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Project Report On: Trade Finance
Project Report On: Trade Finance
Project Report on
Declaration
TRADE FINANCE carried at
I hereby declare that the report on “TRADE FINANCE” that has been submitted to NMIMS
SUBMITTED BY: CORPORATE GUIDE:
University School of Business Management and Bank of India, Sion (west), Mumbai towards
[Relationship Beyond Banking]
ABHINAV KUMAR Mr.
Partial Fulfillment of myM.V.RANGNEKAR
Master of Business Administration Programme is my original and
Branch Office :MALAD (W),MUMBAI
bonafide work
MBA,NMIMS. Chief
Manager(Officiating),
I also certify that to the best of knowledge and beliefs this work has not been worried out another
BOI
person or group of person or an
MALAD WEST
Project Report on FACULTY GUIDE :
organization as a whole.
[Type the document subtitle]
Punit
[Pick the date]
ACKNOWLEDGEMENT
NARSEE MONJEE INSTITUTE OF MANAGEMENT STUDIES,VILE
PARLE (W),MUMBAI
At the very onset, I must express my profound gratitude to Chief Manager - Mr.M.V.Rangnekar
who has given me an opportunity to carry out this project work.
I wish to express my deep sense of gratitude to my Guide, Ms. S. Nigudkar, Manager (Credit)
for his able guidance and useful suggestions, which helped me in completing the project work, in
time.
Words are inadequate in offering my thanks to the Project Trainees and Project Assistants, BOI
for their encouragement and cooperation in carrying out the project work.
I would like to express my sincere gratitude to my college for allowing me to do this project with
sufficient time.
Finally, yet importantly, I would like to express my heartfelt thanks to my beloved parents for
their blessings, my friends/classmates for their help and wishes for the successful completion of
this project.
Abhinav Kumar
2
EXECUTIVE SUMMARY
Banking Industry which is basically my concern industry around which my project has to be
revolved is really a very complex industry.
I was assigned the task of analyzing the credit health of organizations that approach Bank of
India for credit facilities. After analyzing credit health, the credit rating is determined. On the
basis of credit rating, the interest rate guidelines circular is consulted to fix a price for the credit
facilities i.e. determine the interest rate. This would entail analysis of past and present financial
statements, Balance Sheet, Cash Flow Statements, examination of Profitability statements,
projected financial statements and CMA data.
After doing this study learned that the financial health and credit rating are theoretical methods
for determining the right interest rate. However, in practice, banks consider other factors such as
history with client, market reputation and future benefits with clients. Thus, a difference exists
between theory and practice.
I learnt a lot during the project. Firstly it provided me much needed corporate exposure (working
with team, business communication, prioritizing work). Though we are continuously given inputs
on soft skills and business communication during our program; but there is no better place to
hone these skills than the workplace.
3
TABLE OF CONTENT
ACKNOWLEDGEMENT
EXECUTIVE SUMMARY
2.3 METHODOLOGY
22
2.4 SCHEDULE
23
2.4 LIMITATIONS
23
CHAPTER 3-PROPOSAL
3.1 PENGUIN ELECTRONICS INDUSTRIES
24
4
3.2 COMPANY REQUEST
26
ANNEXURE
BIBLIOGRAPHY
AUTHOR’S PROFILE
The co-existence of the public sector, private sector and the foreign banks has generated
competition in the banking sector leading to a significant improvement in efficiency and
customer service.
Background
Bank of India was founded on 7th September, 1906 by a group of eminent businessmen from
Mumbai. The Bank was under private ownership and control till July 1969 when it was
nationalized along with 13 other banks.
5
Beginning with one office in Mumbai, with a paid-up capital of Rs.50 lacs and 50 employees, the
Bank has made a rapid growth over the years and blossomed into a mighty institution with a
strong national presence and sizable international operations. In business volume, the Bank
occupies a premier position among the nationalized banks.
Manpower is the key factor for the success of any organization. Bank of India has a dedicated
family of about 40155 qualified / skilled employees who will and always will be delighted to
extend their services to the customers with heartfelt efforts. The Bank is a Public Sector Unit
with 64.47% Share Capital held by the Government of India. The Bank came out with its Initial
Public Offer (IPO) in 1997. Presently 35.53 % of Share Capital is presently held by Institutions,
Individuals and Others.
The Bank has over the years earned the reputation of being a techno-savvy Bank and is one of
the front runners amongst public sector bank in the field of technology. It is one of the pioneer
public sector banks, which have Core Banking Solution implemented in 2593 branches covering
95.6%of domestic business mix. Bank’s revamped web-site using latest Next Generation Web
2.0 technology was launched. Around 35000 ATMs made available to our card holders through
owned as well as shared ATMs network. SMS alerts for cheque book request and any debits in
accounts through any of the delivery channel like ATM, Internet Banking provided to all
customers. Solar Power System implemented at 143 locations to overcome acute power shortages
and erratic power supply as well as Bank’s commitment towards ‘Go Green’.
Overview of Bank
VISION
“To Become The Bank Of Choice For Corporates, Medium Business And
Upmarket Retail Customers And Developmental Banking For Small Business,
Mass Market And Rural Markets”
MISSION
QUALITY POLICY
7
Urban 607 Zonal Offices
48
RISK MANAGEMENT
8
TIER 2 CAPITAL 4667 5303 5745 7255 7218
2094
TOTAL CAPITAL 10492 14712 18211 21098 3
2749
TOTAL ASSETS 141817 178830 225502 274966 66
1618
RISK WEIGHTED 89261 122221 139931 167008 57
CRAR-TIER 1(%) 6.53 7.7 8.91 8.29 8.48
CRAR-TIER 2(%) 5.22 4.34 4.1 4.34 4.46
CRAR(%) 11.75 12.04 13.01 12.63 12.94
9
DEPOSITS(%)
AVG.YIELD ON ADVANCES 8.42 9.78
CREDIT DEPOSIT
RATIO(%) 74.56 76.29
NET INTEREST MARGIN(%) 2.51 2.97
BUSINESS PER
EMPLOYEE(IN Cr) 10.11 8.33
EPS(Rs.) 33.15 57.26
Ratio Analysis of various factors will be done. With the help of ratio analysis
liquidity and profitability of the firm is analyzed.
The firm should maintain a sound working capital position. It should have
adequate working capital to run its business operations. Both excessive as
well as inadequate working capital positions are dangerous from the firm’s
point of view.
Excessive working capital means holding costs and idle funds, which earn
no profits for the firm. The dangers of excessive working capital are as
follows:
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• It becomes difficult to implement operating plans and achieve the
firm’s profit target.
• Operating inefficiencies creep in when it becomes difficult even to
meet day-to-day commitments.
• Fixed assets are not efficiently utilized for the lack of working capital
funds
• Paucity of working capital funds render the firm unable to avail
attractive credit opportunities etc.
• The firm looses its reputation when it is not in a position to honor its
short-term obligations. As a result, the firm faces tight credit terms.
Nature of business:
The working capital requirement of the firm is closely related to the nature of
its business. A service firm, like an electricity undertaking or a transport
corporation, which has a short operating cycle and which sells predominantly
on cash basis, has a modest working capital requirement. On the other hand,
a manufacturing concern like a machine tools unit, which has a long
operating cycle and which sells largely on credit, has a very substantial
working capital requirement.
12
Seasonality of operations:
Firms, which have marked seasonality in their operations usually, have highly
fluctuating working capital requirements. If the operations are smooth and
even through out the year the working capital requirement will be constant
and will not be affected by the seasonal factors.
Production policy:
Market conditions:
Conditions of Supply:
The time taken by a supplier of raw materials, goods, etc. after placing an
order, also determines the working capital requirement. If goods as soon as
or in a short period after placing an order, then the purchaser will not like to
maintain a high level of inventory f that good. Otherwise, larger inventories
should be kept e.g. in case of imported goods.
13
Business Cycle Fluctuations:
Different phases of business cycle i.e., boom, recession, recovery etc. also
effect the working capital requirement. In case of recession period there is
usually dullness in business activities and there will be an opposite effect on
the level of wor5king capital requirement. There will be a fall in inventories
and cash requirement etc.
Credit policy:
The credit policy means the totality of terms and conditions on which goods
are sold and purchased. A firm has to interact with two types of credit
policies at a time. One, the credit policy of the supplier of raw materials,
goods, etc., and two, the credit policy relating to credit which it extends to its
customers. In both the cases, however, the firm while deciding the credit
policy has to take care of the credit policy o the market. For example, a firm
might be purchasing goods and services on credit terms but selling goods
only for cash. The working capital requirement of this firm will be lower than
that of a firm, which is purchasing cash but has to sell on credit basis.
Operating Cycle:
Time taken from the stage when cash is put into the business up to the stage
when cash is realized.
14
Working capital management refers to the administration of all components
of working capital – cash, marketable securities, debtors (receivables), and
stock (inventories) and creditors (payables). The financial manager must
determine levels and composition of current assets. He must see that right
sources are tapped to finance current assets, and that current liabilities are
paid in time.
A large investment in current assets under certainty would mean a low rate
of return on investment for the firm, as excess investment in current assets
will not earn enough return. A smaller investment in current assets, on the
other hand, would mea interrupted production and sales, because of
frequent stock-outs and inability to pay creditors in time due to restrictive
policy.
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The two important aims of the working capital management are: profitability
and solvency. Solvency, used in the technical sense, refers to the firm’s
continuous ability to meet maturing obligations. If the fir maintains a
relatively large investment in current assets, it will have no difficulty in
paying claims of creditors when they become due and will be able to fill all
sales orders and ensure smooth production. Thus, a liquid firm has less risk
of insolvency; that is, it will hardly experience a cash shortage or a stock-out
situation. However, there is a cost associated with maintaining a sound
liquidity position. A considerable amount of the firm’s will be tied up in
current assets, and to the extent this investment is idle, the firm’s
profitability will suffer.
To have higher profitability, the firm may sacrifice solvency and maintain a
relatively low level of current assets. When the firm does so, its profitability
will improve as fewer funds are tied up in idle current assets, but its solvency
would be threatened and would be exposed to greater risk of cash shortage
and stock-out.
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• Long-term Financing. The sources of long-term financing include
ordinary share capital, preference share capital, debentures, long-term
borrowings from financial institutions and reserves and surplus
(retained earnings).
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 finance.
• Matching approach
• Conservative approach
• Aggressive approach
Matching Approach
Conservative approach
Under a conservative plan, the firm finances its permanent assets and also a
part of temporary currents assets with long-term financing. In the periods
when the 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.
Aggressive approach
INVENTORY MANAGEMENT
INTRODUCTION: Inventories constitute the most significant part of
current assets of a; large number 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 the inventories
maintained by the firm, a considerable amount of funds is required to
be committed to them. It is, therefore, absolutely imperative to
manage inventories efficiently and effectively in order to avoid
unnecessary investment.
Inventories are stock of the product a company is manufacturing for sale and
components that make up the product. The various forms in which
inventories exist in a manufacturing company are:
Raw materials are those basis inputs that re converted into finished
product through the manufacturing process. Raw materials inventories
are those units, which have been purchased and stored for future
productions.
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Work-in-progress inventories are semi-manufactured products. They
represent those products that need more work before they become
finished products for sale.
Finished goods inventories are those completely manufactured
products, which are ready for sale. Stocks of the raw materials and
work-in-process facilitate production, while stock of finished goods is
required for smooth marketing operations. Thus the inventories serve
as a link between the production and the consumption of goods.
The levels of the three kinds of inventories for the firm depend on the nature
of the business. A manufacturing firm will have substantially high level of
finished goods inventories and no raw material and work-in progress
inventories within manufacturing firm, there will be differences.
Operating cycle period: the firm begins with the purchase of raw material,
which are paid for after a delay, which represents the accounts payable
period. The firm converts raw material into finished goods and then sell the
same. The time that, elapses between the purchase of raw material and the
collection of cash for the sales is referred to as the operating cycle. The
length or time duration of the operating cycle of any firm can be defined as
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the sum of its inventory conversion period and the receivables conversion
period.
The total of ICP and RCP is also known as Total Operating Cycle period (TOCP). The
firm might be getting some credit facilities from the supplier o a material, wage
earners, etc. this period for which the payment of these parties are deferred or
delayed is known as Deferral Period (DP). The Net Operating Cycle (NOC) of the firm
is arrived at by deducting the DP fro the TOCP. NOC is also known as cash cycle.
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a) The “Average” value in the numerator is the average of opening balance and
closing balance of the respective item. However, if only the closing balance is
available, then even the closing balance may be taken as the “Average”.
b) The figure “365” represents number of days in a year. It may also be taken as
“360” for the ease of calculation.
c) The “total” figure in the denominator refers to the total value of the item in a
particular year.
d) In the calculation of RMCP, WPCP, ad FGCP. The denominator is calculated at
cost-basis and the profit margin has been excluded. The reason big that there
is no investment of funds in profit as such.
2. DISCOUNTING OF BILLS
Under the purchase or discounting of bills, a borrower can obtain credit from a bank
against its bills. The bank purchase or discounts the borrower’s bills. He amount
provided under this agreement is covered within the overall cash credit or overdraft
limit
Before purchasing or discounting the bills, the bank satisfies itself as credit
worthiness of the drawer. Though, the item “bills purchased” implies that the bank
becomes owner of the bill. In practice, bank hold bills as security for the credit.
When a bill is discounted, the borrower is paid he discounted amount of the bills,
(visa, full amount of bill minus the discount charged by the bank). The bank collects
full amount on maturity. The major part of bank borrowings comes through
Discounting Bills. On this firm has to pay interest of 12%.
NON-FUND BASED
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1. LETTER OF CREDIT
Commonly used in international trade, the letter o credit is now used in domestic
trade as well. A letter of credit, or L/C, is used by a bank on behalf of its
customers (buyer) to the seller. As per this document, the bank agrees to honor
drafts on it for the supplies made to the customer if the seller fulfills the
conditions laid down in the L/C.
(i) It virtually eliminates credit risk, if the bank has a good standing.
(ii) It reduces uncertainty, as the seller knows the conditions that should be
fulfilled receive payment.
.
2. BANK GUARANTEE
Bank Guarantee is very similar to Letter of Credit but it is provided for much
longer period compared to letter of credit. Very small portion of working capital
is funded by Bank Guarantee.
The firm is having low credit holding period it can try to increase is so
that, those funds can remain with it for a longer period n can be utilized
for fulfilling the working capital requirements. For this purpose firm can be
little strict credit standards it can also adopt discount policy.
LOAN ASSESSMENT
Steps in loan processing :
Submission of Project Report along with the Request Letter.
Preparation of proposal
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If No queries raised If queries raised
Communication of Sanction
Acknowledgement of Sanction
on various Terms & Condition
Disbursement
Credit Report and Credit Rating
The credit report is an important determinant of an individual's financial credibility. They are
used by lenders to judge a person's creditworthiness. They also help the person concerned to
narrow down on the financial problem areas.
Credit report is a document, which comprises detailed information about the credit payment
history of an applicant. It is mostly used by the lenders to determine the credit worthiness of an
applicant. The business credit reports provide information on the background of a company. This
assists one to take crucial business related decisions. People can also assess the amount of
business risk associated with a company and then decide whether they would be comfortable in
providing them with credit facilities. The degree of interest that would be shown by investors in
their company can also be gauged from the business credit reports as they can get an idea of the
conception of their customers regarding themselves. Since these records are updated at regular
intervals of time they enable people to identify the risk levels associated with a business as well
as its future. These reports also allow businesses to get detailed information about the financial
status of business partners and suppliers.
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2.3 METHODOLOGY
The methodology to be adopted for the project is explained as under:
1. The initial step of the project was studying about the company and
then evaluating the financial position of the company on the basis of
ratio analysis.
2. Comparing the firm’s financial position with the help of following
ratios-
• Liquidity ratios
• Solvency/Leveraging ratios
• Coverage ratios
• Activity/turnover ratios
• Profitability ratios
• Investors ratios
3. The project will focus on the study of overall working capital
management at the organizations, for which the following study and
analysis will be undertaken:
• This project is aimed to estimate the operating plan for the year 2010-
2011
• This will also include the calculations and analysis of the operating
cycle for the company.
• Study of CMA form and to prepare for the current year.
• It will also include the ratio analysis of the financial statement so that
the profitability and liquidity trade off can be analyzed.
2.4 SCHEDULE
The complete project will be for duration of 8 weeks. The study of company’s
financial position by doing ratio analysis of the financial statement so that
the profitability and liquidity condition of the organization can be studied
.Here the operating plan will be prepared and the study and analysis of the C
M A form will be done. This will include the estimation of working capital
requirement for 2008-2009, forecasting for 2009-2010 .
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2.5 SCOPE OF THE STUDY
Studying working capital management of the Penguin Industries ltd and
deciding its credibility.
2.6 LIMITATIONS
In spite of my continued efforts to make the project as accurate and wide in
scope as possible, certain limitations are becoming evident while
implementing the project. These limitations cannot be removed and have to
be accepted as permanent constraints in implementing the project.
CHAPTER 3 – PROPOSAL
BORROWER PROFILE
ESTABLISHED IN 1983
ADVANCE SINCE 1 1987
PRESENT PROPOSED
RISK RATING LC1 LC1
PRICING RATING LC1 LC1
25
EXTERNAL CREDIT RTING
ASSET CODE 11(STANDARD)
NO MAJOR GROUP
GROUP AFFILIATION
MR RAKESH N
KEY PERSON .GARODIA
CONSORTIUM NO
FINANCIALS BELOW
POSITION OF ACCOUNTS ANNEXURE 1
LAST SANCTION AUTHORITY: DY GM.LIMIT FBL -6 CRORES.NFBL: 0.40 CROR
NO CPA RELATED TO LAST SANCTION OF 31.03.09 IS
CORPORATE OFFICE
4, Piramal Industrial Estate
MANAGEMENT
26
MANAGEMEN
T
MR.ASHOK
MR RAKESH MR. ARUN MR. V G. KUSUM GAYATRI
N
N. N. DESHPAND A DEVI
.GARODIA
GARODIA GARODIA E .GARODIA N.GARODIA
CHIEF
DIRECTOR DIRECTOR DIRECTOR DIRECTOR DIRECTOR
EXECUTIVE
Rated
sl no Facility Amount Rating
1 Cash credit 45 BBB/stable
2 Long term loan 11 BBB/stable
3 Bills discounting 15 P3+
4 Letter of credit 3.5 P3+
5 Bank guarantee 0.5 P3+
RATIOS
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CURRENT RATIO 1.28 1.35
DEBT /EQUITY 0.8 0.6
PROFITABILITY 2.98 0.4
DSCR - -
INTEREST COVERAGE 2.85 1.28
FINANCIAL INDICATORS
Audited31.03 Est.31.03 Audited Estd.31.03 Proj
Finnancial indicators .07 .07 31.03.08 .09 31.03.10
Paid up capital
a)Equity 1 1 1 1 1
b)Preference share
Tangible net worth 13.62 14.26 14.85 15.45 16.13
Investment in companies 3.42 6 5.72 6.18 6.18
Adjusted TNW -
Capital employed 16.83 15.45 16.26 16.13 16.53
Net block 6.22 5.05 7.22 5.54 5.17
Net sales 59.03 40 46.01 33 34.65
Total sales 59.03 40 46.01
Other income 0.59 0.35 1.43 0.61 0.61
EBITA/PBITA 2.9 2.89 2.97 2.35 2.45
Interest 0.57 0.96 0.55 0.7 0.7
Gross profit/loss 2.33 1.93 2.42 1.65 1.75
Taxes 0.28 0.28 0.31 0.18 0.2
Cash Accruals 2.05 1.65 2.11 1.47 1.55
Depreciation 0.69 0.9 0.74 0.75 0.75
Net profit/Loss 1.36 0.75 1.37 0.72 0.8
Net profit/Capital
employed% 8.08 4.85 8.43 4.46 4.84
Current assets 16.55 14.13 16.6 14.01 14.37
Currrent liabilities 9.36 9.73 13.28 9.6 9.19
Ratios
Current Ratios 1.77 1.45 1.25 1.46 1.56
Debt /Equity
a) Term LIAB/TNW 0.24 0.08 0.09 0.04 0.02
b)Tol/TNW 0.92 0.77 0.99 0.67 0.59
(Profitability- PAT) /Net
sales 2.3 1.88 2.98 2.18 2.31
DSCR-Company as a
whole Avg 2.51 Avg 2.51 Avg 2.51 Avg 2.51 Avg 2.51
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Interest coverage 4.6 2.72 4.84 3.1 3.21
(Inventory+Receivables)/
sales% 30 27 19 33 17
COMMENTS IN BRIEF
The company has submitted audited balance sheet for 2008-2009.The selected financial
indicator above reveals satisfactory financial position except Low profitability and decline
in sales and ISCR during 08-09.Net worth shown a increased trend with retension of profits
and is Rs 14.87 cr as on 31.03.10. ISCR is at 1.28 and is not above the acceptable level of 1.5.
PROFITABILITY
CURRENT RATIO
INTEREST
NET SALES
30
Company has achieved the sale of Rs 46.01 crores as on 31.03.08 as the
estimates of Rs 40 crores. Hence company is considered doing well.
OTHER INCOME
Company has other income of Rs 1.43 crores which comprises of profit of
sale of investments of Rs 0.74 crore, rent from its leased property at
Daman of Rs 0.41 crores. Interest of deposits and MF of Rs 0.20 crores.
PROFITS/PROFITABILITY
Company has earned profits of Rs 1.37 crores during 2007-08.As they
have closed their audit unit at Daman and are operating from their new
unit set up at Baddi, Himachal Pradesh. Profitabilty at 2.18% for the year
ended 31.03.09 would be slightly lower than as compared to 2.98% for
the year 31.03.08.the lower profitability was explained due to thin
margins in electronics industry due to stiff competition.
INVESTMENTS
Company has invested in some Blue Chip Companies to the tune of Rs 4.76
crores and in MF of Rs 0.76 crores as on 31.03.08.
CURRENT RATIO
Current Ratio was at 1.25 as on 31.03.08 and is estimated to improve to 1.46
as on 31.03.09. Current ratio is above the benchmark level and hence
acceptable.
DEBT-EQUITY RATIO
THE DER was 0.99 as on 31.03.08 and is slated to improve to 0.67 and to
0.59 during next two years. The same is acceptable levels.
31
ISCR as on 31.03.08 was at 4.84 .The estimated ISCR at 3.10 and projected
at 3.21 as on 31.03.09 and 31.03.10 respectively.
NET BLOCK
Company net block was Rs 7.22 crores as on 31.03.08. As the company has
shifted to Baddi, they have sold their plant and machinery. There was an
adjustment in depreciation on account of sale of plant and machinery which
has amounted to reduction in net block to Rs 5.54 crores as on 31.03.09.
CONTINGENT LIABILITY
FAVOURABLE CONDITIONS
32
manufacturing unit at Baddi. The average DSCR for the balance
repayment period works out to be 2.51 which is very comfortable.
JUSTIFICATION
ANNEXURE
EFFICIENCY RATIOS:
33
Net Sales / Total Tangible Assets (Times) >1.50
LIQUIDITY RATIOS:
LEVERAGE RATIOS:
TURNOVER RATIOS:
34
Bank Finance Turnover (Times) >5.00
PROFITABILITY RATIOS:
STRUCTURAL RATIOS:
B) FINANCIAL ANALYSIS
LIQUIDITY RATIOS (SHORT- TERM LIQUIDITY)
Liquidity ratios measure the short term solvency, i.e., the firm’s ability to pay
its current dues and also indicate the efficiency with which working capital is
being used.
35
‘Current assets’ means the assets that are either in the form of cash or
cash equivalents or can be converted into cash or cash equivalents in short
time(say within a year) like cash, bank balances, marketable securities,
sundry debtors, stock, bills receivables, prepaid expenses.
Current Liabilities
Objective.
• The ratio is mainly used to give an idea of the company's ability to pay
back its short-term liabilities with its short-term assets.
• The higher the current ratio, the more capable the company is of
paying its obligations. A ratio under 1 suggests that the
company would be unable to pay off its obligations if they came due at
that point.
• While this shows the company is not in good financial health, it does
not necessarily mean that it will go bankrupt - as there are many ways
to access financing - but it is definitely not a good sign.
Liquid assets are those assets which are either in the form of cash or cash
equivalents or can be converted into cash within a short period. Liquid assets
are computed by deducting stock and prepaid expenses from the current
assets. Stock is excluded from liquid assets because it may take some time
before it is converted into cash. Similarly, prepaid expenses do not provide
cash at all and are thus, excluded from liquid assets.
Current liabilities
Objective.
• The ratio tells creditors how much of the company's short term debt
can be met by selling all the company's liquid assets at very short
notice. also called acid-test ratio.
• The current ratio does not indicate adequately the ability of the
enterprise to discharge the current liabilities as and when they fall due.
Liquid ratio is considered as a refinement of current ratio as non-liquid
portion of current assets is eliminated to calculate the liquid assets.
Thus it is a better indicator of liquidity.
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• A quick ratio of 1:1 is considered standard and ideal, since for every rupee of
current liabilities, there is a rupee of quick assets. A decline in the liquid ratio
indicates over-trading, which, if serious, may land the company in difficulties.
• Debt-equity Ratio
The debt-equity ratio is worked out to ascertain soundness of the long term
financial policies of the firm. This ratio expresses a relationship between debt
(external equities) and the equity (internal equities).
Debt means long-term loans, i.e., debentures, public deposits, loans (long
term) from financial institutions. Equity means shareholder’s funds, i.e.,
preference share capital, equity share capital, reserves less losses and
fictitious assets like preliminary expenses.
Objective.
Long-term debts
Objective.
Capital Employed
Objective.
• A debt ratio of greater than 1 indicates that a company has more debt
than assets, meanwhile, a debt ratio of less than 1 indicates that a
company has more assets than debt. Used in conjunction with other
measures of financial health, the debt ratio can help investors
determine a company's level of risk.
40
Computation. This ratio is calculated as follows:
Capital Employed
Objective.
• This ratio indicates the extent to which the long term funds are sunk
into fixed assets.
• It has been an accepted principle of financial management that not
only fixed assets should be financed by way of long-term loans but also
a part of current assets or working capital should be financed by way of
long-term funds, and this part may be in the form of permanent
working capital.
• A very high trend of this ratio may indicate that a major portion of long
term funds is utilized for the purpose of fixed assets leaving a small
proportion for the investment in the current assets or working capital.
• A very low trend of this ratio coupled with a constant declining trend of
current ratio may indicate an urgent for the introduction of long-term
funds for financing the working capital in the business.
Objective.
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• It is preferable to run a business as little inventory as possible on hand,
while not affecting potential sales opportunities.
• If this ratio is high compared to the average for the industry, it could
mean that the business is carrying too much inventory.
• Proprietary Ratio
The proprietary ratio establishes a relationship between proprietor’s fund and
total assets.
Proprietor’s fund means share capital plus reserves and surplus both of
capital and revenue nature. Loss, if any, should be deducted. Funds payable
to others should not be added.
Total Assets
Objective.
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PROFITABILITY RATIOS
Profit as compared to the capital employed indicated profitability of the
concern. A measure of ‘profitability’ is the overall measure of efficiency. The
different profitability ratios are as follows:
Net Sales
Objective.
• The net profit ratio determines the overall efficiency of the business.It
indicates that proportion of sales available to the owners after the
consideration of all types of expenses and costs – either operating or
non-operating or normal or abnormal.
• A high net profit indicates profitability of the business. Hence, higher
the ratio, the better the business is.
COVERAGE RATIOS
• Interest Coverage Ratio
The interest coverage Ratio establishes the relationship between PBIT (Profits
before interest and taxes) and Debt interest.
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Debt Interest
The numerator considers the profit before income tax and interest on both
term and working capital borrowings.
The denominator considers the interest charges, which are in the form of
interest on long-term borrowings and not the interest on working capital
facilities.
Objective.
The 'coverage' aspect of the ratio indicates how many times the
interest could be paid from available earnings, thereby providing a
sense of the safety margin a company has for paying its interest for
any period.
As a general rule of thumb, investors should not own a stock that has
an interest coverage ratio under 1.5. An interest coverage ratio below
1.0 indicates the business is having difficulties generating the cash
necessary to pay its interest obligations.
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Turnover indicates the speed with which capital employed is rotated in the
process of doing business. Activity ratios measure the effectiveness with
which a concern uses resources at its disposal. The following are the
important activity (turnover or performance) ratios:
Computation. This ratio is computed with the help of the following formula:
Capital Employed
Objective.
This ratio indicates the effectives of the organization with which the
capital employed is being utilized.
A high capital turnover ratio indicates the capability of the organization
to achieve maximum sales with minimum amount of capital employed.
It indicates that the capital turnover ratio better will be the situation.
Objective.
As such, higher this ratio, the better will be the situation. However, a
very high ratio may indicate overtrading – the working capital being
meager for the scale
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b) Finished goods Inventory Turnover
Computation. This ratio is calculated as follows:
Objective.
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It also indicates pricing strategy: companies with low profit margins
tend to have high asset turnover, while those with high profit margins
have low asset turnover.
A high Assets turnover ratio indicates the capability of the organization
to achieve maximum sales with the minimum investment in assets. It
indicates that the assets are turned over in the form of sales more
number of times. S such, higher the ratio, better will be the situation.
a) Total Assets Turnover
Total Assets
Fixed Assets
Fixed assets include net fixed assets, i.e., fixed assets after providing for
depreciation.
Current Assets
Objective.
Objective.
• This ratio indicates the speed at which the sundry debtors are
converted in the form of cash. However this intention is not correctly
achieved by making the calculations in this way.
No of Working Day
Inference
It is highest in case of ITC followed by HUL and DS Group respectively.
Daily Sales
RETURN ON INVESTMENT
The ratios computed in this group indicate the relationship between the
profits of a firm and investment in the firm. There can be three ways in which
the term ‘investment’ may be interpreted, i.e., Assets, Capital Employed and
Shareholder’s Funds. As such, there can be three broad classifications of ROI:
ROA = EBIT
Objective.
The assets of the company are comprised of both debt and equity.
Both of these types of financing are used to fund the operations of the
company. The ROA figure gives investors an idea of how effectively the
company is converting the money it has to invest into net income.
The higher the ROA number, the better, because the company is
earning more money on less investment.
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Average Capital employed
Objective.
Shareholder’s funds
• This is the most popular ratio to measure whether the firm has earned
sufficient returns for its shareholders or not. As such, this ratio is the
most crucial one from the owners/shareholders point of view. Higher
the ratio better will be the situation.
INVESTOR RATIOS
• Earnings per Share (EPS)
Computation. The ratio is calculated as:
Objective.
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• As such, increasing EPS may indicate the increasing trend of current
[profits per equity share. However, EPS does not indicate how much of
the earnings are paid to the owners by way of dividend and how much
of the earnings are retained in the business.
Another aspect of the gross working capital points to the need of arranging
funds to finance current assets. Whenever a need for working capital funds
arises due to the increasing level of business activity or for nay other reason,
financing arrangement should be made quickly. Similarly, if suddenly, some
surplus funds arise they should not be allowed to remain idle, but should be
invested in short term securities. Thus, the financial manager should have
knowledge of the sources of working capital funds as well as investment
avenues where idle funds may temporarily are invested.
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For every firm, there is a minimum amount of net working capital, which is
permanent. Therefore, a portion of working capital should be financed with
permanent sources of funds such as equity share capital, debentures, long-
term debt, preference share capital or retained earnings. Management must,
therefore, decide the extent to which the current assets should be financed
with equity capital or borrowed capital.
It may be emphasized that both gross and net concepts of working capital
are equally important for the efficient management of working capital. There
is no precise way to determine the exact amount of gross or net working
capital of a firm. A judicious mix of long and short term finances should be
invested in current assets. Since current assets involve cost of funds, they
should be put to productive use.
These phases affect cash flows, which most of the time, are neither
synchronized nor certain. They are not synchronized because cash flows
usually occur before cash inflows.
Cash inflows are uncertain because sales and collections which give rise to
cash inflows are difficult to forecast accurately, on the other hand, are
relatively certain. The firm is, therefore, required to invest in current assets
for a smooth, uninterrupted functioning. It needs to maintain liquidity to
purchase raw materials and pay expenses such as wages and salaries, other
manufacturing, administrative and selling expenses and taxes as there is
hardly a matching between cash inflows and outflows. Cash is also held to
meet any future exigencies. Stocks of raw materials and work-in-progress are
kept to ensure smooth production and to guard against non-availability of
raw material and other components. The firm holds stock of finished goods to
meet the demand of customers on continuous basis and sudden demand
from some customers. Debtors are created because goods are sold on credit
for marketing and competitive reasons. Thus, a firm makes adequate
investment in inventories, and debtors, for smooth, uninterrupted production
and sale.
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The grass operating cycle of a manufacturing concern is the sum of Inventory
Conversion Period and debtors (receivable) conversion period. Thus, Gross
Operating Cycle is gives as follows:
The inventory conversion period is the total time needed for producing and
selling the product. It is the sum of (1) raw material conversion period, (2)
work-in-progress conversion period, and (3) finished goods conversion
period.
[Cost of production]/360
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Finished goods conversion period is the average time taken to sell the
finished goods. It can be calculated as follows-
Debtor’s conversion period is the average time taken to convert debtors into
cash. It represents the average collection period. It is calculated as
follows:
DCP= Debtors
[Credit sales]/360
Creditor’s deferral period is the average time taken by the firm in paying its
suppliers. It is calculated as follows:
CDP= Creditors
[Credit purchases]/360
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obtained in order to carry out the firm’s operations. The firm has to negotiate
working capital from sources such as commercial banks. The negotiated
sources of working capital financing are called non-spontaneous sources.
If net operating cycle of a firm increases, it means further need for
negotiated working capital.
There are two ways of calculations of cash conversion cycle. One is that
depreciation and profit should be excluded in the computation of cash
conversion cycle since the firm’s concern is with cash flows associated with
conversion at cost; depreciation is a non-cash item and profits re not costs.
A contrary view air that a firm has to ultimately recover total costs and make
profits; therefore the calculation of operating cycle should include
depreciation, and even the profits.
BIBLIOGRAPHY
I.M PANDEY
Financial management using Financial modeling by Ruzbeh J.
Bodhanwala
M.Y KHAN
R.P Rustogi
Finance and Financial Reporting (IAI), CT-2
Westerfield Jaffe
www.bankofindia.com
www.worldbank.org.in
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www.rbi.org.in
www.mospi.nic.in
www.moneycontrol.com
www.indiainfoline.com
www.bankinginfo.com
AUTHOR’s PROFILE
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