return on equity (ROE) shows this result for the firm's shareholders.
Firm value is enhanced when, and if, the return on capital, which
results from working capital management, exceeds the cost of capital,
which results from capital investment decisions as above. ROC
measures are therefore useful as a management tool, in that they link
short-term policy with long-term decision making. See Economic
value added (EVA).
Management Of Working Capital
Guided by the above criteria, management will use a combination of policies
and techniques for the management of working capital. These policies aim at
managing the current assets (generally cash and cash equivalents,
inventories and debtors) and the short term financing, such that cash flows
and returns are acceptable.
Cash management. Identify the cash balance which allows for the
business to meet day to day expenses, but reduces cash holding costs.
Inventory management. Identify the level of inventory which allows
for uninterrupted production but reduces the investment in raw
materials - and minimizes reordering costs - and hence increases cash
flow; see Supply chain management; Just In Time (JIT); Economic
order quantity (EOQ); Economic production quantity
Debtors management. Identify the appropriate credit policy, i.e. credit
terms which will attract customers, such that any impact on cash flows
and the cash conversion cycle will be offset by increased revenue and
hence Return on Capital (or vice versa); see Discounts and
allowances.
Short term financing. Identify the appropriate source of financing,
given the cash conversion cycle: the inventory is ideally financed by
credit granted by the supplier; however, it may be necessary to utilize
a bank loan (or overdraft), or to "convert debtors to cash" through
"factoring".
OBJECTIVES
The objectives of the study are as follows:
To study the working capital management of Microqual Techno Pvt.
Ltd.
To understand the different methods of managing inventory at
different levels of production in Microqual Techno Pvt. Ltd.
To analyze the impact of working capital policies on the overall
financial performance of a business concern.
To learn the practical techniques adopted for Ratio Analysis.
To analyze the existing and future analysis based on Ratio Analysis
Corporate Mission Objective
1.”Without continual growth and progress, such words as improvement
achievement and success have no meaning.”
-Benjamin Franklin
Growth is the most integral part of the Organization.
2. Customer Satisfaction is the Ultimate target.
3. We are committed to give Solutions to our customers rather than only
products.
RESEARCH METHODOLOGY
The methodology describes the process of research work. This contains the
overall research design and the data collection methods.
Topic of Research :
The topic of the present study is “Information Memorandum”.
Data Collection Methods:
Data was collected by the review of published literature that includes official
documents of Microqual Techno Pvt. Ltd. and other related documents of
the company.
Secondary Data
The secondary data was gathered from the books related to finance and
Information Memorandum and articles from websites, Accounting Standard
published by institute of Chartered accountants of India.
Primary Data
The primary data has been collected from various employees of the company
and onsite observation
LIMITATIONS OF THE STUDY
This study is limited to two year.
The study is restricted to the application of ratio analysis.
This study is limited to only one company.
The data of this study has been primarily taken from company annual reports only.
INDUSTRY OVERVIEWINDUSTRY OVERVIEW
•This section provides an overview of key markets that Microqual serves in
terms of growth dynamics - till date and going forward.
•
As demand for Microqual solutions is directly correlated to mobile base
stations (BTS) installed, this section also outlines in particular the envisaged
rollout of mobile communications infrastructure in India in the coming few
years.
The Indian telecom industry has been witnessing explosive growth rates
since 1997. The beginning of internet and mobile telephony coupled with
Telecom Regulatory Authority of India (TRAI) coming into existence
provided the foundation for this growth. And, with the FDI limit now hiked
to 74%, investments of over USD 15 Billion are expected in this sector (over
the next 5 yrs).
During the year 2005-06, the mobile subscriber base has grown by over 75%
from 52 million to over 91 million. The total telecom subscriber base is
expected to cross 200 million by the end of 2008-09, at a CAGR of over
30%.
The tele-density has also gone up from 2 per cent in 1999 to over 10
per cent currently, and is set to cross 20 percent in the next 5 years. With the
government stressing on increasing the rural tele-density, the revenues from
telecoms is expected to almost triple to USD 23-25 billion by 2009 from
USD 9 billion in 2002.
MICROQUAL – BUSINESS OVERVIEWMICROQUAL – BUSINESS OVERVIEW
Microqual’s domain of business activities is best understood when viewed in
context of its place in the communications ecosystem.
The mobile communications ecosystem is composed of three primary
participants – the Services Operators (Telcos), Core Equipment Suppliers
(OEMs) and Infrastructure Solution providers. Key players in each of the
areas are illustrated in the accompanying graphic. Microqual is a firmly
entrenched player in the RF passive components space which is one of the
critical parts of the communications value chain.
The RF passive components and installation kits space is relatively
fragmented with small, medium and large sized companies specializing in
particular areas likes antennae, repeaters, RF cables, electrical installation
kits etc.
Microqual has over the years pioneered a unique engagement model with its
clients in this space wherein it aggregates full system solutions for all three
kinds of sites i.e. In Building, Outdoor and Repeater Sites.
In doing so, the Company manufactures most of the critical RF passive
components and buys-out hardware items in “kitting” together a pre-
configured solution for its clients.
This engagement model has met with highly encouraging response from its
clients with the key benefit accruing to them in the form of a complete
outsource of configuring and putting together over 40 critical but disparate
items of infrastructure (which activity when performed in-house consumes
substantial organizational resources for the clients).
Further, the Company has over the years developed substantial
organizational capabilities and competence in the area of wireless
communications infrastructure solutions and particularly in the areas of RF
passive components.
KEY PERSONNEL - BIOSKEY PERSONNEL - BIOS
•Mr. Mahesh Choudhary
(Age: 27 yrs, Designation: MD & CEO)
Mr. Mahesh is the principal founder and driving force behind Microqual.
He co-founded the company (with family) post his business studies. He is
the chief architect of the company’s vision and strategy and has guided the
Company in becoming the 7th fastest growing tech company in India
(Deloitte survey). Mr. Mahesh discharges executive responsibilities in
overseeing all strategic and tactical business matters at Microqual
.
•Mr. Varun Choudhary
(Age: 22 yrs, Designation: Sales & Marketing Director)
Mr. Varun joined Microqual fresh post graduate business studies. He has
grown to successfully handle the complete Sales & Marketing portfolio at
the Company.
•Mr. Sushil Choudhary
(Age: 38 yrs, Designation: Chief Operating Officer)
Graduated in Science (B.Sc. – Chem), Mr. Sushil discharges executive
responsibilities spanning new initiatives and projects (especially
Uttarakhand & Aurangabad). He has honed his operations expertise in
managing Prem Dye Chem Industries (the family business) since the last 15
years in managing operating functions of Sales (Exports), Production (4
Units- 2 in Panvel & 2 in Vapi) & Finance.
•Mr. Premchand Choudhary, Mr. Poonamchand Choudhary, Mr. Balkrishan
Choudhary
(Age: Late 50s, Designation: Directors)
The elder members of the Choudhary family are members of the Board at
Microqual. They come from business backgrounds of running the family
enterprise (Prem DyeChem Industries Pvt. Ltd.) over the last 28 years. They
serve in mature guidance and prudent governance of the Company based on
values and practices established over time in the family businesses.
Mr. B.K Pandey
(Age: 59 yrs, Designation: Plant Head)
Plant head of rudrapur branch very rich work experience for last 30 years in
Auto Component manufacturing
COMPANY PROFILE COMPANY PROFILE
MICROQUAL TECHNO (P) LTD BASIC INTRODUCTION
Company Name MICROQUAL TECHNO (P)
LTD
Business Type Manufacturer
Product/Service Network communications,
communication cables, GPS
Company Address: 6, Amruth Nagar Main Road,
Konanakunte Cross, Bangalore,
Karnataka, India
No. of Total Employees: 101 - 500 People
Ownership & Capital
Year Established:
Legal Representative/Business
Owner:
1999
MAHESH CHOUDHARY
Trade & Market
Main Markets:
Total Annual Sales Volume:
Southeast Asia
Below US$1 Million
Factory Information
No. of R&D Staff:
Contract Manufacturing:
11 - 20 People
OEM Service Offered
Microqual Techno Pvt. Ltd. (Microqual / the Company) is a pioneer
in provisioning passive microwave components, services and solutions to
Mobile Telecom Operators and Telecom Equipment Manufacturers in India.
The company is a specialist in the design, manufacture and sales of
components, systems and services for wireless applications (GSM, CDMA,
WiMAx, etc). The company has a leading position in India in the market for
In-Building Solutions.
This Mumbai based company has been rated and awarded for being
the 7th fastest growing technology company in India (and 103rd in Asia) in
recent Deloitte Survey (early 2006). The CEO has also been nominated
recently (Oct 2006) for the top 10 fast a growth company executives survey.
With production facilities in Bangalore, the Company aggregates
components based wireless telecom solutions. These are of the nature of In-
building, Outdoor and Repeater site infrastructure solutions which are
aggregated using passive and active RF components viz. antennae, repeaters,
combiners, splitters, couplers, filters, duplexers, RF cables etc.
Against the backdrop of the massive RFPs of BSNL and Bharti
telecom, and towards addressing the opportunities in the Indian mobile
telecom market in general (aggregating to Rs.70 Bn over the next 3-5 yrs for
Microqual’s product markets), the Company intends to aggressively gear up
backend operations by –
–Setting up a 2nd manufacturing unit for passive components at
Uttarakhand, India
–Setting up an RF Cables manufacturing unit at Aurangabad, Maharashtra,
India
Post this expansion, the Company is expected to emerge as a clear
dominant player in the RF / Wireless infrastructure solutions space in India.
Towards financing the growth plan in this respect, and more
specifically with respective to setting up manufacturing facilities in
Maharashtra and Uttarakhand and towards meeting heightened working
capital requirements –
The Company intends to raise equity funds to the tune of USD 10
Million.
PROMOTERS & MANAGEMENT:
Promoted by Mr. Mahesh Choudhary and family, Microqual is a closely
held company actively managed by its promoters. The promoter family hail
from a background in manufacture and marketing of dyes & chemicals.
Strategic and tactical fronts are managed at the Company by Mr. Mahesh,
Mr. Varun and Mr. Sushil Choudhary. These three cousins run the company
hands on with shared responsibilities in the areas of business development,
manufacturing, sales & marketing and finances. At operating levels, the
Company is managed professionally by specialists in the areas of RF passive
components design and manufacturing.
Performance Highlights:
Ramping up from revenues of Rs. 25 Mn in 2003, Microqual has posted
impressive growth (CAGR of 93%) over three years and has closed FY 2006
with revenues of ~ Rs. 180 Mn. The Company has clocked revenues of
Rs.150 Mn for H12007 and is on track to deliver upwards of Rs. 350 Mn for
FY 2007.
The Company has been ranked - 7th fastest growing tech company in India
(and 103rd in Asia) by a recent Deloitte survey.
Clients:
Microqual has served and has strong relationships with nearly the entire
spectrum of mobile telcos in India. The company provisions its solutions by
joining hands with equipment manufacturers like Ericsson, Motorola, Nokia
et al that undertake O&M and / or network roll out services for or on behalf
of the Telcos. A representative list of clients includes–
Telcos:
Orange (Mumbai, Kolkata), Vodafone (Delhi, Bangalore, Kolkata, Chennai),
Airtel (Mumbai, Chennai, Bangalore, Bhopal, Cochin, Coimbatore), BPL
(Mumbai, Maharashtra), Tata Telecom (Mumbai), Shyam Telelink
(Rajasthan), Tata Cellular (Hyderabad), Spice Telecom (Punjab), RPG
Cellular / Aircel (Chennai), Idea (Delhi)
Telecom Equipment Manufacturers:
Erricson, Alcatel, Nortel, Nokia, Motorola
Investment Highlights
•Microqual’s growth story is interwoven with the explosive growth in
telecom in India. With wireless telecom (read: mobile services– GSM,
CDMA, WiMAX etc) leading the growth going forward, the company is
uniquely positioned to optimally exploit this immense market opportunity.
•
•The big opportunity in the immediate future is w.r.t to the public RFPs of
BSNL and Bharti telecom. Coupled with strong apex guidance from
Vodafone, Reliance telecom, Idea and other telcos, the mobile telecom
infrastructure spend over the next 3-5 yrs is anticipated to be the biggest ever
globally. Microqual management believes they are well positioned to garner
a significant portion of these spends which aggregate to over Rs.70 Bn for
the next 3-5 yrs (relating to product markets served by Microqual).
•
•Going ahead, the business plan of the Company looks at aggressively
ramping up revenues to around Rs.3.5 Bn in the next 3 years. Also, being
the sole domestic manufacturer of significant components of bundled
wireless solutions, the Company would swing significant clout in the Indian
market and is anticipated to emerge as a clear dominant player in this arena.
•
•Given Microqual’s strong relationships, firm entrenchment in the market
and proven execution capabilities the Company stands well heeled to
effectively meet the massive market demand coming up. This coupled with
its strategic growth initiatives which afford a clear and strong competitive
advantage; the Company is well poised to deliver superlative performance
with respect to its aggressive growth plans for the next 3-5 yrs.
SUPPLY CHAIN
The supply chain function at Microqual Techno Pvt. Ltd comprises
production planning, dispatch, warehousing and transportation. Since the
front end of the supply chain ends at the Clearing Forwarding Agent (CFA)
or the stockiest, production planning and dispatch is done to meet the
requirements of the CFA.
The entire supply chain has been knit together into an efficient unit
through “Project Garuda” —an initiative that integrates IT tools and
compensation schemes that measure the health of the supply chain. In this,
the first year of its implementation, Project Garuda lays down a set of
measurable parameters to test the health of the supply chain. The system is
divided into two tiers and puts in an evaluation mechanism for each element
of the supply chain from forecasting and production planning to inventory
management. By utilizing this matrix as a tool for monitoring penalizes
performance, the company has been able to devise a variable pay structure
that negative deviations. On the IT front, there is complete internal
networking through a new SAP platform. The company is exploring to move
forward and reach out to stockiest and integrate them into Dabur’s ERP.
This will go a long way to improve the quality of forecasts provided for
Production planning.
HUMAN RESOURCES
Recognizing that people are key constituents of Microqual Techno Pvt. Ltd
and represent the DNA of the organization, we have been constantly raising
our own standards of being an employee friendly organization. The year
under review witnessed a significant achievement: of being listed as a “Great
Place to Work”, in a survey conducted by Grow Talent & Company and
Great Place to Work Institute, USA. Microqual Techno Pvt. Ltd was listed
as the 10th “Great Place to Work”. The results were published in Business
World dated February2006.
INFORMATION TECHNOLOGY
As planned, the Company’s new SAP based ERP went live on 1 April 2006
across all its operations apart from those in Bangladesh, Nepal and Egypt.
Despite initial teething problems the system has been broadly stabilized. We
believe that SAP implementation would not only give the Company greater
operational flexibility and uniformity but also provide it the necessary tools
to make informed and timely strategic business decisions. Going forward,
the Company will be rolling out SAP to its businesses in Bangladesh, Nepal
and Egypt. In addition, and more importantly, it will also aim at leveraging
the entire gamut of enhanced benefits available in the new system.
RESEARCH AND DEVELOPMENT
Research and Development (R&D) provides Microqual Techno Pvt. Ltd
with critical edge in the market. The activities are focused around two basic
domains. First, to continuously develop new products; and second, to test
and guarantee their efficacy.
R&D activities include research on Ayurvedic and herbal products, organic
substances, photochemical, tissue culture, foods, cosmetics, oral care and
other personal care. During 2005-06, the company displayed its efficiencies
in terms of high “speed to market” by successfully developing its Vatika
Honey & Saffron soap. The entire development process from concept to
delivery in the market was carried out in-house and at very fast pace. The
company’s products regularly go through clinical research and toxicity
studies. This is done in collaboration with external organizations like the
Microqual Techno Pvt. Ltd Dhanwantry hospital in Chandigarh and a
number of other renowned institutions.
RISK MANAGEMENT
Microqual Techno Pvt. Ltd has a robust and well-structured risk
management system in place. The entire system is driven by its people and
the process goes deep down into lower layers of management. The Chief
Risk Officer (CRO) of the company, who is responsible for and ensures
Effective Risk Management — both risk identification and mitigation,
champions the risk management system. A team of risk officers at each
company location supports the CRO. Each employee is entitled to identify
risk and report it to the concerned risk officer who in turn reports it to the
CRO.
The risks are reported in the Risk Register and classified in
terms of their impact and probability of occurrence. The Risk Register is an
inventory of risks affecting Microqual Techno Pvt. Ltd covering its various
functions like marketing, operations, regulatory affairs, finance and human
resource development. The risks are further mapped in terms of mitigation
action to be taken and the people responsible for taking the actions. The Risk
Register is reviewed periodically by senior management and is presented to
the Audit Committee on a quarterly basis. While we have a systematic risk
identification and mitigation framework in place, there are certain business
risks, which are external and intrinsic to the company. Over these risks the
company has very little control.
Some of these include a general downturn in market demand
conditions, loss of value to the “ayurveda” equity due to false claims about
the product constitution or efficacy, look-alike products in the market,
escalation in raw material prices and changes in regulatory frameworks
pertaining to health related issues. In the past, all our transactional data was
stored in a central server at our corporate office in Ghaziabad, UP. One of
the important risk reduction initiatives taken during the year was setting up
of a disaster recovery site in Mumbai where all the data is stored as a back
up.
INTERNAL CONTROLS AND THEIR ADEQUACY
Microqual Techno Pvt. Ltd has a robust internal audit and control system
which is a process overseen by
the Board of Directors, management and other personnel, and provides
reasonable assurance regarding the effectiveness and efficiency of
operations, reliability of financial reporting, and compliance with applicable
laws and regulations.
Price Waterhouse Coopers is the internal auditor for the company and its
subsidiaries. The Company’s Internal Audit function is staffed with qualified
and experienced people. The Standard Operating Procedures (SOPs) put in
place by the company are in line with the best global practices, and have
been laid down across the process flows, along with authority controls for
each activity. Microqual Techno Pvt. Ltd has implemented the COSO
framework for internal controls and adequacy of internal audit. Under this
framework, various risks facing the company are identified and assessed
routinely across all levels and functions and suitable control activities are
designed to address and mitigate the significant risks.
CAUTIONARY STATEMENT
Statements in this management discussion and analysis describing the
Company’s objectives, projections, estimates and expectations may be
‘forward looking statements’ within the meaning of applicable laws and
regulations. Actual results may differ substantially or materially from those
expressed or implied. Important developments that could affect the
Company’s operations include a downward trend in the domestic FMCG
industry, rise in input costs, exchange rate fluctuations, and significant
changes in political and economic environment in India, environment
standards, tax laws, litigation and labor relations. In the segment wise
financials the overseas business is included therefore the financials as per
segment reporting above and those stated under the management discussion
of each business may differ to that extent.
MANAGEMENT DISCUSSION AND ANALYSIS
Annual Report has a detailed Chapter on Management Discussion and
Analysis which forms part of this report.
DISCLOSURES
Disclosures on materially significant related party transactions i.e.
transactions of the Company of material nature, with its promoters, the
Directors or the management, their subsidiaries or relatives, etc. that may
have potential conflict with the interests of the Company at large.
Dealings in Company’s shares on the part of persons in management
have been reported to Board periodically and whenever required to the Stock
Exchanges. The material, financial and commercial transactions where
persons in management have personal interest exclusively relate to
transactions involving Key Management Personnel forming part of the
disclosure on related parties referred to in Note in Schedule P to Annual
Accounts which was reported to Board of Directors.
CORPORATE GOVERNANCE
Good corporate governance and transparency in actions of the management
is key to a strong bond of trust with the Company’s stakeholders. Microqual
Techno Pvt. Ltd understands the importance of good governance and has
constantly avoided an arbitrary decision-making process. Our initiatives
towards this end include:
Professionalisation of the board
Lean and active Board(reduced from 16 to 10 members)
Less number of promoters on the Board
More professionals and independent Directors for better management
Governed through Board committees for Audit, Remuneration,
Shareholder Grievances, Compensation and Nominations
Meets all Corporate Governance Code requirements of SEBI
IT INITIATIVES
In Microqual Techno Pvt. Ltd knowledge and technology are key resources
which have helped the Company achieve higher levels of excellence and
efficiency. Towards this overall goal of technology-driven performance,
Microqual Techno Pvt. Ltd is utilizing Information Technology in a big
way. This will help in integrating a vast distribution system spread all over
India and across the world. It will also cut down costs and increase
profitability.
Migration from Baan and Mfg ERP Systems to centralized SAP ERP
system for all business units.
Implementation of a country wide new WAN Infrastructure for
running centralized ERP system.
Setting up of new Data Centre at KCO Head Office.
Extension of Reach System to distributors for capturing Secondary
Sales Data.
Roll out of IT services to new plants and CFAs.
Future Challenges
Forward Integration of SAP (system application and product database)
with Distributors and Stockiest.
Backward Integration of SAP with Suppliers.
Implementation of new POS system at Stockiest point and integration
with SAP-ERP.
Implementation of SAP HR and payroll.
SAP Roll-out to DNPL and other new businesses.
SAP is a part of ERP. There has been implementation of SAP (ECC-6.0
version) from Aug.08 to Jan.09. It majorly covers following areas:
PP- production planning
MM-material management
FICO-financial & controlling
SD-sales and distribution
Bank and cash entries, preparation of journals, preparing vendors are dealtin
FICO
WORKING CAPITAL MANAGEMENT
Working Capital is the money used to make goods and attract sales. The less
Working Capital used to attract sales, the higher is likely to be the return on
investment. Working Capital management is about the commercial and
financial aspects of Inventory, credit, purchasing, marketing, and royalty and
investment policy. The higher the profit margin, the lower is likely to be the
level of Working Capital tied up in creating and selling titles. The faster that
we create and sell the books the higher is likely to be the return on
investment.
Efficient management of working capital is extremely important to
any organisation. Holding too much working capital is inefficient, holding
too little is dangerous to the organisation's survival.Working capital is the
everyday term for what accountants call net current assets. The working
capital figure is the total of current assets minus the total of current
liabilities. The main current assets are stock, debtors and cash. The current
liabilities are creditors and accrued expenses. The key factor in the word
"Current" is that they are expected to turn into cash, or be paid from cash,
within twelve months.
As a general rule the organisation wants as little money tied up in
working capital as possible. However, there are always trade-offs. The
most obvious problem is running out of cash so you cannot pay the wages,
or being unable to provide a service because you have run out of a vital
resource: for example, a meals service being unable to produce the required
number of meals because they did not have enough foodstuffs in stock.
In order to assess whether you have a "safe" amount of working
capital there are two important calculations you can make:
The Current Ratio
The Current Ratio is the relationship between the total current assets and the
total current liabilities. Generally speaking a service organisation should
have about £1.25 current assets for every £1 of current liabilities. If there
are significant trading operations such as shops or mail order selling then the
ratio should be closer to £2 of current assests for every £1 of current
liabilities.
The Quick Ratio or "Acid Test"
The Quick Ratio is the relationship between the total of debtors and cash
compared with current liabilities. Generally the debtors and cash together
should approximately equal the current liabilities.
Working capital is the money you will need to keep your business going
until you can cover your operating costs out of revenue. As a small business
owner, it will be wise to have enough working capital on hand to cover items
such as the following during the first few months that you are in business:
Replacing inventory and raw materials:
You will need to fund the purchase of inventory out of working capital
until you start to see cash from sales, which could take months.
Paying employees:
Even the most loyal worker wants to get paid on time, regardless of how
much or how little cash your firm earns during its first months.
Paying yourself:
Unless you have made other arrangements, you will need to withdraw some
money to support yourself.
Debt payments:
If you have borrowed money to get started, you probably have to begin
repaying it right away. Missing your first loan payments will not do your
credit rating any good.
An emergency fund:
you need some cash on hand to cover unforeseen shortfalls that may result
from any number of factors such as delays in getting your space ready, a
slow paying client, or slow business.
A managerial accounting strategy focusing on
maintaining efficient levels of both components of working capital, current
assets and current liabilities, in respect to each other. Working capital
management ensures a company has sufficient cash flow in order to meet its
short-term debt obligations and operating expenses.
Implementing an effective working capital management system is an
excellent way for many companies to improve their earnings. The two main
aspects of working capital management are ratio analysis and management
of individual components of working capital.
A few key performance ratios of a working capital management system
are the working capital ratio, inventory turnover and the collection ratio.
Ratio analysis will lead management to identify areas of focus such as
inventory management, cash management, accounts receivable and payable
management.
SHORT-TERM WORKING CAPITAL FINANCING
Equity :
If your business is in its first year of operation and has not yet become
profitable, then you might have to rely on equity funds for short-term
working capital needs. These funds might be injected from your own
personal resources or from a family member, friend or third-party investor.
Trade Creditors :
If you have a particularly good relationship established with your trade
creditors, you might be able to solicit their help in providing short-term
working capital. If you have paid on time in the past, a trade creditor may be
willing to extend terms to enable you to meet a big order. For instance, if
you receive a big order that you can fulfill, ship out and collect in 60 days,
you could obtain 60-day terms from your supplier if 30-day terms are
normally given. The trade creditor will want proof of the order and may
want to file a lien on it as security, but if it enables you to proceed, that
should not be a problem.
Factoring :
Factoring is another resource for short-term working capital financing. Once
you have filled an order, a factoring company buys your account receivable
and then handles the collection. This type of financing is more expensive
than conventional bank financing but is often used by new businesses.
Line of credit :
Lines of credit are not often given by banks to new businesses. However, if
your new business is well-capitalized by equity and you have good
collateral, your business might qualify for one. A line of credit allows you to
borrow funds for short-term needs when they arise. The funds are repaid
once you collect the accounts receivable that resulted from the short-term
sales peak. Lines of credit typically are made for one year at a time and are
expected to be paid off for 30 to 60 consecutive days sometime during the
year to ensure that the funds are used for short-term needs only.
Short-term loan :
While your new business may not qualify for a line of credit from a bank,
you might have success in obtaining a one-time short-term loan (less than a
year) to finance your temporary working capital needs. If you have
established a good banking relationship with a banker, he or she might be
willing to provide a short-term note for one order or for a seasonal inventory
and/or accounts receivable buildup.
LONG-TERM WORKING CAPITAL FINANCING
Bonds:
These debt securities are promises made by the issuing company to pay the
principal when due and to make timely interest payments on the unpaid
balance.
Long-term loan:
Commercial banks make loans to borrowers who can repay the principal
with interest, and they will often require collateral for upwards of 85 - 90
percent of the loan value. You will need to demonstrate a track record of
sales revenues to justify your ability to make periodic installments.
Unfortunately, as a small business or start up, your fledgling business idea
probably doesn't have either the sufficient assets or customer base to warrant
serious consideration for a bank loan.
IMPORTANCE OF GOODWORKING CAPITAL
MANAGEMENT
Availability of Raw Material Regularly
Full Utilization of Fixed Assets.
Increase in Credit Rating.
Advantage of Favorable Business Opportunity.
Facilitates the distribution of Dividend.
Facility to Obtaining Bank Loan.
Increase in Efficiency of Management.
Meeting unseen contingencies.
FACTORS AFFECTING WORKING
CAPITAL
Nature of Business
Size of Business
Growth & Expansion plan of Company
Business Fluctuations
Credit Policy relating to Sales
Credit Policy relating ti Purchase
Availability of Raw Material
Availability of Credit from Banks.
Level of taxes
Dividend & depreciation policy
Efficiency of Management
APPROACHES TO WORKING CAPITAL
MANAGEMENT
The objective of working capital management is to maintain the optimum
balance of each of the working capital components. This includes making
sure that funds are held as cash in bank deposits for as long as and in the
largest amounts possible, thereby maximizing the interest earned. However,
such cash may more appropriately be "invested" in other assets or in
reducing other liabilities.
Working capital management takes place on two levels:
Ratio analysis can be used to monitor overall trends in working capital
and to identify areas requiring closer management (see Chapter Three).
The individual components of working capital can be effectively
managed by using various techniques and strategies (see Chapter Four).
When considering these techniques and strategies, departments need to
recognize that each department has a unique mix of working capital
components. The emphasis that needs to be placed on each component
varies according to department. For example, some departments have
significant inventory levels; others have little if any inventory.
Furthermore, working capital management is not an end in itself. It is
an integral part of the department's overall management. The needs of
efficient working capital management must be considered in relation to other
aspects of the department's financial and non-financial performance.
Working Capital Management Manages Flow of Funds
Liquidity to Meet Day-to-Day Expenses and Liabilities is the Goal
Working capital is the cash needed to carry on operations during cash
conversion cycle, i.e. the days form paying for raw material to collecting
cash form customer.
Raw materials and operating supplies must be bought and stored to ensure
uninterrupted production. Wages, salaries, utility charges and other
incidentals must be paid for converting the materials into finished products.
Customers must be allowed a credit period that is standard in the business.
Only at the end of this cycle does cash flow in again.
Working Capital Management Approach
Working capital management involves:
Ratio Analysis:
Ratios such as Working Capital Ratio, Inventory Turnover Ratio and
Receivables Collection Ratio can focus attention on problem areas for
management action
Managing Different Components:
Specific solutions are available to manage the individual components
of working capital such as inventory, receivables, cash and financing
Managing Working Capital Components
Management of associated cash inflows and outflows is the basic aim of
managing each of the components. Selected solutions must result in
acceptable cash flows, and also produce a return in excess of costs.
Inventory Management: Inventories of materials are needed to ensure
smooth flow of production. Inventories need money to buy, space to store
and wages to handle. On the other hand, if you purchase too low quantities,
the frequency of orders and incidental material handling costs go up. So you
have to identify an economic order quantity that balances the costs.
Solutions such as SCM and Just in Time procurement have also been
developed to manage inventories.
Receivables Management:
Giving credit has become a standard business practice and it means that
collection of cash from customers has to be postponed. Offering discounts to
customers who pay promptly (within 10 days, for example) and accounts
receivable funding through factoring operations are some important ways to
manage receivables.
Cash Management:
Cash in the till does not earn any income. On the other hand it can help:
To exploit opportunities for short-term profitable deployment,
Meet maturing liabilities if expected inflows do not materialize and
Ensure uninterrupted completion of day-to-day transactions.
Considering these factors, policies are developed for the amount of cash
balance to be maintained at all times.
Short-Term Financing: Supplier credit is a significant source of working
capital finance. You can buy raw materials and use it for 60 or so days
before paying for it. During this period you might be able to produce and sell
products, and generate funds to pay the supplier in part. The factoring
operations mentioned earlier can generate additional funds. Any remaining
shortfall is typically financed with short-term bank loans or lines of credit
(where you draw funds only if and when needed).
Cash Flow Forecasts: Cash flow forecasts are prepared to estimate cash
outflows and inflows, and identify the timing and extent of shortfalls in
funds availability. Based on these estimates, bank finance or other funding
options can be arranged in time.
Working capital is distinct from fixed capital in that it is short-term in
nature. There is no long-term commitment of funds. As against this, even a
short-term liquidity problem can affect the profitability of the business. If
the liquidity problem persists, the very survival of the business can be in
danger. This is why working capital management has become a critical
function.
OPERATING CASH FLOW
It is the lifeblood of a company and the most important barometer that
investors have. For two main reasons, operating cash flow is a better metric
of a company's financial health than net income. First, cash flow is harder to
manipulate under GAAP than net income (although it can be done to a
certain degree). Second, 'cash is king' and a company that does not generate
cash over the longterm is on its deathbed.
By operating cash flow I don't mean EBITDA (earnings before
interest taxes depreciation and amortization). While EBITDA is sometimes
called "cash flow", it is really earnings before the effects of financing and
capital investment decisions. It does not capture the changes in working
capital (inventories, receivables, etc.). The real operating cash flow is the
number derived in the statement of cash flows.
Overview of the Statement of Cash Flows:
The statement of cash flows for non-financial companies consists of three
main parts:
Operating flows - The net cash generated from operations (net income
and changes in working capital).
Investing flows - The net result of capital expenditures, investments,
acquisitions, etc.
Financing flows - The net result of raising cash to fund the other flows
or repaying debt.
By taking net income and making adjustments to reflect changes in the
working capital accounts on the balance sheet (receivables, payables,
inventories) and other current accounts, the operating cash flow section
shows how cash was generated during the period. It is this translation
process from accrual accounting to cash accounting that makes the operating
cash flow statement so important.
ACCRUAL ACCOUNTING VS. CASH FLOWS :
The key differences between accrual accounting and real cash flow are
demonstrated by the concept of the cash cycle. A company's cash cycle is
the process that converts sales (based upon accrual accounting) into cash as
follows:
Cash is used to make inventory.
Inventory is sold and converted into accounts receivables (because
customers are given 30 days to pay).
Cash is received when the customer pays (which also reduces
receivables).
There are many ways that cash from legitimate sales can get trapped on the
balance sheet. The two most common are for customers to delay payment
(resulting in a build up of receivables) and for inventory levels to rise
because the product is not selling or is being returned.
WORKING CAPITAL TURNOVER
A measurement comparing the depletion of working capital to the generation
of sales over a given period. This provides some useful information as to
how effectively a company is using its working capital to generate sales.
A company uses working capital (current assets - current liabilities) to fund
operations and purchase inventory. These operations and inventory are then
converted into sales revenue for the company. The working capital turnover
ratio is used to analyze the relationship between the money used to fund
operations and the sales generated from these operations. In a general sense,
the higher the working capital turnover, the better because it means that the
company is generating a lot of sales compared to the money it uses to fund
the sales.
WORKING CAPITAL LOAN
Definition
A short-term loan which provides money to buy earning assets.
A loan whose purpose is to finance everyday operations of a company.
A working capital loan is not used to buy long term assets or investments.
Instead it's used to clear up accounts payable, wages, etc.
Working capital loan funds provide your business the cash it needs to keep
growing until you can cover all operating expenses out of revenue. Without
a working capital loan most businesses are unable to generate enough
revenue to stay afloat. These funds provide access to cash which can be used
to pay rent or mortgage payments, utilities, marketing expenses, inventory,
employees, etc. Obtaining capital through this method can be difficult for
many businesses, so it is essential to have good business credit scores
established.
Building solid business credit scores are the key to obtaining
substantial working capital loan funds that can be used to grow your
business. Not all types of working capital require business credit history, but
it is important to have that in place. Lenders use your business credit scores
just like they use personal credit scores when evaluating whether you are
worthy of receiving capital. Making sure that your lines of credit help build
your credit will put you in the right direction to getting the loans that your
business needs to succeed.
There are five common types of a working capital loan. They include:
Equity:
Obtained from personal resources like equity in your house, funds from
friends or family members, or from angel investors.
Trade Creditor:
A trade creditor will extend a loan to you so you can purchase a large
quantity from their place of business. They will often check your business
credit history before extending credit to you.
Factoring/Advances:
You can sell future credit card receipts for instant capital if your business
accepts credit cards. Another option is to sell your accounts receivable to a
factoring company who handles the collection.
Line of Credit:
Your business can apply for a bank line of credit, giving you the ability to
borrow for short term needs. Good business credit scores will assist with
your approval for a line of credit.
Short term loan:
A bank can also extend credit to allow you to purchase inventory for a
season. This note will typically be less than a year. Again, good established
business credit scores will nearly guarantee access to this kind of funding.
INVENTORY MANAGEMENT
Inventories are lists of stocks-raw materials, work in progress or finished
goods-waiting to be consumed in production or to be sold.
The total balance of inventory is the sum of the value of each individual
stock line. Stock records are needed:
to provide an account of activity within each stock line;
As evidence to support the balances used in financial reports.
A department also needs a system of internal controls to efficiently manage
stocks and to ensure that stock records provide reliable information.
Departmental financial reports show only the total inventory balance.
Analysts from outside the department can examine this balance by using
ratio analysis or other techniques. However, this gives only a limited
assessment of inventory management and is not adequate for internal
management. Good financial management necessitates the careful analysis
of individual inventory lines.
Inventory management is an important aspect of working capital
management because inventories themselves do not earn any revenue.
Holding either too little or too much inventory incurs costs.
Costs of carrying too much inventory are:
opportunity cost of foregone interest;
warehousing costs;
damage and pilferage;
obsolescence;
Insurance.
Costs of carrying too little inventory are:
stock out costs:
- Lost sales;
- delayed service.
ordering costs:
- Freight;
- order administration;
- loss of quantity discounts.
Carrying costs can be minimized by making frequent small orders but
these increases ordering costs and the risk of stock-outs. Risk of stock-outs
can be reduced by carrying "safety stocks" (at a cost) and re-ordering ahead
of time.
The best ordering strategy requires balancing the various cost factors
to ensure the department incurs minimum inventory costs. The optimum
inventory position is known as the Economic Reorder Quantity (ERQ).
There are a number of mathematical models (of varying complexity) for
calculating ERQ. (Any standard accounting text will provide examples of
these).
Analytical review of inventories can help to identify areas where
inventory management can be improved. Slow moving items, continual
stock outs, obsolescence, stock reconciliation problems and excess spoilage
are signals that stock lines need closer analysis and control.
However, it is important to keep an overall perspective. It is not
cost-effective to closely manage a large number of low value inventory
lines, nor is it necessary. A usual feature of inventories is that a small
number of high value lines account for a large proportion of inventory value.
The "80/20" rule (PARETO) predicts that 80% of the total value of
inventory is represented by only 20% of the number of inventory items.
Those high value lines need reasonably close management. The remaining
80% of inventory lines can be managed using "broad-brush" strategies.
The overall management philosophy of an organization can affect
the way in which inventory is managed. For example, "Just In Time" (JIT)
production management organizes production so that finished goods are not
produced until the customer needs them (minimizing finished goods
carrying costs), and raw materials are not accepted from suppliers until they
are needed. (Large organizations have the power to insist that suppliers hold
stocks of raw materials and thereby pass the carrying cost back to the
supplier). Thus, JIT inventory strategies reduce bottlenecks and stock
holding costs.
In summary:
There is a trade-off to be made between carrying costs, ordering costs,
and stock out costs. This is represented in the Economic Reorder Quantity
(ERQ) model.
Inventories should be managed on a line-by-line basis using the 80/20
rule.
Analytical review can help to focus attention on critical areas.
Inventory management is part of the overall management strategy.
KEY WORKING CAPITAL RATIOS
A ratio used to measure a company's ability to recover operating costs from
annual revenue. This ratio is calculated by taking the company's total annual
expenses (excluding depreciation and debt-related expenses) and dividing it
by the annual gross income:
The following, easily calculated, ratios are important measures of working
capital utilization
.
Ratio Formulae Result Interpretation
Stock Turnover
(in days)
Average Stock *
365/
Cost of Goods Sold
= x days On average, you turn over 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.
Receiv
ables
Ratio
(in days)
Receivables
Ratio
(in days)
Debtors * 365/
Sales
= x days It take you on average x days to collect
monies due to you. If your 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
= x times Current Assets are assets that you can
reay turn in to cash or will do so within
12 months in the course of business.
Liabilities 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 times 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 - Inventory)/
Total Current
Liabilities
= x times Similar to the Current Ratio but takes
account of the fact that it may take time
to convert inventory 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.
HANDLING RECEIVABLES (DEBTORS)
Debtors (Accounts Receivable) are customers who have not yet made
payment for goods or services which the department has provided.
The objective of debtor management is to minimize the time-lapse between
completion of sales and receipt of payment. The costs of having debtors are:
opportunity costs (cash is not available for other purposes);
Bad debts.
Debtor management includes both pre-sale and debt collection
strategies.Pre-sale strategies include:
offering cash discounts for early payment and/or imposing penalties
for late payment;
agreeing payment terms in advance;
requiring cash before delivery;
setting credit limits;
setting criteria for obtaining credit;
billing as early as possible;
Requiring deposits and/or progress payments.
Post-sale strategies include:
Placing the responsibility for collecting the debt upon the center that
made the sale;
Identifying long overdue balances and doubtful debts by regular
analytical reviews;
Having an established procedure for late collections, such as
- a reminder;
- a letter;
- cancellation of further credit;
- telephone calls;
- use of a collection agency;
- legal action.
MANAGING PAYABLES (CREDITORS)
Creditors (Accounts Payable) are suppliers whose invoices for goods or
services have been processed but who have not yet been paid.
Organizations often regard the amount owing to creditors as a source
of free credit. However, creditor administration systems are expensive and
time-consuming to run. The over-riding concern in this area should be to
minimized costs with simple procedures.
While it is unnecessary to pay accounts before they fall due, it is
usually not worthwhile to delay all payments until the latest possible date.,
Regular weekly or fortnightly payment of all due accounts is the simplest
technique for creditor management.
Electronic payments (direct credits) are cheaper than cheque payments,
considering that transaction fees and overheads more than balance the
advantage of delayed presentation. Some suppliers are reluctant to receive
payments by this method, but in view of the substantial cost advantage (and
the advantages to the suppliers themselves) departments may wish to
encourage suppliers to accept this option. However, electronic payments are
likely to be used in conjunction with, rather than as a replacement for,
cheque payments.
CASH AND BANK
Good cash management can have a major impact on overall working capital
management.
The key elements of cash management are:
cash forecasting;
balance management;
administration;
Internal control.
Cash Forecasting.
Good cash management requires regular forecasts. In order for these to be
materially accurate, they must be based on information provided by those
managers responsible for the amounts and timing of expenditure. Capital
expenditure and operating expenditure must be taken into account. It is also
necessary to collect information about impending cash transactions from
other financial systems, such as creditors and payroll.
Balance Management.
Those responsible for balance management must make decisions about how
much cash should at any time be on call in the Departmental Bank Account
and how much should be on term deposit at the various terms available.
There are various types of mathematical model that can be used. One type is
analogous to the ERQ inventory model. Linear programming models have
been developed for cash management, subject to certain constraints. There
are also more sophisticated techniques.
Administration .
Cash receipts should be processed and banked as quickly as possible
because:
They cannot earn interest or reduce overdraft until they are banked;
Information about the existence and amounts of cash receipts is
usually not available until they are processed.
Where possible, cash floats (mainly petty cash and advances) should be
avoided. If, on review, the only reason that can be put forward for their
existence is that "we've always had them", they should be discontinued.
There may be situations where they are useful, however. For example, it
may be desirable for peripheral parts of departments to meet urgent local
needs from cash floats rather than local bank accounts.
Internal Control.
Cash and cash management is part of a department's overall internal control
system. The main internal cash control is invariably the bank reconciliation.
This provides assurance that the cash balances recorded in the accounting
systems are consistent with the actual bank balances. It requires regular
clearing of reconciling items.
OTHER COMPONENTS
Working capital, defined as the difference between current assets and current
liabilities, may also include the following factors:
prepayments to creditors;
current portions of long-term liabilities;
revenue received before it has been earned;
Provisions.
IMPORTANCE OF CASH FLOW
When planning the short- or long-term funding requirements of a business, it
is more important to forecast the likely cash requirements than to project
profitability etc. Whilst profit, the difference between sales and costs within
a specified period, is a vital indicator of the performance of a business, the
generation of a profit does not necessarily guarantee its development, or
even the survival.
CASH FLOW VS PROFIT
Sales and costs and, therefore, profits do not necessarily coincide with their
associated cash inflows and outflows. While, a sale may have been secured
and goods delivered, the related payment may be deferred as a result of
giving credit to the customer. At the same time, payments must be made to
suppliers, staff etc., cash must be invested in rebuilding depleted stocks, new
equipment may have to be purchased etc.
The net result is that cash receipts often lag cash payments and, whilst
profits may be reported, the business may experience a short-term cash
shortfall. For this reason it is essential to forecast cash flows as well as
project likely profits.
CALCULATING CASHFLOW
Normally, the main sources of cash inflows to a business are receipts from
sales, increases in bank loans, proceeds of share issues and asset disposals,
and other income such as interest earned. Cash outflows include payments to
suppliers and staff, capital and interest repayments for loans, dividends,
taxation and capital expenditure.
Net cash flow is the difference between the inflows and outflows
within a given period. A projected cumulative positive net cash flow over
several periods highlights the capacity of a business to generate surplus cash
and, conversely, a cumulative negative cash flow indicates the amount of
additional cash required to sustain the business.
Cash flow planning entails forecasting and tabulating all
significant cash inflows relating to sales, new loans, interest received etc.
and then analyzing in detail the timing of expected payments relating to
suppliers, wages, other expenses, capital expenditure, loan repayments,
dividends, tax, interest payments etc. The difference between the cash in-
and out-flows within a given period indicates the net cash flow. When this
net cash flow is added to or subtracted from opening bank balances, any
likely short-term bank funding requirements can be ascertained.
PLANNING TO PROJECT CASHFLOW
Before using a model for short-term cash flow forecasting, a manager or
entrepreneur should:
Decide the central purpose of the exercise (internal planning and
control, negotiate a loan etc.).
Identify the target audience (directors, bank manager etc.)
Set the time intervals and horizon (e.g. monthly for twelve months)
Sort out the level of detail required.
Check that all the necessary key assumptions and data are to hand and
have been adequately researched.
Compile opening balances for all items which will involve cash flows
within the forecasting period.
OBJECTIVES OF CASH FLOW
Useful for Short - term financial planning.
Useful for preparing the Cash Budget.
Comparison with the Cash Budget.
Study of the Trends of Cash Receipts & Payments.
It Explains the Deviation of Cash from Earnings.
Helpful in making Dividend Decisions.
CASH INFLOW
2007-08
Gross Cash Accrual 44507811.71
Share Capital & Share
Premium 0.00
Term Loan 3.63
Cash Credit 281224.92
Increase in Creditors 152205.05
Increase in Provisions 2885749.83
SUB-TOTAL (A) 47826995.13
CASH OUTFLOW
Increase in Fixed Assets 149.44
Pre-operative Expenditure 0.00
Repayment of Cash Credit 210918.69
Repayment of Term Loan 1.15
Increase in Inventories 55809.35
Increase in Debtors 14231091.81
SUB-TOTAL (B) 14497970.44
Opening Bal. 650.00
Surplus/(Deficit) 33329024.69
Closing Bal. 33329674.69
WAYS OF IMPROVING CASH FLOW
30+ Ways of Improving Net Cash flow
1. Increase sales (particularly those involving cash payments).
2. Reduce direct and indirect costs and overhead expenses.
3. Defer discretionary projects which cannot achieve acceptable cash
paybacks (e.g. within one year).
4. Increase prices especially to slow payers.
5. Review the payment performances of customers - involve sales force.
6. Become more selective when granting credit.
7. Seek deposits or multiple stage payments.
8. Reduce the amount/time of credit given to customers.
9. Bill as soon as work has been done or order fulfilled.
10.Improve systems for billing and collection.
11.Use the 80/20 rule to control inventories, receivables and payables.
12.Improve systems for paying suppliers.
13.Generate regular reports on receivable ratios and aging.
14.Establish and adhere to sound credit practices - train staff.
15.Use more pro-active collection techniques.
16.Add late payment charges or fees where possible.
17.Increase the credit taken from suppliers.
18.Negotiate extended credit from suppliers.
19.Make prompt payments only when worthwhile discounts apply.
20.Reduce inventory (stock) levels and improve control over work-in-
progress.
21.Sell off or return obsolete/excess inventory.
22.Utilize factoring, or discount facilities, to accelerate receipts from
sales.
23.Defer or re-stage all capital expenditure.
24.Use alternative financing methods, such as leasing, to gain access to
the use (but not ownership) of productive assets.
25.Re-negotiate bank facilities to reduce charges.
26.Seek to extend debt repayment periods.
27.Net off or consolidate bank balances.
28.Sell off surplus assets or make them productive.
29.Enter into sale and lease-back arrangements for productive assets.
30.Defer dividend payments.
31.Raise additional equity.
32.Convert debt into equity.
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.
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. 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.
IF YOU… THEN…
Collect receivable (debtors)
faster
You release cash
from the cycle
Collect receivable(debtors)
slower
Your receivables
soak up cash
Get better credit (in terms
of cash duration or
amount) from suppliers
You increase your cash
resources
Shift inventory (stock)
faster
You free up cash
Move inventory(stock)
slower
You consume more
cash
Sources of Additional Working Capital
Sources of additional working capital include the following:
Existing cash reserves
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
RATIO ANALYSIS
Ratio analysis measures the profitability, efficiency and financial soundness of the businesses. The relationships between tow facts i.e., gross profit and sales or current assets and current liabilities is studied and the result is presented in the form of simple ratios
Ratio analysis is a “study of relationship among the various financial factors in a business”
The technique of ratio analysis can be employed for measuring short-term
liquidity or working capital position of a firm. The following ratios can be
calculated for these purposes: The following ratios can be calculated for
these purposes:
Profitability ratios:
Gross profit ratioNet profitExpenses ratioReturn on investment or capital employedReturn on equity capitalEarning per share
Activity or performance or turnover ratios:
Stock or inventory turnover ratio
Total capital turnover ratios
Working capital turnover ratio
Fixed assets turnover ratio
Debtor’s turnover ratio
Creditor’s turnover ratio
Stock or inventory turnover ratio
Financial ratios:
a) Liquidity ratio shorterm financial or solvency ratiosi) Current ratioii) Liquidity ratio
b) Solvency ratios or longterm financial ratios:i) Debt equity ratio
i) Interest coverage or debt service ratioii) Fixed assets ratio
b) Proprietary ratioc) Solvency ratio d) Capital gearing ratio.e) Liquidity ratio shorterm financial or solvency ratios
i) Current ratioii) Liquidity ratio
f) Solvency ratios or long term financial ratios:i) Debt equity ratioii) Total debt ratioiii) Interest coverage or debt service ratioiv) Fixed assets ratio
g) Proprietary ratioh) Solvency ratio i) Capital gearing ratio.
DATA ANALYSIS
MICROQUAL TECHNO PVT LTD. RUDRAPUR (2007-2008) Ratio analysis 1-Apr-2007 to 31 march-2008
Principal Group Amount Particular Ratios
Working capital (current assets – current liabilities)
32196383.85(Dr) Current ratio(current assets - current liabilities)
1.52:1
Cash-in-hand 23555.85(Dr) Quick Ratio(current assets-stock-in-hand: current liabilities)
0.76:1
Bank account 534070.45(Dr) Debt/equity ratio :1
Sundry debtors 48464242.99(Dr)Gross profit % 39.05%
Sundry creditors 34015783.43(Cr) Net profit % 31.88%
Sales account 213670539.71(Cr)
Operating cost %(as percentage of sale account)
68.12%
Purchase account 169938927.97 Recv. Turnover in days
82.27 days
100.00%
Stock-in-hand 47221613.47(Dr) Return on investment %(net profit/ capital account +net profit)%
Net profit 68118029.71(Cr) Return on working capital %(net profit / working capital)%
211.57%
Working capital turnover (sale account / working capital
6.46
Inventory turnover (sales account / closing stock)
4.52
MICROQUAL TECHNO PVT LTD. RUDRAPUR (2008-2009) Ratio analysis 1-Apr-2008 to 31 march-2009
Principal Group Amount Particular Ratios
Working capital (current assets – current liabilities)
65671484.27(Dr) Current ratio(current assets - current liabilities)
29.92:1
Cash-in-hand 18141.82(Dr) Quick Ratio(current assets-stock-in-hand: current
29.92:1
liabilities)
Bank account 426261.56(Dr) Debt/equity ratio :1
Sundry debtors 51151549.65(Dr)Gross profit % 25.62%
Sundry creditors 15833562.18(Cr) Net profit % 18.23%
Sales account 210663321.18(Cr) Operating cost %(as percentage of sale account)
81.77%
Purchase account 144045544.59(Dr) Recv. Turnover in days
81.84days
Stock-in-hand Return on investment %(net profit/ capital account +net profit)%
100.00%
Net profit 38400954.94(Cr) Return on working capital %(net profit / working capital)%
58.47%
Working capital turnover (sale account / working capital
3.21
Inventory turnover (sales account / closing stock)
0.00
DEBTORS TURNOVER RATIO:
(RS. IN LACS)
Year 2008 2009
Sales 2136.70 2106.63
Average Debtors 484.64 511.51
Debtor Turnover Ratio 4.40 times 4.22times
Interpretation:
This ratio indicates the speed with which debtors are being converted or
turnover into sales. The higher the values or turnover into sales. The higher
the values of debtors turnover, the more efficient is the management of
credit. But in the company the debtor turnover ratio is decreasing year to
year. This shows that company is not utilizing its debtor’s efficiency. Now
their credit policy becomes liberal as compare to previous year.
INVENTORY TURNOVER:
(Rs. In lacs)
Year 2007-2008 2008-2009
Inventory 4.52 0.00
Interpretation:
This ratio establishes the relationship between costs of goods sold
and average stock and reflects the speed to turning over the stock
into sales. In 2008 the company has higher inventory turnover ratio as
compare to 2009 year. This shows that the company’s inventory
management technique is efficient in 2008.
CURRENT RATIO:
Year 2007-2008 2008-2009
Current Ratio 1.52 29.92
INTERPRETATION
A current ratio of 2:1 is considered as ideal i.e. if C.R. is 2 or more it means
that the concern has the ability to meet current obligations. Here the C.R. in
2008 is 1.52 which less than 2 it indicates that the concern has difficulty in
meeting its current obligations, but in 2009 it is 29.92 means short term
financial position is sound in enterprise.. Increase in current ratio shows
the liquidity soundness of company.
Conclusion:
The current ratio of the company in 2008 is 1.52:1 which is less than 2:1, hence the short term solvency of the is not favorable, but in 2009 it is 29.92 which is much more than idle ratio and hence the short term solvency is favorable.
QUICK RATIO:
(Rs. in lacs)
Year 2007-2008 2008-2009
QUICK RATIO: 0.76 29.92
Interpretation :
The Quick ratio shows the liquidity position of the firm. Generally a quick ratio of 1:1 is considered ideal.
Although the quick ratio is more penetrating test of liquidity than the C.R,
yet it should be used more cautiouslyQuick ratio shows company short term
debts pay to outsiders. In 2009 the current liabilities of the company
increased. But still increase in current assets are more than its current
liabilities.
Conclusion:
Here the quick ratio in2008 is 0.76:1, which is less than the ideal quick ratio
1:1, which shows that the short term solvency of the company is not proper,
but in 2009 the ratio is 29.92 which is much greater then ideal quick ratio,
which shows that the short term solvency of the company is good
Generally the quick ratio is more reliable than C.R. now we conclude that
the short term solvency the company is sound in 2009.
WOKRING CAPTIAL TURNOVER :
Year 2007-2008 2008-2009
Working Capital Turnover 6.64 3.21
Interpretation:
This ratio measures the relationship between working capital and sale. The
ratio shows the number of times the working capital results, in sales. This
ratio must be normal. Excess ratio shows overtrading and lower ratio shoes
under trading. Both the situations of overtrading and under trading show the
weaknesses of the enterprise. It indicates how much net working capital
requires for sales. In 2008, the reciprocal of this ratio (1/6.64 = .15) shows
that for sales of Rs. 1 the company requires .15 paisa as working capital
whereas in 2009 the reciprocal of this ratio (1/3.21= .31) shows that for sale
of Rs. 1 the company requires 31 paisa as working capital. Thus this ratio is
helpful to forecast the working capital requirement on the basis of sale.
GROSS PROFIT RATIO:
Year 2007-2008 2008-2009
GROSS PROFIT RATIO 39.05% 25.62%
INTERPRETATION
The high gross profit margin ratio is a symbol of good management if the actual gross profit ratio is lower than the expectations than it provides that the profit in the business is not sufficient in comparison to sales this situation is not healthy for the business. Hence a low gross profit margin ratio should be carefully investigated. The reasons for this may be higher cost of production inefficient utilization of plant and machinery etc.
Conclusion:
Here the gross profit ratio in year 2008 is 39.05% depicts that the company is working efficiently and carries a sound management but in 2009 it is just 25.62 which is less than 2008, there is no ideal standard measure for gross profit ratio but it should be sufficient to cover the selling price expenses of the firm.
NET PROFIT RATIO:
YEAR 2007-2008 2008-2009
NET PROFIT RATIO 31.88% 18.23%
INTERPRETATION
Net profit ratio is the symbol of profitability and efficiency of the business. Decrease in the ratio indicates managerial inefficiency and excessive selling and distribution expenses. in the same way increase shows better performance..
Conclusion
Here the ratio in 2008 is 31.88 and in 2009 it is 18.23 it shows that the performance of the management decreased. net profit of 31.88% is quiet satisfactory but 18.23 is not as compare to 2008.the management have to find out causes for the decline in the net profit be made and corrective action should be taken to remove the causes responsible for the fall in the net profit ratio.
CASH BANK BALANCE:
(Rs. In lacs)
Year 2007-2008 2008-2009
Cash Bank Balance 5.57 4.44
Interpretation :
Cash is basic input or component of working capital. Cash is needed to keep the business running on a continuous basis. So the organization should have sufficient cash to meet various requirements. The above graph is indicate that in 2008 the cash is 5.57 lac but in 2009 it has decreased to 4.44 lac
DEBTORS:
(Rs. In lacs)
Year 2007-2008 2008-2009
DEBTORS 484.64 511.51
Interpretation:
Debtors constitute a substantial portion of total current assets. In India it constitute one third of current assets. The above graph is depicting that there is increase in debtors. It represents an extension of credit to customers. The reason for increasing credit is competition and company liberal credit policy
FINDINGS
An increase in the current ratio indicates that the company is strengthening its liquidity position. As the company current ratio is increasing rapidly and it is much greater than the conventional norm (2:1) but it is prolific for the Company to maintain an optimum level of liquidity to earn a maximum Return on investment.
The net profit of the company decreasing year to year this means management need to take corrective action to remove the causes responsible for the fall in the net profit ratio.
During the study period, the liquid ratio is found fluctuating every
year. Company’s quick ratio is less than ideal ratio (1:1) in previous year which indicate that company had liquidity problem but in Current year company has no liquidity problem because it is much more than an ideal ratio.
The company working capital turnover ratio is decreasing which indicates that the company is not using its working capital efficiently.
The number of debtors of the company increasing, this shows the increasing credit is competition and company liberal credit policy
The company debtor turnover ratio is decreasing year to year. This
shows that company is not utilizing its debtors efficiently. Now their
credit policy becomes liberal as compare to previous year.
SUGGESTIONS
On the basis of the analyses few suggestion are as follows:
The company is a profit seeking one; it has to commit all of its resources to achieve its goal as it is trying to enhance the value of its own and thereby to its shareholders. To achieve this, profitability, liquidity and solvency position are crucial elements to be monitored carefully, thereby the trade off can be reached.
Overall performance and effectiveness of the firm are satisfactory but the company has to make effective working capital management. The company should concentrate on working capital management and it should be managed effectively and reviewed periodically and thereby optimum Utilization of fixed assets is possible.
Company should also take finite steps to:
1) Improve operational efficiency by way of increase in production and reduction in consumptions like power, raw material, packing material, stores & spaces etc.
2) Drastically reduce operational capital expenditure.3) Defer non-essential capacity expenditure and capacity expansion.4) Put on hold any plans for acquisitions unless considered strategically
critical.5) Reduce unproductive expenditure/ overheads like telephone,
travelling expenditures.6) Reduce the repairs and maintenance expenditure, building repairs and
machinery repairs etc. 7) Defer non essential capital expenditure.
8) The entire inventory like raw material, stores & spares, packing material, chemicals, felt; wire etc. to be reduced kept at minimum level.
10) Sales department must see that finished goods stock is kept at minimum
CONCLUSION
Working capital plays an important role in a business enterprise it should be at optimal level and to maintain this level, efficient management and control is needed. Each of the components of the working capital needs proper management to optimize profit.
The study reveals that the liquidity position of this company is comparatively good in year 2008-09 as compare to previous years.
The ratios reveal that the company’s ability in managing the current assets is found inadequate which require generation of more sales. On the whole, it can be concluded that the company’s overall working capital management is not at desired level and we have made the realistic recommendation for the improvement in operational and managerial efficiency of the company as to maintain and increase further by effective utilization and control of all the assets.
BIBLIOGRAPHY
Books:
Pandy I M, Financial Management Vikas Publishing House (P) Ltd.
Gupta S P, Financial Management Sultan Chand & Sons
Kothari C.R. “Research Methodology Method & Techniques” Wishwa Prakashan , Daryaganj , New Delhi-110 002
WEB SITES:
www.microqual.com
www.ey.com/india
www.icai.org
www.Business Line.com
GLOSSARY
Acid Test Ratio: - It is also termed as quick ratio and is calculated by
dividing the current assets excluding inventory and pre-paid expenses
by current liability. It is the best measure for the liquidity of a firm.
Current ratio: - A measure of liquidity. It is the ratio of current assets
and current liabilities.
Debtor’s Collection Period: - The period taken to collect debtors. It is
equal to number of days in a year dividing by debtor’s turnover.
Inventory Turnover: - Equal to sales divided by total inventory.
Quick Ratio: - Current assets (quick assets) divided by current
liabilities. It is the best measure of liquidity.
Total Assets Turnover: - A ratio indicative of the efficiency with
which a firm uses its assets. It is calculated by dividing annual sales
by total assets.
Return on Investment: - It is calculated by dividing net profit after
taxes by total assets or by multiplying its net profit margin by the total
assets turnover. It is some times also called the return on total assets.
Block of Assets: - A group of assets falls within a class of assets being
building, machinery, plant or furniture in respect of which the same
rate of depreciation is charged.
Common-Size Statement: - Balance sheet or income statement in
which items are expressed in ‘%‘rather than in absolute rupees.
Current assets: - Assets which can be converted in the ordinary course
of business in to cash with in a year or length or operating cycle
whichever is higher.
Current Liabilities: - Liability that is intended to be paid within a year
in the ordinary course of business from the date of inception.
EBIT/PBIT: - Earning before interest and tax / Profit before interest
and tax.
Financial Analysis: - The use of financial data to evaluate the
financial position of a firm.
Gross Profit Margin: - Calculated by dividing gross profit by net sales.
Income Statement: - It presents the net income of a firm for a period of
time (says a quarter or year).
Net working Capital: - The excess of current assets over the current
liabilities.
Ratio Analysis: - Uses of financial ratios to evaluate the performance
such as liquidity, solvency and profitability.
Solvency: - Ability of a firm to meet its obligations when they become
due.
