Sultanate of Oman
Course code : 406 Register No: 32118 Enrollment No: 08008PF103
Under the Guidance of
Prof. N. Aravindakshan
Submitted in partial fulfillment of the requirement for the award of the degree of
M.G.UNIVERSITY KOTTAYAM – KERALA
March – 2010
This project is based on the study of working capital management in Arabian Industries LLC, An insight view of the project will encompass – what it is all about, what it aims to achieve, what is its purpose and scope, the various methods used for collecting data and their sources, including literature survey done, further specifying the limitations of our study and in the last, drawing inferences from the learning so far. “Arabian Industries LLC” an Oman’s prestigious Engineering and Manufacturing Company; is a well established engineering company. It is an Omani company which always maintained the highest international standards of excellence through quality, technology and innovation. It has the ability to provide the best in engineering and back up services for the petroleum and allied industries. The company has ISO 9001-2000 certification and has executed projects in various Middle East countries. It captured the various facets of the Oman economy in sectors ranging from maintenance, manufacturing, fabrication and infrastructure, etc. Working capital is the life-blood of all types of enterprises, manufacturing and trading both. It is constantly required to buy raw materials for payment of wages and other day-to-day expenses. Without adequate working capital, manufacturing operations will be crippled. It is a base on which all the activities of business enterprise depend. The working capital management refers to the management of working capital, or precisely to the management of current assets. A firm’s working capital consists of its investments in current assets, which includes short-term assets— cash and bank balance, inventories, receivable and marketable securities. This project tries to evaluate how the management of working capital is done in Arabian Industries LLC, through inventory ratios, working capital ratios, trends, computation of cash, inventory and working capital, and short term financing. Working capital is primarily concerned with inventories management, Receivable management, cash management & Payable management. The objective of the company now is to increase the scale of its business by increasing its profits and the turnover and also by venturing into new line of business. It is now targeting to be the World Class Industrial Enterprise from the present status. It is striving to have a huge global base.
31ST March 2010
This is to certify that Mr.Sasikumar.R. Register No.-32118 a IVth semester MBA student of M.G.University - Kerala, has visited our Organization and conducted a study about it’s Working Capital Management and he has successfully completed his Project works, during the period from January to February 2010..
We wish all the best in his future endeavors.
Thanks with Regards, Yours faithfully,
MaheshNair, Finance Manager Arabian Industries LLC.
This is to certify, that Mr. Sasikumar.R is a bonafide student of Polyglot Institute, Sultanate of Oman, and is presently pursuing a Post Graduate Degree in Master of Business Administration in Finance and marketing. Under our guidance, he has submitted his project report titled “Working Capital Management” of Arabian Industries LLC, in partial fulfillment of the requirement for the summer internship project during the Post Graduate Degree in Master of Business Administration studies. This report has not been previously submitted as part of another degree or diploma of another Business School or University.
Prof. N. Aravindakshan Dept. of Management Polyglot Institute, Muscat, Sultanate of Oman
Place: Muscat, Sultanate of Oman Date: 31st March 2010
I, Sasikumar.R., the undersigned, an MBA student of M.G.University, Kerala do hereby declare that this report titled “Working Capital Management” of ArabianIndustries LLC, under the guidance of Prof. N.Aravindakshan, Professor of Finance and Accounting, Department of University Studies, Polyglot Institute, Sultanate of Oman, submitted in partial fulfillment of the requirement for the summer internship project during the Post Graduate Degree in Master of Business Administration studies. This is my original work and has not been previously submitted as a part of another degree or diploma of another Business school or University. The findings and conclusions of this report are based on my personal study and experience, during the tenure of my summer internship.
Place: Muscat, Sultanate of Oman. Date: 31st March 2010.
Prof. N.Aravindakshan, Dept. of University Studies, Polyglot Institute, Muscat, Sultanate of Oman.
I take this opportunity to thank various people, who all have helped me to complete successfully my internship programme with a project at Arabian Industries LLC. I would like to express my gratitude towards thanking the following people: Prof. N.Aravindakshan: (Former Co-Ordinator, Institute of Management in Kerala, University of Kerala, Kollam Centre:) Prof. N Aravindakshan, guided me with his valuable suggestion. He was a source of inspiration for me to complete the study and make this report on time and was instrumental in shaping this report. Dr.K Vijaya Kumar.(Centre Co-ordinator) I am highly indebted to the centre co-ordinator Dr.. K.Vijaya Kumar, Department of Management Studies for inspiring me and for his valuable guidance and assistance provided. Mrs. Sindhu Divakaran Mrs.Sindhu Divakaran, Faculty of Management Studies, Polyglot Institute, has also guided me with her valuable suggestions and advice for making this report a good success. Mr.P.O. Jabir - Operation Manager-Polyglot Institute, Sultanate of Oma, I take this opportunity to express my sincere and whole hearted thanks to Mr.P.O.Jabir, Operation Manager, and all the staff members of Polyglot Institute, Sultanate of Oman., for their tremendous help and support during the period of my project study. Mr. Mahesh Nair I express my sincere gratitude to Mr.Mahesh Nair-Manager Finance-Arabian Industries LLC, for the valuable advice and guidance extended to me for the completion and shaping of the dissertation. Mr.Abdulkhadar Padiyath, I wish to extend my sincere thanks to Mr.Abdulkhader Padiyath (Manager Finance -(Assistant), for His help and support in shaping this report. I also extend my sincere gratitude to all employees of Arabian Industries LLC, for their kind cooperation and support for the completion of this report.
TABLE OF CONTENTS
1. Executive Summary 2. Certificate from organization 3. Certificate from Guide 4. Declaration 5. Acknowledgement
6. List of Tables and Chart
Chapter No: Page No. 1
2 3 3 4 5 5 8 8
1. Introduction 1.1 1.2 1.3
1.4 Background of the study Statement of Problem Need and Importance of the study Objectives of the study Hypothesis Methodology Limitations of the study Chapterization-
1.6 1.7 1.8
Manufacturing Industry in Oman-A Profile
10 10 12 13 14 15 15 16 17
2.1 2.2 2.3 2.4 2.5
2.6 2.7 2.8 2.9
Introduction Present Scenario Foreign Investment Oman Economy – A Review Major Diversification Manufacturing industry in Oman Infrastructure Industry for Crude Oil Aim of Mfg. Industry inOman The Scope of Oil and Gas Industry
A profile of Arabian Industries LLC
19 20 21
3.1 3.2 3.3
Introduction Industry Profile Subsidiary and Joint Venture
3.6 3.7 3.8
Mission and Vision Objectives and Goals Product and Project Profiles Financial Highlights Literature Review
24 28 31 35 44
A Theoretical Perspective of Working Capital Management
51 56 56 59 61
4.1 4.2 4.3 4.4 4.5 5
Introduction Need of Working Capital Concept of Working Capital Classification of Working Capital Determinants of Working Capital
66 67 67 68 69
5.1 5.2 5.3 5.4 5.5 6
Introduction Scope of the Study. Type of Data Collection Objective of the Study Scope and Limitation of the Study
Working Capital Level and Analysis
6.1 6.2 6.3 6.4 6.5 6.6 6.7 Working Capital Level Working Capital Trend Analysis Current Asset Analysis Current liability Analysis Changes of Working Capital Operating Cycle Working Capital Leverage
72 73 76 79 80 83 90
Analysis of Financial Statements
92 93 93 94 94
7.1 7.2 7.3 7.4
Introduction Role of Ratio Analysis Limitations of Ratio Analysis Classification of WC Ratio
Efficiency Ratio Liquidity Ratio
Working Capital Management-Finance and Estimation
110 110 120 118 124 125 128
8.1 8.2 8.3 8.4 8.5 8.6 8.7 9
Introduction Receivables Management Inventory Management Cash Management Working Capital – Finance and Estimation Source of Working Capital Estimation of working capital
Summary of Findings, Conclusion and Suggestions
131 132 133
9.1 9.2 9.3
Findings Conclusions Suggestions
LIST OF TABLES, AND FIGURES. Sl. No. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 Description/name of the Table Business Unit wise Performance-FBU Business Unit wise Performance-MBU-TSU Business Unit wise Performance-PDU Business Unit wise Performance-EMU Division Wise Performance Financial Performance Financial Summary Cash Flow Analysis Five Year Planned Turnover Business Plan Capital Expenditure Size of Working Capital Working Capital - Variance Working Capital-size Analysis of Current Asset and Liabilities Current Asset - Size Composition of Current Asset Current Liabilities Changes in Working Capital Operating Cycle Working Capital leverage Working Capital Turnover Ratio Inventory turnover Debtors Turnover Current Asset Turnover Current Ratio Quick Ratio Absolute Liquid Ratio Size of Receivable Average Collection Period Size of Inventory Components of Inventory Table No. 3-1 3-2 3-3 3-4 3-5 3-6 3-7 3-8 3-9 3-10 3-11 6-1 6-2 6-3 6-4 6-5 6-6 6-7 6-8 6-9 6-10 7-1 7-2 7-3 7-4 7-5 7-6 7-7 8-1 8-2 8-3 8-4 Page No. 36 36 37 37 38 38 39 41 41 43 43 72 74 74 76 76 77 79 82 89 91 95 98 100 101 104 106 108 111 112 115 115
33 34 35 36 37 38
Inventory turnover Ratio Inventory Holding Period Size and Index of Cash Operating Cycle Cash Conversion Cycle Estimation of Working Capital
8-5 8-6 8-7 8-8 8-9 8-10
117 117 121 123 127 128
LIST OF GRAPHS
Sl. No. 1 2 3 4 5 6 7 8 2 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26
Description-Name of Charts Performance Review-FBU Performance Review-MBU-TSU Performance Review-PDU Performance Review-EMU Finance PerformanceFinancial Summary Cash Flow Analysis Permanent Working Capital Temporary Working Capital Working Capital Index Current Asset Index Current Asset Component Current Liability Index Changes in Working Capital Net Operating Cycle Working Capital Leverage Working Capital Turnover Ratio Inventory Turnover Ratio Receivable Turnover Ratio Current Asset Turnover Ratio Current Ratio Quick Ratio Cash and Bank to Current Liabilities Receivable Index Average Collection Period Inventories Index Components of Inventories
Chart No 3-1 3-2 3-3 3-4 3-5 3-6 3-7 4-1 4-2 6-1 6-2 6-3 6-4 6-5 6-6 6-7 7-1 7-2 7-3 7-4 7-5 7-6 7-7 8-1 8-2 8-3 8-4
Page No. 36 36 37 37 39 40 41 59 60 73 77 78 79 82 89 91 96 97 100 101 104 106 108 111 112 115 116
28 29 30 31 32 33
Inventory Turnover Ratio Inventory Holding Period Cash Index Cash Conversion Cycle Cash Conversion Cycle Estimation of Working Capital-2010
8-5 8-6 8-7 8-8 8-9 8-10
117 118 121 123 124 127 129
Structure of Arabian Industries LLC
AI LLC-Holding Company Structure
Determinants of Working Capital
Research Methodology – Data to Action
Working Capital Cycle
Cash Conversion Cycle
BIBLIOGRAPHY BOOKS REFERRED 1) Banarjee.A.K., Nair.R.K., Agarwal. V.K. – Organisational Behaviour
(2007) – Pragathi Publishers – Meerut 2) Gupta.R.L – Advanced Accountancy (2006) – Sultan Chand and Sons 3) Khan M.Y. Jain P.K. – Financial Management
(2008) – Tata Mc Graw Hill Publishers – New Delhi 4) Maheshwari.Dr.S.N. – Management Accounting and Financial Control (2006) – Sultan Chand and Sons – new Delhi 5) Maheshwari.Dr.S.N - Accounting for Management (2005) – Sultan Chand and Sons 6) Pandey.I.M – Financial Management (2008) – Vikas Publishing House – New Delhi
7) Sharma.R.K., Shashi K Gupta - Business Management (2008) – Kalyani Publishers – Ludhiana.
Financial Statement – (Annual Report for 2009) Company Journals – Arabian Industries LLC. Main Economic and Social Indicators – 2009 - Ministry of National Economy – Sultanate
AI LLC AIM LLC AIP LLC AITS LLC APO ARO BUH CCC CFO CNC COO CPP DCP DSS EPC FGCP GCC GOC GWC ICP IOD LLC MBU MD NWC PBU PDO PWC QAQC RCP RMCP TOR TWC WCC WCM WIPCP Arabian Industries LLC Arabian Industries Manufacturing LLc Arabian Industries Project LLC Arabian Industries Technical Support LLC Account Payable Outstanding Account Receivable Outstanding Business Unit Head Cash Conversion Cycle A US Magazine Computed Numerically Controlled Chief Operating Officer Creditors payment Period Debtors Conversion Period Decision Support System Engineering, Procurement and Construction Finished Goods Conversion Period Gulf Co-Operation Council Gross Operating Cycle Grows Working Capital Inventory Conversion Period Inventory Over Days Liability Limited Company Manufacturing Business Unit Managing Director Networking Capital Project Business Unit Petroleum Development Oman Permanent Working Capital Quality Assurance and Quality Control Receivable Conversion Period Raw Material Conversion Period Turn Over Ratio Temporary Working Capital Working Capital Cycle Working Capital Management Work in Progress Conversion Period
CHAPTER - I
1-BACKGROUND OF THE STUDY 2-STATEMENT OF PROBLEM 3-OBJECTIVES OF THE STUDY 4-HYPOTHESIS 5-METHODOLOGY 6-LIMITATIONS OF THE STUDY 7-STRUCTURE
OF THE WORKS.
BACKGROUND OF THE STUDY.
“THE MAJOR OBJECTIVE OF THIS STUDY IS FOR THE PROPER UNDERSTANDING OF ARABIAN INDUSTRIES LLC AND TO SUGGEST NECESSARY MEASURES TO OVERCOME THE INDUSTRY.”
THE WORKING CAPITAL OF THE SHORTFALLS IF ANY IN
The project undertaken is on “Working Capital Management of Arabian Industries LLC.”. It describes about how the company manages its working capital and the various steps that are required in the management of working capital. Cash is the lifeline of a company. If this lifeline deteriorates, so does the company's ability to fund operations, reinvest and meet capital requirements and payments. Understanding a company's cash flow health is essential to making investment decisions. A good way to judge a company's cash flow prospects is to look at its Working Capital Management (WCM).
Working capital refers to the cash of a business requires for day-to-day operations or, more specifically, for financing the conversion of raw materials into finished goods, which the company sells for payment. Among the most important items of working capital are levels of inventory, accounts receivable, and accounts payable. Analysts look at these items for signs of a company's efficiency and financial strength.
The working capital is an important yardstick to measure the company’s operational and financial efficiency. Any company should have a right amount of cash and lines of credit for its business needs at all times. This project describes how the management of working capital takes place at Arabian Industries LLC..
There are numerous instances in the history of business world where inadequacy of working capital has led to business failures when a firm finds it difficult to meetings day to day affairs. Operating expenses essential out lays may have to be postponed for want of funds, operating plans will go out of gear & enterprise objectives on investment slumps the suppliers & creditors of the firm may have to wait longer to raise their dues & will hesitate to extend further credit to the firm.
Thus efficient management of working capital in an important prerequisite for successful working of a business concern it reduces the chances of business failure generates a felling of security and confidence in the minds of personnel in the organization it assurance solvency of steady of the organization.
STATEMENT OF PROBLEM In the management of working capital, the firm is faced with two key problems: 1. First, given the level of sales and the relevant cost considerations, what are the optimal amounts of cash, accounts receivable and inventories that a firm should choose to maintain? 2. Second, given these optimal amounts, what is the most economical way to finance these working capital investments? To produce the best possible results, firms should keep no unproductive assets and should finance with the cheapest available sources of funds. Why? In general, it is quite advantageous for the firm to invest in short term assets and to finance short-term liabilities. Besides this followings are some other problem , a firm is facing. Through this study we try to find answer for these problems. 1. What are root causes of working capital on business? 2. What are the major effects on accounts receivable? 3. What is the nature of relationship between working capital and capital employed 4. What steps should be taken to ensure that it effect on the profit of the firm will not be negative? 5. How can working capital be managed? 6. What make up the working capital cycle? 7. How can debtors be controlled?
NEED AND IMPORTANCE OF THE STUDY. 1.This projects is helpful in knowing the companies position of funds maintenance and setting the standards for working capital inventory levels, current ratio level, quick ratio, current asset turnover level & size of current liability etc. 2. This project is helpful to the managements for expanding the dualism & the project viability & present availability of funds. 3. This project is also useful as it combines the present year data with the previous year data and there by it show the trend analysis, i.e. increasing fund or decreasing fund. 4. The project is done as a whole entirely. It will give overall view of the organization and it is useful in further expansion decision to be taken by management.
OBJECTIVES OF THE STUDY
The main objective of the study is to determine the effect of working capital on business profitability which has to do with:-
1. Maintenance of working capital at appropriate level, and 2. Availability of ample funds as and when they are needed
To accomplishment of these two objectives, the management has consider the composition of current assets pool. The working capital position sets the various policies in the business with respect to general operations like purchasing, financing, expansion and dividend etc,
The subsidiary Objective of Working Capital Management is to provide adequate support for the smooth functioning of the normal business operations of a company. This Objective can be subdivided into 2 parts:1. Liquidity 2. Profitability 1) Liquidity
The quantum of Investment in Current Assets has to be made in a manner that it not only meets the needs of the forecasted sales but also provides a built in cushion in the form of safety stocks to meet unforeseen contingencies arising out of factors such as delays in arrival of Raw Material, sudden spurts in demand etc. Consequently, the investment in current assets for a given level of forecasted sales will be higher if the management follows a conservative attitude than when it follows an aggressive attitude. Thus, a company following a conservative approach is subject to a lower degree of risk than the one following an aggressive approach. Further, in the former situation the high amount of Investment in Current Assets imparts greater liquidity to the company than under the latter situation wherein the quantum of investment in Current Asset is less. This aspect exclusively covers the liquidity dimension of Working Capital. 2) Profitability Once we recognize the fact that the total amount of financial resources at the disposal of a company is limited and these can be put to alternative uses, the larger the amount of investment in current assets, the smaller will be the amount available for investment in other profitable avenues at hand with the company. A conservative approach in respect of Investment in Current Assets leaves fewer amounts for other Investments than an aggressive approach does.
Hypothesis is a conjectural statement of the relationships between two or more variables. It is testable, tentative problem explanation of the relationship between two or more variables that create a state of affairs or phenomenon.E,C, Osuola said hypothesis should always be in declarative sentence form, and they should relate to them generally or specially variable to variables.
1. Explain observed events in a systematic manner 2. Predict the outcome of events and relationships 3. Systematically summarized existing knowledge.
In essence, there exist null hypothesis set up only to nullify the research hypothesis and the alternative hypothesis, for the purpose of the study. For the efficiency of the study, the hypothesis is as follows:
1. Working capital does not help the business concern in maintaining the goodwill 2. Working capital does not create an environment of security, confidence, and overall efficiency in a business
1. Working capital helps the business concern in maintaining the goodwill. 2. Working capital creates an environment of security, confidence, and overall efficiency in business. 1.6 METHODOLOGY Methodology may be a description of process, or may be expanded to include a philosophically coherent collection of theories, concepts or ideas as they relate to a particular discipline or field of inquiry. This project requires a detailed understanding of the concept – “Working Capital Management”. Therefore, firstly we need to have a clear idea of, what is working capital, how it is managed in Arabian Industries LLC, what are the different ways in which the financing of working capital is done in the organization etc.
To recognize the various type of information which are necessary for the study of working capital management. The management of working capital involves managing inventories, accounts receivable and payable and cash. Therefore one also needs to have a sound knowledge about cash management, inventory management and receivables management.
Then comes the financing of working capital requirement, i.e. how the working capital is financed, what are the various sources through which it is done.
And, in the end, suggestions and recommendations on ways for better management and control of working capital are provided.
Collection of data from various department of AILLC to analyze the working capital management of the firm.
There are several ways of collecting both data-Primary and Secondary datas,
considerably in context of money, cost, time and other sources at the disposable of the researcher.
There are two types of data: · Primary data · Secondary data
Definition:The first handed information/Fresh data collected through various methods is known as primary data. In respect of primary data which the researchers are directly collects data that have not been previously collected. The primary data was gathered through personal interaction with various functional heads and other technical personnel. Some information was also collected by observation.
2-Secondary Data : Definition:-
The data which have been already collected & comprised for another purpose. Secondary data was collected various reports, annual reports, documents charts, management information systems, etc in AI LLC, And also collected various magazines, books, newspapers etc.
The analysis of the information gathered has been made on the basis of the clarifications sought during the personal discussions with the concerned people and perception during the personal visits to the important areas of services.
In marking observations identifying problems and suggesting certain remedies such emphasis was given on the basis of opinions gathered during the personal discussions and with the personal experience gained during the academic study of M.B.A course.
The data presentation tools are mainly mathematical tools, Tables and Charts are used for this study. The most important parts of tools include; a) Table numbers b) Title of the table c) Caption d) Stub or the designation of the rows and columns e) The body of the table f) The head note or prefatory note or explanatory just before the title. g) Source note, which refers to the literally or scientific source of the table has observed that a table has the following merits over a prose information that; h) A table ensures an easy location of the required figure; i) j) Comparisons are easily made utilizing a table than prose information; Patterns or trends within the figures which cannot be visualized in the prose information can be revealed and better depicted by a table; and a table is more concise and takes up a less space than a prose formation: 1.6.3 TIME SPAN
A period of six year i.e. 2004-2009 has been taken for the study.
OF THE STUDY.
The following are the various limitations involved in the study. . 1. The study in limited 4 years (2004-2005) to (2005-2006) performance of the company. 2. The data used in this study have been taken from published annual report only. 3. This study in conducted within a short period. During the limited period the study may not be retailed, full fledged and utilization in all aspects. 4. Financial accounting does not take into account the price level changes. 5. We cannot do comparisons with other companies unless and until we have the data of other companies on the same subject. 6. Only the printed data about the company will be available and not the back–end details. 7. Future plans of the company will not be disclosed to us. 8. Lastly, due to shortage of time it is not possible to cover all the factors and details regarding the subject of study. 1.8 CHAPTERIZATION This research work is to be organized in nine chapters as follows: Chapter – 1 Chapter-II Chapter-III Chapter-IV Chapter – V Chapter VI Chapter VII Chapter – VIII Chapter – IX - Introduction - Manufacturing Industry in Oman – A profile - Arabian Industries LLC-A Profile - A Theoretical Perspective of Working Capital Management - Research methodology - Analysis of Working Capital Level - Analysis of Financial Statement - Management of working capital and it’s Financing and Estimation - Findings, Conclusion and Recommendations
CHAPTER – II
1-Introduction 2-Present Scenario 3-Foreign Investment 4-Oman Economy 5-Major Diversification 6-Oman Industry- An over view 7-ManufacturingIndustry in Oman 8-The Scope of Oil and Gas Industry.
OMAN PETROLEUM INDUSTRY - INTRODUCTION Oman's petroleum deposits were discovered in 1962, decades after most of those of its neighbours. Moreover, Oman's oil fields are generally smaller, more widely scattered, less productive, and more costly per barrel than in other Persian Gulf countries. The average well in Oman produces only around 400 barrels per day (bbl/d), about one-tenth the volume per well of those in neighboring countries. To compensate, Oman uses a variety of enhanced oil recovery (EOR) techniques. While these raise production levels, they increase the cost. According to the 2008 BP Statistical Energy Survey, Oman had proved oil reserves of 5.572 billion barrels at the end of 2007, the bulk of which are located in the country's northern and central regions. The largest and traditionally most reliable fields are in the north. These fields, which include Yibal (the biggest), Fahud, al-Huwaisah, and several others, are now mature and face future declines in production. In spite of declining production, Oman remains a significant nonOPEC oil exporter. According to the 2008 BP Statistical Energy Survey, Oman produced an average of 717.8 thousand barrels of crude oil per day in 2007, 0.9% of the world total and a change of -4.6 % compared to 2006./P> /P>Oman exports significant amounts of liquefied natural gas and, according to the 2008 BP Statistical Energy Survey, had 2007 proved natural gas reserves of 0.69 trillion cubic metres and 2007 natural gas production of 24.1 billion cubic metres./P> .
2.2 PETROLEUM INDUSTRY – PRESENT SCENARIO. The petroleum industry forms the backbone of Oman's economy. Over the past three decades, the oil reserve has helped the Sultanate move from strength to strength economically. But can Oman depend wholly on its natural resources or it needs to diversify into other areas to sustain and bolster its economy is an important question mark.
The oil price slump in 1998-99 forced Oman to take steps to diversify and put greater emphasis on other industries, such as tourism and liquid natural gas. Oman's Basic Statute of the State expresses in Article 11 that "The National Economy is based on justice and the principles of a free economy." Recent official statistics reveal that the oil sector's share in the GDP has risen to 49 per cent in 2005 from 42.2 per cent in 2004. According to the 2006 annual report of the Central Bank of Oman (CBO), "The fiscal position remained strong in 2005, with the fiscal recording a surplus of about 2.6 per cent of GDP. As against a budgeted deficit of RO540 million in 2005, there was a net surplus of RO303 million." Revenues from the petroleum sector rose 44.3 per cent in 2005. Non-oil revenues rose 9.2 per cent, driven by a strong 17.8 per cent growth in non-oil industrial activities. The average price of Omani crude was about US $50.26 per barrel in 2005, representing a 46 per cent rise over the average price of US $34.42 in 2004. As a result, the share of oil and gas sector in the GDP, exports and net government revenue rose to 49 per cent, 84.2 per cent and 79 per cent, respectively, in 2005. After a period of subdued inflation, 2004 saw signs of minor rise in prices, which persisted in 2005. Consumer price inflation rose from 0.7 per cent in 2004 to 1.9 per cent in 2005. But the Sultanate's inflation at 2.3 per cent was still lower than the average inflation in advanced countries in 2005.
A VIEW OF OIL DRILLING AREA A close look at the June 1995 “Vision Conference: Oman 2020” reveals that a lot of strategic planning went into the formulation of initiatives aimed at securing Oman's future prosperity and growth. These include:-
To have economic and financial stability. To reshape the role of the government in the economy and to broaden private sector participation.
To diversify the economic base and sources of national income. To globalise the Omani economy. To upgrade the skills of the Omani workforce and develop human resources.
It is expected that by 2020 the economy will not be reliant on oil, but rather diversified into non oil sectors, raising higher levels of savings and investments. Studies reveal that the crude oil sector's share of GDP is estimated to drop to 9 per cent in 2020, compared with 41 per cent in 1996. Also, the gas sector is expected to contribute around 10 per cent to GDP, compared with less than 1 per cent in 1996, while the non-oil industrial sector's contribution is expected to increase from 7.5 per cent to 29 per cent.
In a bid to reinforce the existing set-up as well as make room for further development in the petroleum sector, the government has undertaken a string of measures to provide incentives to foreign investors. These include: 1. Tax exemption for five years (sometimes renewable for a further five years) for industrial enterprises which contribute to Oman's economy. 2. Foreign investors allowed to hold 49 per cent of equity, which could be increased in mitigating circumstances. 3. Concessional financing may be arranged through the Ministry of Commerce and Industry and Oman Development Bank. 4. A clear and efficient legal network which offers advice on company law, copyright law, arbitration and agency law. 5. A diverse economy which encourages privatisation of infrastructure and services. 6. Price stability, with an inflation rate of not more than 1 per cent since 1992. 7. Stable currency with full convertibility. 8. No personal income tax and no foreign exchange controls. 9. Tax and import duty exemptions. 10. Interest-free long-term loans to partly foreign-owned industrial and tourism projects.
Foreign business participation in Oman is encouaged provided the company is established in accordance with the Foreign Business and Investment Law of 1974. Foreign companies are formed as an incorporation of a local company or other commercial entity. They may also exist as a branch office, a consultancy or by appointing a commercial agent, ensuring that the company only supplies services and/or goods to be imported into the Sultanate. PDO – HEAD QUARTERS
Airline and shipping offices as well as companies with occasional business are not governed by the Foreign Business and Investment Law. Potential businesses should supply the company's articles of incorporation and other pertinent information when applying for authorisation to the Foreign Capital Investment Committee at the Ministry of Commerce and Industry. 2.4 OMAN ECONOMY PETROLEUM INDUSTRY – A REVIEW
According to the CBO annual report, the improved macroeconomic environment has been reflected in the upgrading of the Sultanate's rating by Moody's from Baa2 to Baa1 in October 2005. In January 2006, Standard and Poor's also reaffirmed their local and foreign currency sovereign credit ratings for Oman at "A-/A-2" and "BBB+/A-2", respectively, with a "stable" outlook. It may be noted that the government debt as a percentage of GDP continued to decline and, by the end of 2005, fell to 8.6 per cent. The most striking aspect of the developments in the banking system in 2005 relates to the surge in profits. Net profits of banks rose from RO79.4 million in 2004 to RO123.2 million in 2005 while net foreign assets of commercial banks rose by 127.9 per cent, from RO256.6 million in 2004 to RO584.9 million in 2005.The current account (comprising trade, services, income and transfers) showed a surplus of RO1813 million in 2005 as against RO219 million in 2004. The trade account, reflecting the excess of export earnings over merchandise imports, showed a high surplus of RO4100 million in 2005 as against a surplus of RO2118 million in 2004.
The nominal GDP, exports and government revenue are expected to benefit further from the favourable oil price scenario in 2006. This favourable phase provides an opportune time to use the surplus oil revenue in diversifying the economy. Greater openness to trade and foreign investment, phased implementation of the privatisation programme of the government, and reversing the declining trend in oil production will help strengthen the growth impulses in the economy.
In 2002, the petroleum ministry took big steps to encourage international companies to invest in abandoned concession onshore and offshore areas. Oil and Gas Minister Dr. Mohammed Bin Hamad al-Rumhi had then called on Petroleum Development Oman (PDO) and international companies operating in oil and gas exploration and production to continue their efforts to discover new fields and improve extracting methods and techniques.
The minister upheld his ministry's resolve to provide necessary infrastructure and the government constructed three pipelines to transport gas from the central region to Sur, Sohar and Salalah for existing industrial estates and power plants.
The transported gas was to be used to operate power plants in Salalah and Barka, and petrochemical, aluminum, cement factories, oil refinery and other industries in Sohar and Raysut industrial estates. With the new infrastructure in place, the scene has improved significantly. Foreign investors are now keen on joint ventures in these regions.
ON THRESHOLD OF MAJOR DIVERSIFICATION
When His Majesty Sultan Qaboos Bin Said assumed power in 1970, he embarked on his vision of putting the Sultanate on a progressive path of making the country economically stable. He left the doors open for other countries to join hands with the local government in constructing Oman into a nation that would stride comfortably into the 21st century.
In his zeal for economic development and modernization, he launched a programme to built and expand the country's almost non-existent infrastructure. As the 70s rolled on, the country achieved substantial progress in developing physical and social infrastructure. New roads, a new deepwater port, an international airport, electricity-generating plants, schools, hospitals and low-cost housing were built from money that came exclusively from oil receipts.
THE MANUFACTURING INDUSTRY - AN OVERVIEW The manufacturing sector is part of the goods-producing industries super sector group. The Manufacturing sector comprises establishments engaged in the mechanical, physical, or chemical transformation of materials, substances, or components into new products. Establishments in the Manufacturing sector are often described as plants, factories, or mills and characteristically use powerdriven machines and materials-handling equipment. However, establishments that transform materials or substances into new products by hand or in the worker's home and those engaged in selling to the general public products made on the same premises from which they are sold, such as bakeries, candy stores, and custom tailors, may also be included in this sector. Manufacturing establishments may process materials or may contract with other establishments to process their materials for them. Both types of establishments are included in manufacturing.
. The manufacturing industry - the powerhouse driving many economies - has been reeling under the most challenging time in its history. Manufacturers are striving to be more innovative, compete globally, and expand and market their products to emerging markets worldwide. Intense pressure to reduce costs and the need to effectively manage a complex supply chain have manufacturers shifting their production bases and spreading out operations well beyond their home grounds. This course provides an overview of the manufacturing industry. It first examines the state of affairs in the manufacturing industry, including its subsectors, key players, and trends. The course then reflects on the main issues and challenges facing the industry, and, finally, it examines strategic solutions that successful companies are employing to overcome these challenges.
The depletion of the sultanate's crude oil reserves accelerated the government's bid to increase the use of gas in electric power generation and industry. In the early 1970s, the sultanate began to use gas in electric power generation. Gas pipelines were laid, and generators were converted from diesel to gas. This was done in the Muscat metropolitan area just before the second oil price shock despite resistance by importers of diesel. Plans were to increase gas use by extending the government gas grid linking the south and the east to the north. Power generation facilities north of Muscat in 1992 were using gas as a feedstock, and plans were to increase gas-fired units elsewhere. Although the government has promoted the industrial use of gas, oil firms remain the principal consumers, using a total of 8.5 million cubic meters per day of associated gas. Gas is required for re-injection, compression fuel, and power generation to support facilities at producing fields.
This is likely to continue in the short term, given the slow pace of switching industrial use from petroleum. The government's focus in the 1990s on exploiting natural gas reserves and increasing output to meet rising demand complements its priority in maintaining current oil output levels. It seeks to do this without depleting crude reserves by using gas produced in association with oil output for reinjection at mature fields to increase production and, by substituting gas for oil, to release greater volumes of crude oil for export.
OFFSHORE OIL RIG The Sultanate’s industrial strategy is multi-pronged. Besides utilising locally available natural resources such as oil, gas and minerals, it aims at diversification of products for local consumption as well as exports. While industrial projects based on fossil fuels and their derivates provide tremendous impetus to the economic development of a country, small and medium units play a supportive but significant role in the industrialization process. Mega projects like oil refineries and their downstream industries and steel mills require massive investments whereas medium and small units could be set up with less capital in areas where indigenously available resources could be made use of. 2.8 THE
AIM OF THE
To achieve an average annual growth of 14,3 % in domestic product of manufacturing industry.
To increase the manufacturing industry exports at an annual average growth rate of 18, 2%. To achieve regional equilibrium in industrial development. To transfer and domesticate foreign and local capital in the industrial sector. To develop educational syllabus and introduce industry subject for trade orientation with its different aspects as a basic subject in all educational stages.
To reduce cost of the industrial production and develop the competitiveness of industrial products.
To provide the infrastructure services of the industry.
Despite a sharp fall in average oil prices in 2009, the Omani govt. has managed to keep it’s fiscal amount close to balance. Oman’s economy has navigated through the global economic crisis in relatively good shape. Although country’s real non oil growth fell sharply in 2009, it remained in positive territory. Oman’s financial sector was less affected by the global economic crisis and the countries modest level of indebtedness has limited it’s external vulnerability.
GAS INDUSTRY IN OMAN – AN OVERVIEW
The continued growth in demand and an industry struggling to meet this voracious demand have pushed oil prices to an all-time high. Big oil companies, even while investing heavily in exploration, technology, operational improvement, and research and development, are still left with huge surpluses in an industry so far known only as a modest return. In reality, there has never been a more challenging time for the oil and gas industry. While oil companies face tough challenges in finding new sources of oil and gas to replace the old ones, the emerging oil demand and supply equation renders some of the world's most powerful nations increasingly dependent on some of the world's most unstable regions. As a result, companies are applying advanced technologies and improved processes to meet growing demand, as well as working to keep abreast of the constantly shifting geopolitical landscape so critical to success in this sector. This course provides a high-level view of the industry environment, including its scope and structure, and navigates learners through relevant business and regulatory issues. Also examined are the forces shaping this industry, its key players, business drivers and challenges, and the strategic solutions for these challenges? A report on the state of affairs in the oil and gas industry and analysis based insights are also presented. The overall purpose of this course is not to make learners industry experts, but to help them get a feel of the industry and learn some of the winning strategies the key players are successfully applying. CRUDE OIL DRILLING
CHAPTER - III
1-Introduction 2-Industry Profile 3-Subsidiary and Joint Venture 4-Mission and Vision 5-Objectives and Goals 6-Product and Project Profiles 7-Financial Highlights 8-Literature Review
3.1 INTRODUCTION TO ARABIAN INDUSTRIES LLC
Arabian Industries LLC is a leading engineering company catering to the needs of the energy sector for the MENA region. It has facilities and expertise to meet the varied client needs of the Oil/Gas and other energy sectors in the production, Processing and delivery phases. Started in 1991 in The Sultanate of Oman, they have grown steadily and won many accolades and appreciations. The most prestigious achievement is the Year 2008 “His Majesty Cup award for best five factories”. Their commitment to the job, quality of work, earnestness to provide Total Solutions and desire to surpass client expectations has consistently earned repeat business from their esteemed clients. These qualities enable them to compete in international markets and succeed.
Arabian Industries LLC – Company Structure
Arabian Industries LLC
Arabian Industries Project LLC
Arabian Industries Manufacturing LLC
Technical Support LLC
Arabian Industries Joint Venture
“Arabian Industries LLC” is an Oman’s Prestigious Engineering and Manufacturing Company; established in the year 1991, is a well established engineering company. It is 100% Omani company which always maintained the highest international standards of excellence through quality, technology and innovation. It has the ability to provide the best in engineering and back up services for the petroleum and allied industries. The company has ISO 9001-2000 certification and has executed projects in various Middle East countries. It captured the various facets of the Oman economy in sectors ranging from maintenance, manufacturing, fabrication and infrastructure, etc. “Arabian Industries LLC and its subsidiaries are committed to become one of the leading companies providing complete solutions to the energy sector by enhancing customer satisfaction, strengthening employee & supplier relations and continually improving its product & services through the Quality Continuous Improvement, Enhancing Employees Safety, Providing proper resources & suitable working environment, achieving national development and improving profitability and budget”. 3.2 PROFILES OF ARABIAN INDUSTRIES LLC. Arabian Industries LLC is a leading engineering company catering to the needs of the energy sector for the MENA region with active participation in Oman’s Hydrocarbon, Petrochemical and Energy Sector industries. .. Started in 1991 in The Sultanate of Oman, they have grown steadily and won many accolades and appreciations. Arabian Industries LLC clientele include all major operating companies in Oman including Petroleum Development Oman /Shell, Oman Gas Company, Occidental of Oman, Occidental Mukhaizna, Oman Refinery and other Omani Oil, Gas, Water and Process Sector clients.
The Company posted a growth of approximately 200% during the period from 1991 to 2009 and is currently rated one of the leading EPC Contractors in the Region. Their commitment to the job, quality of work, earnestness to provide Total Solutions and desire to surpass client expectations has consistently earned repeat business from their esteemed clients. These qualities enable them to compete in international markets and succeed. Arabian Industries LLC, is currently executing a number of major contracts in Oman for activities, which include Greenfield and Brownfield EPC & CME&I Construction Contracts for Facilities, Pipelines and Process Plant, Long Term Maintenance Contracts for Oil & Gas facilities, Pipeline Integrity Management Services including rehabilitation and routine / planned maintenance of cross country pipelines and Environmental Services.
Arabian Industries LLC, owns one of the biggest fleet of plant and equipment amongst the oil and gas sector contractors in Oman and directly employs approximately 2500 multi-disciplined experienced staff personnel. Apart from the Head Office located at Al Khuwair House, various site, Arabian Industries LLC, currently have a Project Coordination office, Staff Camp, Fabrication Shop, Vehicle Maintenance Workshop and other related facilities in Rusayl, Sultanate of Oman. These are in addition to on-site offices, accommodation, workshops and warehouses throughout its operating areas in the Country.
Arabian Industries LLC, is one of the first companies in the Sultanate of Oman to have ISO 9002 Quality System Certification of Compliance for its entire scope of activities. This System was updated to ISO 9001 in the year of 2000. The The Company’s Health, Safety, Environmental & Waste Management standards are one of the most effective amongst the Omani contracting community with a number of major milestone achievements to its credit.
SUBSIDIARY COMPANIES & JOINT VENTURES
◙ARABIAN INDUSTRIES MANUFACTURING LLC
Arabian Industries Manufacturing Co. LLC (AIM) (a subsidiary of Arabian Industries LLC), is the manufacturing division providing complete solutions for engineering, procurement and fabrication of equipments to cater to clients in the Oil & Gas, Petrochemicals, Power , Fertilizer, Chemicals, and Refinery industries..
◙ ARABIAN INDUSTRIES PROJECTS LLC Arabian Industries Projects LLC (AIP), a subsidiary of Arabian Industries LLC, is the Projects Division providing Engineering, Procurement, Construction and commissioning services, to cater to clients in the Oil & Gas, Petrochemicals, Power, Fertilizer, Chemicals and Refinery Industries.
◙ ARABIAN INDUSTRIES TECHNICAL SUPPORT LLC Arabian Industries Technical Support LLC (AITS), a subsidiary of Arabian Industries LLC, is a provider of total maintenance solutions under one roof to cater to clients in the Oil & Gas, Petrochemicals, Power, Fertilizer, Chemicals and Refinery Industries. JOINT VENTURES Arabian Industries LLC has entered into a JV with two foreign companies. They are listed below.
WORLEY PARSONS –ARABIAN INDUSTRIES J.V. (WPAI J.V.) The WPAI - J.V. was formed between Arabian Industries LLC. and Worley Parsons (Oman) during the middle of 2005 as a framework to cater to the Engineering, Maintenance and Construction contract for Petroleum Development of South Oman, awarded by PDO. This is a five year contract which can be extended to 7 years. NORM PROJECT J.V. This is another J.V. formed between Arabian Industries LLC. and an International institution (specializing in the treatment of radioactive contamination). NORM stands for “Naturally Occurring Radioactive Materials” which are found in the PDO sites during production of Oil from oil-wells.. This entails suitable investments in setting up decontaminating facilities and developing the required infrastructure in PDO sites for the said purpose.
CREDENTIALS OF ARABIAN INDUSTRIES LLC. • • • grow. ASME ‘U’, 'U2' ‘S’ & ‘R’ Stamps: For the manufacture and repair of Pressure Society is their cradle so they need to preserve and enrich it; Customers are their The employees are their biggest assets, so they need to nourish and help them
Vessels at their state-of-art facilities at Rusayl & Sohar work centre. Patrons so they need to honor their commitments with them;
CORPORATE PHILOSOPHY A corporate philosophy is — Creating Jobs, Adding Value to the Individual, and Contributing to Society inspires Temp Holdings to become a company that helps people fulfill their dreams and find happiness through work. Based on this philosophy, Arabian Industries LLC, will enter the future as a trusted and reliable company throughout Oman and the rest of the world. We will also pursue business activities that emphasize corporate social responsibility (CSR) in order to contribute to a better society.
Creating Jobs Arabian Industries LLC, creates various types of employment by examining working arrangements, working environment, job content, and conditions of employment Contributing to society Arabian Industries LLC, contributes to society’s betterment by creating jobs and developing effective human resources Adding Value to the individual Arabian Industries LLC, supports people who want to improve themselves through their work, regardless of age, sex, or nationality.
3.4.1 CORPORATE MISSION AND VISION
Overview Arabian industry is a leading EPC Contracting Company, specialized in design, engineering, project construction, fabrication, and testing activities in Oil and Gas, Refineries, Petrochemicals and Power sectors.
1 Mission To achieve market leadership through excellence in the quality of product and services by adopting state of the art technologies and innovative management approaches aim towards customer satisfaction.
2 Vision Arabian Industries LLC is committed to providing their clients with the best possible service and results at a competitive price, without compromising on quality, health, safety, environment, business ethics or welfare of their staff. “As a recommended supplier, and a preferred employer, AI LLC is meeting the objectives and needs of their clients & employees.”
3 Policy Arabian Industries LLC and its subsidiaries are committed to become one of the leading company providing complete solutions to the energy sector by enhancing customer satisfaction, strengthening employee & supplier relations and continually improving its product & services.
Integrity in diversity. Though their business expands to diverse sectors they still abide by their vision & policy and maintain integration of their Quality management system and consistency of operations through empowerment, motivated & dedicated peers and strong leadership
5 Approach AILLC is a customer-focused organization nurturing the culture of internal-customers & externalcustomers through out the organization. They achieve this through team-building, supply chain management and continual training & development of their employees.
AI LLC’s quality management system established since 1996 has been certified to ISO 9001 – 2000. Their pressure equipments manufacturing facilities are accredited by ASME for U, U2, S and R stamps. Oil & Gas field equipments manufacturing facilities are certified by API for conformance to 6A, 6D and 16A requirements.
3.5 CORPORATE OBJECTIVE
A To be of service to the nation and to contribute effectively to its economic
well being and growth through the production, supply and marketing of infrastructure facilities to Petroleum Production and it’s allied industries in Sultanate of Oman.
To sustain and improve its pioneering role in the development of engineering To improve productivity and maintain high standards of quality and adopt
and technology in manufacturing industry through continuous research and development. effective measures for controlling cost in all aspects. 4. To ensure for its customers the availability of its products and services on reasonable terms, for its shareholders a fair return on capital invested and, for itself, development of adequate internal resources for continual growth and expansion.
CORPORATE OBJECTIVE 3.5.1 1 2. 3. 4. 5. 6. CORPORATE GOALS To achieve a net profit of OMR: One Million per year with a turnover of OMR: 100 Million by the year of 2010 To focus on cost reduction and technology up gradation in order to become competitive in each line of business. To constantly innovate and develop new technology and services to satisfy customer requirements. To invest in new business lines, where profit can be made on sustainable basis over the long te rm. To compete through speed, agility and flexibility in recognizing and capturing opportunities in existing markets.
CORPORATE GOALS 3.5.2 QUALITY PERFECTIVE
A dedicated team of Quality Assurance and Quality Control Engineers (lead by the Company’s QA/QC Manager and Quality Systems Engineer) supports the implementation and monitoring of Quality Management of the Company. All departments in the Company are certified to ISO 9001 and regular internal and external audits are conducted to check the compliance and renewal of certificate.
ISO 9001:2000 requires that an organization’s quality policy provide a framework for reviewing the company’s quality objectives. The policy should give an overall direction for the organization, and its objectives should flow in that direction. But because of outside forces such as customer requirements and market environments, business conditions can change. If this happens, the alignment between quality policy and objectives can become off-centered. So, the standard requires that management periodically review changes to both the policy and objectives. An organization’s objectives must be measurable and its quality management system processes designed to meet those objectives.
3.5.3 MAJOR CLIENTS
ARABIAN INDUSTRIES LLC
Since the company began operations in 1991, it has successfully executed numerous projects for clients within the Gulf region. It includes some of the most reputed industrial entities like:-
In achieving the objectives of Centre, they promise to:
Attending clients promptly and courteously Respond to complaints/suggestions from the clients within a reasonable time Continuously evaluate the effectiveness of company’s programmes Provide timely support to staff and workers of the firm. Generate Performance report every two weeks after launching the project works. Provide technical advice to the clients on various issues.
MAJOR CLIENTS 1. Petroleum Development Oman LLC (PDO) 2. Sohar Aluminium Company LLC (SAC) 3. Oman Refinery Company LLC (ORC) 4. Oman Gas Company LLC (OGC) 5. Occidental Oman LLC 6. Qatar Petroleum (QP) 7. Oman LNG LLC 8. Daleel Petroleum LLC 9. Enerflex Systems Pty Ltd
10. Petrofac Engineering & Construction Ltd 11. Japan Gas Corporation 12. Hanover Company ,USA
Major Clients 3.6 PRODUCT AND PROJECT PROFILES
AI LLC offers complete engineering and maintenance management services under one roof. By optimizing its experience and technical know-how, the company provides complete assistance on following matters
A project is a series of activities aimed at bringing about clearly specified goals within a defined timeperiod and with a defined budget.
A project has:
a primary target group and final beneficiaries, clearly defined coordination,
management and financing arrangements, a monitoring and evaluation system financial and economic analysis, showing that benefits will exceed costs.
3.6.1 MAJOR PROJECTS OFFERED
ARABIAN INDUSTRIES LLC
1. Projects and Construction (Including EPC) 2. Service Contracts 3. Civil & Building Works 4. Workshop Fabrication 5. Tank Fabrication, Construction & EPC Services 6. High Density Polyethylene Pipe Lining 7. Maintenance & Process Plant Turnaround Services 8. Aluminum Component Fabrication & Installation Services
Major Projects & Products details
1 Project JV Partner Project Value 2 Name of Project Type of Contract Approximate Value 3 Name of Project Type of Contract Project Value 4 Project Type of Contract Project Value 5 Name of Project Type of Contract Project value 6 Name of Project Type of Contract Project value 7 Name of Project Type of Contract Project value 8 Name of Project Type of Contract Project value Additional AR Pipeline Construction work Main Contractor US $ 1 2.5 Million Security Upgrade in Oman LNG Sub contractor USD.1 3.51 million Yibal Brownfiled Expansion – C-980033 Sole Construction Contractor Lump sum US $ 16 Million Barik Central Gathering Station Construction Sole Construction Contractor US $ 11.3 Million C31/1097: Hubara -Saih Rawl - 132 kv Overhead line, EPC , Lump sum US$ 38 million Fahud Steam Injection Project EPC Lump sum US$ 143 million DCME & I Engineering Service Contract No. C-680046, Main sub-contractor for complete mechanical works US$ 40 million (Mechanical) C31/0606: Engineering and Maintenance Contract (EMC Worley Parsons US$ 240 million
3.6.3 MAJOR ACHIEVEMENTS
1-Engineering capabilities Mechanical design of process equipments like pressure vessels, heat exchangers, separators, Design of Shop and site Storage tanks as per international standards API 650, 653, EN 14015 Design of direct and indirect heaters, fuel gas treatment plants Packages: PV Elite, Stadd Pro, AUTOCAD and piping software’s Regular association with reputed international process owners and licensors in the Oil & Gas, Refinery and Petrochemical industry for the design of equipment internals. 2-Welding and joining technology Core competency and expertise in welding and joining technology of all construction metals, especially in DSS,CRA and special alloy steels Qualified for a wide range of welding procedures up to 200 mm thickness SMAW /SAW/GTAW/FCAW/MIG facilities Strip cladding and special weld metal overlays GRP piping fabrication and bonding facilities
3-Testing Hydro/pneumatic testing bays and facilities RT/MT/UT/PT/PWHT/PMI and other NDT facilities PWHT facilities by Internal and external firing methods Local stress relieving facilities by electrical methods Gas fired PWHT furnaces adjustable to equipment sizes.
4-Major Services Offered Maintenance of Static Equipments Maintenance of Heat Exchangers including Tube Cleaning, Re-tubing and Plugging Maintenance, Overhauling and Monitoring of Compressors, Pumps, and Turbines .. Maintenance and Overhauling of Oilfield Equipments; Design, fabrication, erection and commissioning of oil and petroleum storage tanks,
FINANCIAL HIGHLIGHTS FOR 2009
[SOURCE: COMPANY REPORT] 49
FINANCIAL PERFORMANCE REVIEW 2009
BUSINESS PLAN – 2010
New project inflows (excluding EMU) at RO 41.58 million for the year 2008 vis-à-vis RO 20.977 million in the year 2008 – 103.4% growth year on year.
Backlog of works at RO 40.216 million as at December 2008 (of which RO 37.352 million is expected to be executed in 2009) against RO 9.98 million as at December 200 – 347.2% growth year on year.
Projected Gross Sales at RO 42.70 million in 2008 vis-à-vis RO 38.14 million in the previous year – 113.44% growth year on year
Forecasted Net Profit Before Tax at RO 5.33 million in 2008 as against RO 3.58 million in the previous year – 59.8% growth over 2008.
BUSINESS UNITS 1. FABRICATION BUSINESS UNIT 2. TECHNICAL SUPPORT UNIT 3. PROJECT DEVELOPMENT
4. ENGINEERING MAINTENANCE 3.7.1
PERFORMANCE REVIEW FOR 2009
Fabrication Business Unit
Chart-3-1- PERFORMANCE REVIEW FOR 2009-FABRICATION BUSINESS UNIT
P r om c R v w B ef r a e ei n e MU
10 0 60 10 0 40 64 81 10 0 20 10 0 00 80 00 60 00 40 00 20 00 0 R vne eeu Cs ot Mr i agn 19 02 80 0 54 79
Fr c s d oe a te Dc 8 e '0 P ne la n d
Planned Forecasted Dec'08 Revenue 10084.48 7661.920 Cost 9188.48 6438.88
Value in RO, 000
Margin 896 1223
Margins were better than the original business plan based in spite of a lower turnover as
the contracts were taken at better margins. 3.7.2 Performance Review for 2009
Technical Support Unit
Chart-3-2- Performance Review for 2009-Technical Support Unit
PROMNE E I W B -T EF R A C RV - U S E M I
10 60 10 40 10 20 10 00 80 0 60 0 40 0 20 0 0
P ne la n d
F r c se oe a t d Dc 8 e '0
45 3 34 9
Rv n e eeu
Mg a i r n
Table-3-2-Performance Review-Technical Support Unit
Planned Forecasted Dec'08 Revenue 1727 1229
Values in OMR
Cost 1225 810 Margin 487 453
Better marketing strategy and business tie-up’s have been planned for the year 2009 to
have a better turnover to counter the underperformance in terms of planned revenue by this Business Unit.
Performance Review for 2009 of Projects Development Unit Chart-3-3- Performance Review for 2009-PDU
PERFORMANCEREV IEW -2008-PBU
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Revenue Cost Margin 12489 11032 1457 5618 4400 1218
Forecasted Dec'08 P lanned
Values in OMR
Planned Forecasted Dec'08
Revenue 14363 6460
Cost 12686 5060
Margin 1676 1400
Smaller Contracts were executed under this business with higher profit margin as the
carry forward jobs from 2007 to 2008 were limited. However the firm expects a better turnover in the year 2009 based on a healthy order book for the year ended 2008.
Performance Review for 2009 Engineering Maintenance Unit Chart-3-4- Performance Review for 2009-EMU
P R O M N ER VE -E C E F R A C E I W M (jv)
259 46 200 50 200 00 100 50 F re s d o ca te D c'0 e 8 25 50 38 22 200 20 149 94 Pne la n d 227 18
100 00 50 00 0 R ve u e ne Cs ot M rg a in
Values in OMR
Revenue Planned Forecasted Dec'09 25300 28254
Cost 22366 24480
Margin 2932 3774
Engineering Maintenance Contract has delivered results better than expected.
3.7.5 Forecasted Revenue for 2009 52
(Figures of 2008 are based on forecast)
Planned T/O RO 51.75million Planned Profit RO 5.55 million Net Profit Margin target 10.45%
Anticipated Turnover for 2008 RO 44.85 million Anticipated Profit for 2008 RO 5.55 million Anticipated Net Profit Margin for 2009 14.5%.
Table—3-5 Division Wise Performance
Turnover Fabrication Technical Projects EMU Division Total Cost Fabrication Technical Projects EMU Division Total Overhead Directors Fees Net Profit Before Tax Planned 10,354,829 1,727,767 14,362,451 25,300,000 51,745,047 9,434,365 1,226,996 12,687,019 22,367,418 45,715,798 986,375 353,002 4,689,873 Forecasted-2009 7,867,448 1,262,931 6,460,212 28,254,687 43,845,278 6,611,701 809,529 5,059,821 24,480,246 36,961,296 997,875 412,039 5,474,238
Business Plan 2010 Complete the construction works. New Office block. New lease land at Industrial Estate. New land acquired will use to setup facility for new projects. Open offices in other GCC countries.
Financial Performance 2002 to 2009
2002 Turnover Net Profit after tax Net Worth 4216 555 (1591)
2003 5455 184 (633)
2004 4900 145 571
2005 6928 125 1501
2006 11280 285 1785
2007 25000 1695 4136
2008 39166 2649 5241
2009 43845 5095 8555
FINANCIA L SUMMA RY
45000 40000 35000 30000 25000 20000 15000 10000 5000 0 -5000 2002 2003 2004 2005 2006 2007 2008 2009
Net Profit after tax Net Worth
FINANCIAL SUMMARY ASSETS & LIABILITIES
The total Assets (Fixed and Current) as on 31st Dec.2009 Total Liabilities (Long Term & Current) as on 31st Dec .2009 Equity and accumulated Reserves as on 31st Dec. 2009 3.7.7 Future Financial Planning
RO 3.5 million RO 2.5 million RO 1 million
1. 2. 3. 4. 5.
Approval of Capital Expenditure for OMR- 3 million Approval of acquisition of Proposed Land and Building at Salalah. Proceed with the setup of representation Office in all GCC Countries. Raise the Share Capital to RO 5 Million in the year 2010. Payment of Dividend of 75% proposed share holders
Table 3-7-Financial Summary
2005 1748 6 2006 2227 65 2007 3163 111 2008 4720 389 2009 4231 445
TURNOVER NET PROFIT
Chart-3-6 Financial Summary
FIN C AN IAL SU M Y M AR
5000 4500 4000 3500 VALUES 3000 2500 2000 1500 1000 500 0 6 2005 2006 2007 YEAR S 65 111 1748 2227 3163
4720 4231445 389
500 450 400 350 300 250 200 150 100 50 0 N PR FIT ET O T R O U N VER
ARABIAN INDUSTRIES HOLDING COMPANY STRUCTURE
ARABIAN INDUSTRIES LLC HOLDING CO.
ARABIAN INDUSTRIES PROJECT LLC
ARABIAN INDUSTRIES MANUFACTURING CO. LLC
ARABIANINDUSTRIES TECHNICAL SUPPORT LLC
PARSONARABIANINDUSTRIES - JV
NORM ARABIAN INDUSTRIES JV
OBJECTIVES FOR 2010 • Executing jobs in hand in line with schedule & budgets Secure at least 5 projects in the range of 30 Million USD under EMU. Achieve a net profit of RO 6.5 Million (before tax and after adjustment of Management fees) Expand client base especially for the Fabrication Shop. Buildup strong management at various levels to meet the Company long term objectives. FIVE YEAR PLANNED TURNOVER
• • •
Value in RO Million BUSINESS UNIT Engineering Maintenance Contract Arabian Industries Manufacturing Arabian Industries Technical Support Arabian Industries Projects Total 2010 20.000 10.000 2.500 30.000 62.500 2011 25.000 13.000 3.000 35.000 75.000 2012 25.000 15.000 3.500 40.000 83.500 2013 25.000 18.000 4.000 45.000 92.000 2014 25.000 20.000 5.000 50.000 100.000
Chart-3-7 - Cash Flow Analysis
C S F O 2 09 AH L W 0
6 00 0 0 0
5 00 0 0 0
4 00 0 0 0
3 00 0 0 0
2 00 0 0 0
1 00 0 0 0
0 JAN FEB M AR APR M AY J N U M NH O T S JU L AU G SE P O T C N V O D EC
Table – 3-9 Cash Flow Analysis
Jan/10 301900.3 Jul/10 143654.6
Feb/10 511660.3 Aug/10 90899.45
Mar/10 352984.5 Sep/10 192841.2
Apr/10 289537.8 Oct/10 278427.7
May/10 225635.8 Nov/10 347378.2
Jun/10 179465.6 Dec/10 571331.5
CASH FLOW ANALYSIS – 2009
CASH FLOW FORECAST FOR THE YEAR 2009
PERT. JAN FEB MAR APR MAY JUN JUL AUG
CURRENCY IN OMANI RIYAL
SEP OCT NOV DEC
Projects Division Manufacturing
172,500 172,500 172,500 172,500 172,500 172,500 189,750 189,750 189,750 189,750 189,750 189,750
Division NORM Contract Engineering & Maintenance Contract Total Inflow ( collection from
7,037,999 6,902,874 6,767,750 6,497,500 6,497,500 6,624,000 6,641,250 6,641,250 7,273,750 7,273,750 7,273,750 7,906,250 5,060,000 5,060,000 5,060,000 5,060,000 5,060,000 5,060,000 5,060,000 5,060,000 5,692,500 5,692,500 5,692,500 6,325,000
contract Receivables) Salary & Wages (excluding Gratuity) Suppliers / Sub Contractors 4,926,599 4,832,011 4,737,425 4,548,250 4,548,250 4,636,800 4,648,875 4,648,875 5,091,625 5,091,625 5,091,625 5,534,375 1,446,953 1,461,422 1,476,037 1,623,640 1,623,640 1,639,877 1,656,275 1,672,838 1,689,566 1,706,462 1,723,527 1,740,762
Creditors LC & LTR Other Expenses (including Fuel + Vehicle ministrative Overheads) Income Tax
25,000 211,140 207,086 203,033 194,925 194,925 198,720 199,238 199,238 218,213 218,213 218,213 237,188
Bank Charges & Bank Interest Cost
Total Out Flow Net Inflow / Out
Surplus / (deficit)
BUSINESS PLAN - 2010 Table-3-10-Business Plan
Business Unit Arabian Industries Fabrication Unit Arabian Industrial Maintenance Unit Arabian Industries Projects Unit
8,945,451 1,614,118 29,690,189
7,737,077 1,161,660 26,765,988
1,208,374 452,457 2,924,202
EMU Total Overhead Management Fees Net Profit before Tax
19,872,181 55,536,905 1,220,241 454,483 4,528599
3,127,822 7,712,855 -1,220,241 -454,483 6,038,131
Business Unit ARABIAN INDUSTRIES MANUFACTURING UNIT INVESTMENT – AIR COOLERS INTL ARABIAN INDUSTRIES TECHNICAL SUPPORT UNIT INVESTMENT IN NEW TECHNOLOGY ARABIAN INDUSTRIES PROJECT DEVELOPMENNT UNIT NEW PROJECT ENGINEERING MAINTENANCE UNIT CORPORATE TOTAL
Amount in RO
1,018,613 517,500 572,355 697,475 616,613 2,535,893 718,520 46,000 6,722,968
Investment in proposed project OMR 6 Million Equivellant to USD#15,463,917.00
FINANCING PROPOSED FOR THE CAPITAL EXPENDITURE
Total Capital Expenditure planned for 2010 Term Loan for New Project-1 Term loan for New Project 2 Term loan for New project 3 Balance financed by Cash generated from operations
6,000,000 2,500,000 3,000,000 1,500,000 500,000
3.7.10 FUTURE PROPOSALS
Approval of Capital Expenditure RO 6,000,000 Approval of acquiring of shares in new company. Proceed with the setup of representation Office in all GCC countries Raise the Share Capital to RO 5 Million by allocating RO 500,000 from the profits of year 2010.
Approval of payment of Management fees to CMD 10% of Net Profit before tax. Adjust the management fees payable to directors with the amounts receivable from sister co. Payment of Dividend of RO 5,000,000/ to the members by 31st March 2010.
3.8 LITERATURE REVIEW - AN OVER VIEW
“A literature review is an essay or is part of the introduction to an essay, research report, or thesis. It provides an overview and critical analysis of relevant published scholarly articles, research reports, books, theses etc on the topic or issue to be investigated. A detailed guide to the literature review is available on the Language and Learning services website. Literature search: A systematic and exhaustive search for published material on a specific topic.”
It discusses published information in a particular subject area, and sometimes information in a
particular subject area within a certain time period. It is a summary of research that has been published about a particular subject. It provides the reader with an idea about the current situation in terms of what has been done, and what we know. Sometimes it includes suggestions about what needs to be done to increase the knowledge and understanding of a particular problem.
It gives an overview of what has been said, who the key writers are, what are the prevailing
theories and hypotheses, what questions are being asked, and what methods and methodologies are appropriate and useful. As such, it is not in itself primary research, but rather it reports on other findings. Literature reviews can give you an overview or act as a stepping stone. It also provide a solid background for a research paper's investigation. A
LITERATURE REVIEW MUST DO THESE THINGS:
be organized around and related directly to the thesis or research question you are developing synthesize results into a summary of what is and is not known identify areas of controversy in the literature formulate questions that need further research
Structuring a literature review It is often difficult to decide how to organize the huge amount of information you have collected. The structure of each dissertation will be different but there are some general principles and these are really the guidelines you should use for any piece of academic writing. Structuring a literature review Introduction to the literature review Main part Conclusions A literature review is a piece of discursive prose, not a list describing or summarizing one
piece of literature after another. It's usually a bad sign to see every paragraph beginning with the name of a researcher. Instead,
organize the literature review into sections that present themes or identify trends, including relevant theory. 3.9 ABSTRACT OF LITERATURE
The current study contributes to the literature by examining impact of working capital management on the operating performance and growth of new public companies. The study also sheds light on the relationship of working capital with debt level, firm risk, and industry. Using a sample of a manufacturing, the study finds a significant positive association between higher levels of accounts
receivable and operating performance. The study further finds that maintaining control (i.e. lower amounts) over levels of cash and securities, inventory, fixed assets, and accounts payables appears to be associated with higher operating performance, as well. We find that the firms which are experiencing unusually high growth tend not to perform as well as those with low to moderate growth. Further firms which are experiencing high growth tend to hold higher levels of cash and securities, inventory, fixed assets, and accounts payables. These findings tend to suggest that firms are willing to sacrifice performance (accept low or negative operating returns) to increase their growth levels. The higher level of growth is also associated with higher operating and financial risk. The findings of this study suggest that perhaps the firms should stay more focused on their operating performance than on maintaining high growth levels. 3.10 INTRODUCTION
Working capital policy refers to the firm's policies regarding 1) target levels for each category of current operating assets and liabilities, and 2) how current assets will be financed. Generally good working capital policy (i.e. under conditions of certainty) is considered to be one in which holdings of cash, securities, inventories, fixed assets, and accounts payables are minimized. The level of accounts receivables should be used as a means of stimulating sales and other income. Previous literature on working capital management has found a negative association, overall, between level of working capital and operating performance as measured by operating returns and operating margins (Peterson and Rajan, 1997). Under conditions of certainty (i.e. sales, costs, lead times, payment periods, and so on, are known), firms have little reason to hold more working capital than a minimum level.
AN ANALYSIS INTRODUCTION
WORKING CAPITAL MANAGEMENT RESULTS ACROSS INDUSTRIES :-
The importance of efficient working capital management (WCM) is indisputable. Working capital is the difference between resources in cash or readily convertible into cash (Current Assets) and
organizational commitments for which cash will soon be required (Current Liabilities). The objective of working capital management is to maintain the optimum balance of each of the working capital components. Business viability relies on the ability to effectively manage receivables, inventory, and payables. Firms are able to reduce financing costs and/or increase the funds available for expansion by minimizing the amount of funds tied up in current assets. Much managerial effort is expended in bringing non-optimal levels of current assets and liabilities back toward optimal levels. An optimal level would be one in which a balance is achieved between risk and efficiency. A recent example of business attempting to maximize working capital management is the recurrent attention being given to the application of Six Sigma® methodology. When used to identify and rectify discrepancies, inefficiencies and erroneous transactions in the financial supply chain, Six Sigma® reduces Days Sales Outstanding (DSO), accelerates the payment cycle, improves customer satisfaction and reduces the necessary amount and cost of working capital needs. There appear to be many success stories, including Jennifer Towne’s (2002) report of a 15 percent decrease in days that sales are outstanding, resulting in an increased cash flow of approximately 2 million dollars at Thibodaux Regional Medical Center. Furthermore, bad debts declined from 3.4 million dollar to o 600,000 dollar. Even in a business using Six Sigma® methodology, an “optimal” level of working capital management needs to be identified. Industry factors may impact firm credit policy, inventory management, and bill-paying activities. Some firms may be better suited to minimize receivables and inventory, while others maximize payables. Another aspect of “optimal” is the extent to which poor financial results can be tied to sub-optimal performance. Fortunately, these issues are testable with data published by CFO magazine (Mintz and Lazere 1997; Corman 1998; Mintz 1999; Myers 2000; Fink 2001), which claims to be the source of “tools and information for the financial executive,” and are the subject of this research.
The following section presents a brief literature review. Next, the research method is described, including some information about the annual Working Capital Management Survey published by CFO magazine. Findings are then presented and conclusions are drawn.
Many researchers have studied working capital from different views and in different
environments. The following are some useful research: 3.12 RELATED LITERATURE
The importance of working capital management is not new to the finance literature. Over twenty years ago, Largay and Stickney (1980) reported that the then-recent bankruptcy of W.T. Grant, a nationwide chain of department stores, should have been anticipated because the corporation had been running a deficit cash flow from operations for eight of the last ten years of its corporate life. As part of a study of the Fortune 500’s financial management practices. Following are the important views of scholars about working capital management.
1 GILBERT AND REICHERT (1995) :
Find that accounts receivable management models are used in 59 percent of these firms to improve working capital projects, while inventory management models were used in 60 percent of the companies. More recently, Farragher, Kleiman and Sahu (1999) find that 55 percent of firms in the S&P Industrial index complete some form of a cash flow assessment, but did not present insights regarding accounts receivable and inventory management, or the variations of any current asset accounts or liability accounts across industries. Thus, mixed evidence exists concerning the use of working capital management techniques. Theoretical determination of optimal trade credit limits are the subject of many articles over the years (e.g., Schwartz 1974; Scherr 1996), with scant attention paid to actual accounts receivable management. Across a limited sample,
2 WEINRAUB AND VISSCHER (1998) :
Observe a tendency of firms with low levels of current ratios to also have low levels of current liabilities. Simultaneously investigating accounts receivable and payable issues, Hill, Sartoris, and Ferguson (1984) find differences in the way payment dates are defined. Payees define the date of payment as the date payment is received, while payers view payment as the postmark date. Additional WCM insight across firms, industries, and time can add to this body of research. Maness and Zietlow (2002, 51, 496) presents two models of value creation that incorporate effective short-term financial management activities. However, these models are generic models and do not consider unique firm or industry influences. Maness and Zietlow discuss industry influences in a short paragraph that includes the observation that, “An industry a company is located in may have more influence on that company’s fortunes than overall GNP” (2002, 507).
3 ELJELLY, 2004 :
Elucidated that efficient liquidity management involves planning and controlling current assets and current liabilities in such a manner that eliminates the risk of inability to meet due short-term
obligations and avoids excessive investment in these assets. The relation between profitability and liquidity was examined, as measured by current ratio and cash gap (cash conversion cycle) on a sample of joint stock companies in Saudi Arabia using correlation and regression analysis. The study found that the cash conversion cycle was of more importance as a measure of liquidity than the current ratio that affects profitability. The size variable was found to have significant effect on profitability at the industry level. The results were stable and had important implications for liquidity management in various Saudi companies. First, it was clear that there was a negative relationship between profitability and liquidity indicators such as current ratio and cash gap in the Saudi sample examined. Second, the study also revealed that there was great variation among industries with respect to the significant measure of liquidity.
4 BERGAMI ROBERT (2007) :
Analysis that that international trade transactions carry inherently more risk than domestic trade transactions, because of differences in culture, business processes, laws and regulations. It is therefore important for traders to ensure that payment is received for goods dispatched and that the goods received and paid for comply with the contract of sale. One effective way of managing these risks has been for traders to rely on the letter of credit as a payment method. However for exporters in particular, the letter of credit has presented difficulties in meeting the compliance requirements necessary for the payment to be triggered. The current rules that govern letter of credit transactions(UCP 500) have been under review for the past three years and an updated set of rules (UCP 600) is expected to be introduced on 1July 2007. This paper focuses on the changes mooted for 2007and compares these main issues with the existing rules and other associated guidelines and regulations governing this method of payment. This paper considers the implication to changes of letter of credit transactions and the sharing of risk. Firstly the paper provides some background to letters of credit, then comments on existing literature and models, and subsequently an analysis of the most important changes to the existing rules, before reaching a conclusion. The conclusion is that the UCP 600 have not paid enough consideration to traders and service providers and are likely to engender an environment of uncertainty for exporters in particular.
1-INTRODUCTION 2-NEED OF WORKING CAPITAL 3-CONCEPT OF WORKING CAPITAL 4-CLASSIFICATION OF WORKING CAPITAL 5-DETERMINANTS OF WORKING CAPITAL
INTRODUCTION- WORKING CAPITAL MANAGEMENT “Working capital occupies a peculiar position in the capital structure of a company. The decision as to the adequacy of working capital is a complicated and yet a very important decision”.
Working capital is the life-blood of all types of enterprises, manufacturing and trading both. It is constantly required to buy raw materials for payment of wages and other day-to-day expenses. Without adequate working capital, manufacturing operations will be crippled. For trading enterprises, the capacity to stock a variety of goods for sale depends upon its working capital. It is a base on which all the activities of business enterprise depend. Many companies still under estimate the importance of working capital management as a lever for freeing up cash from inventory, accounts receivable, and accounts payable. By effectively managing these components, companies can sharply reduce their dependence on outside funding and can use the released cash for further investments or acquisitions. This will not only lead to more financial flexibility, but also create value and have a strong impact on a company’s enterprise value by reducing capital employed and thus increasing asset productivity. High working capital ratios often mean that too much money is tied up in receivables and inventories. Typically, the knee-jerk reaction to this problem is to apply the “big squeeze” by aggressively collecting receivables, ruthlessly delaying payments to suppliers and cutting inventories across the board. But that only attacks the symptoms of working capital issues, not the root causes. A more effective approach is to fundamentally rethink and streamline key processes across the value chain. This will not only free up cash but lead to significant cost reductions at the same time. Only those enterprises which have adequate working capital can survive in times of depression. The investment in raw materials becomes long- term investments during depression and cash flow declines due to fall in sale. In such circumstances only enterprises with adequate working capital can survive. Excessive working capital is equally unprofitable. The extra working capital is not utilized in business operations and earns no profit for the firm. It results in unnecessary accumulation of inventories, leading to inventory mishandling, waste, theft etc. The abundance of working capital would lead to waste and inefficiency Shortage of working capital funds renders the firm unable to avail attractive credit opportunities etc. The firm loses its reputation when it is not in a position to honor its short term obligations. As a result, the firm faces tight credit terms. It stagnates growth. Definition:1.According to Guttmann & Dougall:-
“Working capital is defined as current assets minus current liabilities”. A positive position means that a company is able to support its day-to-day operations. i.e. to serve both maturing short-term debt and upcoming operational expenses. 2. According to Park & Gladson:“The excess of current assets of a business (i.e. cash, accounts receivables, inventories) over current items owned to employees and others (such as salaries & wages payable, accounts payable, taxes owned to government)” “Working capital like many other accounting terms and financial terms has been used by different people in different senses.”
One school of thought believes that, as all capital resources available to a business organization – From shareholders, bondholders, and creditors (secured and unsecured) works up in the business activities to generate revenues and facilitate future expansion and growth; they are to be considered as ‘working capital’. Another school of thought links working capital with current assets and current liabilities. According to them, the excess of current assets over current liabilities is to be rightly considered as the working capital of a business organization. According to “Shubin” working capital is “the amount of funds necessary to cover the cost of operating the enterprise. Working capital in a going concern is a revolving (circulating fund), it consists of cash receipts from sales which are used to cover the cost of current operations. “Circulating capital means current assets of the company that are changed in the ordinary course of business from one form to another, as for example from cash to inventories, inventories to receivables and receivables to cash.” “Working capital is descriptive of that capital which is not fixed. But, the more common use of working capital is to consider it as the difference between the current assets and the current liabilities”. Current assets and current liabilities are assets and liabilities which arise in the course of business. The WC demonstrates the amount of liquid assets that are available to sustain and build the business by measuring company’s efficiency and short-term financial health. As such, it carries great value to those who might be interested in investing in business or even purchasing it. Working capital, also known as net working capital, is a measurement of a business’s current assets, after subtracting its short-term liabilities, typically short term. Sometimes referred to as operating capital, it is a valuation of the assets that a business or organization has available to manage and build the business. Generally speaking, companies with higher amounts of working capital are
better positioned for success because they have the liquid assets that are essential to expand their business operations when required. Characteristics of Working Capital Working capital is the life blood and nerve centre of a business. Just as circulation of blood is essential in the human body for maintaining life, working capital is very essential to maintain the smooth running of a business. No business can run successfully with out an adequate amount of working capital. The features of working capital distinguishing it from the fixed capital are as follows: 1 Short term Needs: Working capital is used to acquire current assets which get converted into cash in a short period. In this respect it differs from fixed capital which represents funds locked in long term assets. The duration of the working capital depends on the length of production process, the time that elapses in the sale and the waiting period of the cash receipt. 2 Circular Movement:
Working capital is constantly converted into cash which again turns into working capital. This process of conversion goes on continuously. The cash is used to purchase current assets and when the goods are produced and sold out; those current assets are transformed into cash. Thus it moves in a circular away. That is why working capital is also described as circulating capital. 3 An Element of Permanency: Though working capital is a short term capital, it is required always and forever. As stated before, working capital is necessary to continue the productive activity of the enterprise. Hence so long as production continues, the enterprise will constantly remain in need of working capital. The working capital that is required permanently is called “permanent or regular working capital”. 4 An Element of Fluctuation: Though the requirement of working capital is felt permanently, its requirement fluctuates more widely than that of fixed capital. The requirement of working capital varies directly with the level of production. It varies with the variation of the purchase and sale policy; price level and the level of
demand also. The portion of working capital that changes with production, sale, price etc. is called “variable working capital”. 5 Liquidity: Working capital is more liquid than fixed capital. If need arises, working capital can be converted into cash within a short period and without much loss. A company in need of cash can get it through the conversion of its working capital by insisting on quick recovery of its bills receivable and by expediting sales of its product. It is due to this trait of working capital that the companies with a larger amount of working capital feel more secure.’ 6 Less Risky: Funds invested in fixed assets get locked up for a long period of time and can not be recovered easily. There is also a danger of fixed assets like machinery getting obsolete due to technological innovations. Hence investment in fixed capital is comparatively more risky. As against this, investment in current assets is less risky as it is a short term investment. Working capital involves more of physical risk only, and that too is limited. Moreover, working capital gets converted into cash again and again; therefore, it is free from the risk arising out of technological changes. 7 Special Accounting System not needed: Since fixed capital is invested in long term assets, it becomes necessary to adopt various systems of estimating depreciation. On the other hand working capital is invested in short term assets which last for one year only. Hence it is not necessary to adopt special accounting system for them. Among the most important items of working capital are levels of inventory, accounts receivable, and accounts payable. Working capital can be expressed as a positive or a negative number. “When a company has more debts than current assets, it has negative working capital; When current assets outweigh debts, a company has positive working capital”. A company will try to manage cash by:
Identifying the cash balance that allows it to meet day-to-day expenses but minimizes the cost of holding cash;
Finding the level of inventory that allows for continuous production but lessens the investment in raw materials and reduces reordering costs;
Identifying the appropriate source of financing, given the cash-conversion cycle.
It may be necessary to use a bank loan or overdraft. However, inventory is preferably financed by credit arranged with the supplier. If a company is not operating efficiently, this will show up as an increase in the working capital. This can be judged by comparing the amounts of working capital from one period to another. Slow collection and inventory turnover may signal an underlying problem in the company’s operations. Advantages Proper management of working capital gives a firm the assurance that it is able to continue its operations and that it has sufficient cash flow to satisfy both maturing short term debt and upcoming operational expenses. Disadvantages If a company’s current assets do not exceed its current liabilities, then it may run into trouble paying back creditors in the short term. A declining working-capital ratio over a longer time period could also be a red flag that merits further analysis. For example, it could be that the company’s sales volumes are decreasing and, as a result, its accounts receivable are diminishing.
FACTORS INFLUENCING WORKING CAPITAL
NEED OF WORKING CAPITAL
Working capital is among the many important things that contribute to the success of a business. Without it, a business may cease to function properly or at all. Not only does a lack of working capital render a company unable to build and grow, but it may also leave a company with too little cash to pay its short-term obligations. Simply put, a company with a very low amount of working capital may be at risk of running out of money.
When a company has too little working capital, it can face financial difficulties and may even be forced toward bankruptcy. This is true of both very small companies and billion-dollar organizations. A company with this problem may pay creditors late or even skip payments. It may borrow money in an attempt to remain afloat. If late payments have affected the company’s credit rating, it may have difficulty obtaining a loan at an affordable interest rate.
The need for working capital gross or current assets cannot be over emphasized. As already observed, the objective of financial decision making is to maximize the shareholders wealth. To achieve this, it is necessary to generate sufficient profits can be earned will naturally depend upon the magnitude of the sales among other things but sales can not convert into cash. There is a need for working capital in the form of current assets to deal with the problem arising out of lack of immediate realization of cash against goods sold. Therefore sufficient working capital is necessary to sustain sales activity. Technically this is refers to operating or cash cycle.
4.3 CONCEPT OF WORKING CAPITAL
There are two concepts of working capital: 1. 2. Gross working capital Net working capital
Grossw Working Capital
“The gross working capital is the capital invested in the total current assets of the enterprises. Current assets are those Assets which can convert in to cash within a short period normally one accounting year.” Constituents of Current Assets.
Current assets are assets which are expected to be sold or otherwise used within one fiscal year. Typically, current assets include cash, cash equivalents, accounts receivable, inventory, prepaid accounts which will be used within a year, and short-term investments. 1 2 3 4 4.1 4.2 4.3 4.4 5 6 7 8 Cash in hand and cash at bank Bills receivables/Sundry debtors Short term loans and advances. Inventories of stock as: Raw material Work in process Stores and spares Finished goods Temporary investment of surplus funds. Prepaid expenses Accrued incomes. Marketable securities.
Net Working Capital “In a narrow sense, the term working capital refers to the net working capital. Net working capital is the excess of current assets over current liability” “NET WORKING CAPITAL = CURRENT ASSETS – CURRENT LIABILITIES.” Net working capital refers to the difference between current assets and current liabilities. Current liabilities are those claims of outsiders which are expected to mature for payment within an accounting year and include creditors, bills payable and outstanding expenses. Net working capital can be positive or negative Constituents of Current liabilities Current liabilities are considered as liabilities of the business that are to be settled in cash within the fiscal year. Current liabilities include accounts payable for goods, services or supplies, short-term loans, long-term loans with maturity within one year, dividends and interest payable, or accrued liabilities such as accrued taxes. 1. Accrued or outstanding expenses. 2. Short term loans, advances and deposits.
3. Dividends payable. 4. Bank overdraft. 5. Provision for taxation, if it does not amount to appropriation of profit. 6. Bills payable. 7. Sundry creditors. The gross working capital concept is financial or going concern concept whereas net working capital is an accounting concept of working capital. Both the concepts have their own merits. The gross concept is sometimes preferred to the concept of working capital for the following reasons: 1. 2. 3. 4. It enables the enterprise to provide correct amount of working capital at correct time. Every management is more interested in total current assets with which it has to operate then the source from where it is made available. It take into consideration of the fact every increase in the funds of the enterprise would increase its working capital. This concept is also useful in determining the rate of return on investments in working capital. The net working capital concept, however, is also important for following reasons: 1. It is qualitative concept, which indicates the firm’s ability to meet to its operating expenses and short-term liabilities. 2. IT indicates the margin of protection available to the short term creditors. 3. It is an indicator of the financial soundness of enterprises. 4. It suggests the need of financing a part of working capital requirement out of the permanent sources of funds. Working capital, on the one hand, can be seen as a metric for evaluating a company’s operating liquidity. A positive working capital position indicates that a company can meet its short-term obligations. On the other hand, a company’s working capital position signals its operating efficiency. Comparably high working capital levels may indicate that too much money is tied up in the business. The most important positions for effective working capital management are inventory, accounts receivable, and accounts payable. Depending on the industry and business, prepayments received from customers and prepayments paid to suppliers may also play an important role in the company’s cash flow. Excess cash and no operational items may be excluded from the calculation for better comparison. 4.4 CLASSIFICATION OF WORKING CAPITAL
Working capital may be classified in to ways: • • On the basis of concept. On the basis of time.
On the basis of concept working capital can be classified as gross working capital and net working capital. On the basis of time, working capital may be classified as: • • Permanent or fixed working capital. Temporary or variable working capital
A-Permanent OR Fixed Working Capital. The operating cycle is a continuous feature in almost all the going concerns and therefore creates the need for working capital and their efficient management. However the magnitude of working capital required will not be constant, but will fluctuate. At any time, there is always a minimum level of current assets which is constantly and continuously required by a business unit to carry on its operations. This minimum amount of current assets, which is required on a continuous and uninterrupted basis, is after referred to as fixed or permanent working capital. This type of working capital should be financed (along with other fixed assets) out of long term funds of the unit. However in practice, a portion of these requirements also is met through short term borrowings from banks and suppliers credit. Chart 4-1 Permanent Working Capital
The amount of Current Assets require to meet a firms long term minimum needs
Value Permanent Current Asset O Time Permanent Working Capital The amount of current assets required to meet a firm’s long-term minimum needs are called Permanent current assets. X
For e.g., In a manufacturing unit, basic raw materials required for production has to be available at all times and this has to be financed without any disturbance. B-Temporary OR Variable Working Capital. Any amount over and above the permanent level of working capital is variable, temporary or fluctuating working capital. This type of working capital is generally financed from short term sources of finance such as bank credit because this amount is not permanently required and is usually paid back during off season or after the contingency. As the name implies, the level of fluctuating working capital keeps on fluctuating depending on the needs of the unit unlike the permanent working capital which remains constant over a period of time. The Temporary or Variable working capital is the amount of working capital which is required to meet the seasonal demands and some special exigencies. Variable working capital can further be classified as Seasonal Working Capital and Special Working Capital. The capital required to meet the seasonal need of the enterprise is called seasonal working capital. Special working capital is that part of working capital which is required to meet special exigencies such as launching of extensive marketing for conducting research, etc. Temporary working capital differs from Permanent working capital in the sense that is required for short periods and cannot be permanently employed gainfully in the business. Chart 1-2 Temporary Working Capital Y
The amount of Current Asset required to meet short term minimum needs
Temporary current assets Value Permanent Working Capital
Time Temporary Working Capital 4.5 DETERMINANTS OF WORKING CAPITAL
Working capital management is an indispensable functional area of management. However the total working capital requirements of the firm are influenced by the large number of factors. It may however be added that these factors affect differently to the different units and these keep varying from time to time. In general, the determinants of working capital which are common to all organizations can be summarized as under: Nature of Business
This is one of the main factors. Usually in trading businesses the working capital needs are higher as most of their investment is concentrated in stock or inventory. Manufacturing businesses also need a good amount of working capital to meet their production requirements. Whereas, those companies that sell services and not goods, on a cash basis require least working capital because there is no requirement on their part to maintain heavy inventories. Size of Business
In very small company the working capital requirement is quit high due to high overhead, higher buying and selling cost etc. as such medium size business positively has edge over the small companies. But if the business start growing after certain limit, the working capital requirements may adversely affect by the increasing size. Credit Terms / Credit Policy
Some time due to competition or custom, it may be necessary for the company to extend more and more credit to customers, as result which more and more amount is locked up in debtors or bills receivables which increase the working capital requirement. On the other hand, in the case of purchase, if the credit is offered by suppliers of goods and services, a part of working capital requirement may be financed by them, but it is necessary to purchase on cash basis, the working capital requirement will be higher. Credit terms greatly influence working capital needs. If terms are: buy on credit and sell by cash, working capital is lower buy on credit and sell on credit, working capital is medium buy on cash and sell on cash, working capital is medium buy on cash and sell on credit, working capital is higher.
Prevailing trade practices and changing economic condition do generally exert greater influence on the credit policy of concern. A liberal credit policy if adopted more trade debtors would result and when the same is tightened, size of debtors gets slim. Credit periods also influence the size and composition of working capital. When longer credit period is allowed to debtors as against the one extended to the firm by its creditors, more working capital is needed and vice versa.
Collection policy is another influencing factor. A stringent collection policy might not only deter away some credit customers, but also force the existing customers to be prompt in settling dues resulting in lower level of working capital. The opposite holds well with a liberal collection policy. Collection procedure also influences the working capital needs. A decentralized collection of dues from customers and centralized payments to suppliers shall reduce the size of working capital. Centralized collections and centralized payments would lead to moderate level of working capital. But with centralized collections and decentralized payments, the working capital need would be the highest. Seasonality Seasonality of Production Agriculture and food processing and preservation industries have a seasonal production. During seasons, when production activities are in their peak, working capital need is high. Seasonality in supply of raw materials This also affects the size of working capital. Industries that use raw materials which are available during seasons only, have to buy and stock those raw materials. They cannot afford to buy these items in a phased way, since either supplies would get reduced or prices would be higher. Also, from the point of view of quality of raw materials, it pays to buy in bulk during the seasons. Hence the high level of working capital needed when season exists for raw materials. Seasonality of demand for finished goods In case of products like umbrella, rain-coats and other seasonal items, the demand is high during peak seasons. But the production of these items has to be continuous throughout the year to meet the high demand during peak seasons. Thus, working capital requirement would be higher.
“Since Arabian Industries LLC is a contracting company, the above mentioned seasonal factors do not affect its operation or its business cycle. “ Business Trade Cycle
Trade cycle refers to the periodic turns in business opportunities from extremely peak levels, via a slackening to extremely tough levels and from there, via a recovery phase to peak levels, thus completing a business cycle. There are 4 phases of trade cycle.
Boom Period – more business, more production, more working capital. Depression period – less business, less production, less working capital.
Recession period – slackening business, stock pile-up, more working capital. Recovery period – recouping business, stock speedily converts to sales, less working capital. Inflation
Under inflationary conditions generally working capital increases, since with rising prices demand reduces resulting in stock pile-up and consequent increase in working capital. Length of Production cycle
The time lapse between feeding of raw material into the machine and obtaining the finished goods out from the machine is what is described as the length of manufacturing process. It is otherwise known as conversion time. Longer this time period, higher is the volume and value of work-in-progress and hence higher the requirement of working capital and vice versa. System of Production process
If capital intensive, high-technology automated system is adopted for production, more investment in fixed assets and less investment in current assets are involved. Also, the conversion time is likely to be lower, resulting in further drop in the level of working capital. On the other hand, if labor intensive technology is adopted, less investment in fixed assets and more investment in current assets which would lead to higher requirement of working capital. Growth and expansion plans Growth and expansion industries need more working capital than those that are static. Profitability
The profitability of the business may be vary in each and every individual case, which is in turn its depend on numerous factors, but high profitability will positively reduce the strain on working capital requirement of the company, because the profits to the extend that they earned in cash may be used to meet the working capital requirement of the company. Operating efficiency
If the business is carried on more efficiently, it can operate in profits which may reduce the strain on working capital; it may ensure proper utilization of existing resources by eliminating the waste and improved coordination etc. Apart from the above factors, dividend policy, depreciation policy, price level changes, operating efficiency and government regulations also influence the level and the size of working capital.
Length of Production cycle System of Production process
Business Trade cycle
WORKING CAPITAL Profitability
Nature of the Business
Credit term or Credit policy
Size of the Business
CHAPTER – V
1) INTRODUCTION 2) SCOPE OF THE STUDY 3) TYPES OF DATA COLLECTION 4) OBJECTIVE OF STUDY 5) LIMITATIONS OF STUDY
5.1 RESEARCH METHODOLOGY - INTRODUCTION 80
Research Methodology is a purposeful, precise and systematic search for new knowledge, skills, attitudes and values, or for the re-interpretation of existing knowledge, skills, attitudes and values. Research methodology is a way to systematically solve the research problem. It may be understood as a science of studying now research is done systematically. In that various steps, those are generally adopted by a researcher in studying his problem along with the logic behind them.
Data collection is important step in any project and success of any project will be largely depend upon now much accurate you will be able to collect and how much time, money and effort will be required to collect that necessary data, this is also important step.
Various Steps for Research Methodology
This project requires a detailed understanding of the concept – “Working Capital Management”. Therefore, firstly we need to have a clear idea of what is working capital, how it is managed in AI LLC, what are the different ways in which the financing of working capital is done in the company. The management of working capital involves managing inventories, accounts receivable and payable and cash. Therefore one also needs to have a sound knowledge about cash management, inventory management and receivables management. Then comes the financing of working capital requirement, i.e. how the working capital is financed, what are the various sources through which it is done. And, in the end, suggestions and recommendations on ways for better management and control of working capital are provided. 5.2 SCOPE
OF THE STUDY
This project is vital to us in a significant way. It does have some importance for the company too. These are as follows:– This project will be a learning device for the finance student.
Through this project we would study the various methods of the working capital management.
The project will be a learning of planning and financing working capital.
The project would also be an effective tool for credit policies of the companies.
This will show different methods of holding inventory and dealing with cash and receivables.
This will show the liquidity position of the company and also how do they maintain a particular liquidity position.
5.3 TYPES OF DATA COLLECTION There are two types of data collection methods available. 1. 2. 5.3.1 Primary data collection Secondary data collection
Primary data collection method Primary data is the data which the researcher collects through various methods like interviews, surveys, questionnaires etc, to support the secondary data. Some advantages and disadvantages of primary data are as follows:
Secondary data collection method Secondary data is data collected by someone other than the user. Common sources of secondary data for social science include censuses, surveys, organizational records and data collected through qualitative methodologies or qualitative research. Primary data, by contrast, are collected by the investigator conducting the research.
This project is based on primary data collected through personal interview of head of Finance Department, head of Statistical Quality Control department and other concerned staff member of finance department. But primary data collection had limitations such as matter confidential information thus project is based on secondary information collected through four years annual report of the company, supported by various books and internet sides. The data collection was aimed at study of working capital management of the company. Project is based on: Financial Report of Arabian Industries LLC – 2004-2005-2006-2007-2008-2009 5.4 OBJECTIVES OF THE STUDY. This research is focusing on working capital management and its effects on profitability for a sample of Omani firm. Study of the working capital management is important because unless the working capital is managed effectively, monitored efficiently planed properly and reviewed periodically at regular intervals to remove bottlenecks if any the company can not earn profits and increase its turnover. With this primary objective of the study, the following further objectives are framed for a depth analysis. 5.4.1 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. The Main objectives of the studies are: To study the way and means of working capital finance of the company. To estimate the operating cash cycle and working capital requirement of the company. To establish a relationship between Working Capital Management and Profitability over a period of five years of the company.. To find out the effects of different components of working capital management on Profitability To establish a relationship between the two objectives of liquidity and profitability of the Omani firm. To find out the relationship between debt used by Arabian Industry LLC and its Profitability To draw conclusion about relationship of working capital management and profitability of the company. To study the optimum level of current assets and current liabilities of the company. To study the liquidity position through various working capital related ratios. To study the working capital components such as receivables accounts, cash management, Inventory position
Analysis Used in Study : Descriptive analysis. Descriptive Statistics are used to describe the basic features of the data in a study. They provide simple summaries about the sample and the measures. Together with simple graphics analysis, they form the basis of virtually every quantitative analysis of data. With descriptive statistics you are simply describing what is, what the data shows
Research Design STEP 1 - To study the Financial Statement of Arabian Industries LLC STEP 2 – Data Analysis of working capital through Estimation of Working Capital. STEP 3 – Analysis of Inventory Management of Arabian Industries LLC. STEP 4 – Comparison of base year data’s with previous years datas.
Data Collection The information is collected through the Primary Source like:-
Interviewing the employees of the department. Getting information from MIS department. Discussion with the head of the Finance department and Procurement department. 126.96.36.199 The Data was collected from following Secondary Sources like:-
Corporate department Procurement department Finance department Logistic Department
5.5 SCOPE AND LIMITATIONS OF THE STUDY
5.5.1 Scope of the study The scope of the study is identified after and during the study is conducted. The study of working capital is based on tools like trend Analysis, Ratio Analysis, working capital leverage, operating cycle etc. Further the study is based on last 5 years Annual Reports of ArabianIndustries LLC,
And even factors like competitor’s analysis, industry analysis were not considered while preparing this project. 5.5.2 Limitations of the study Following limitations were encountered while preparing this project: 1) Limited data:This project has completed with annual reports; it just constitutes one part of data collection i.e. secondary. There were limitations for primary data collection because of confidentiality. 2) Limited period:This project is based on five year annual reports. Conclusions and recommendations are based on such limited data. The trend of last five year may or may not reflect the real working capital position of the company 3) Limited area:Also it was difficult to collect the data regarding the competitors and their financial information. Industry figures were also difficult to get.
RESEARCH METHODOLOGY – DATA TO ACTION
1) Working capital level. 2) Working capital trend analysis. 3) Current assets analysis. 4) Current liability analysis. 5) Changes of working capital 6) Operating cycle 7) Working capital leverage
Working Capital level
The guiding principle for working capital is called the hedging principle or principle of self-liquidating debt or matching principle (different from the matching principle used in measuring accounting profit). It is an accepted belief in business that the term of a funding arrangement must match the term of the investment itself. This means that any funds used for short-term assets or purposes should be financed from short-term sources. Likewise investments in long term-assets should be funded from long-term sources. Therefore a key criterion for acquiring additional finance is matching up the life of the assets acquired with the term of the loan or other method of funding. For example, the buying of an unusually large quantity of inventory should be financed by a loan, or credit, with a repayment period of less than one year. The level of any long-term assets funded by short-term debt shows the firm's level of 'aggression' in its financing policy. Although this type of action may increase profits (due to the lower cost of short-term debt) it greatly increases the risk of cash shortages if short-term financing can't be renewed. Table 6.1- Size of Working Capital
SOURCE: COMPANY REPORT
EXTRACTED FROM AUDITED BALANCE SHEET OF ARABIAN INDUSTRIES LLC 2004 CURRENT ASSET Bank Balances Trade Debtors Inventory Work in Progress Dues from Related Parties Other Receivables TOTAL CURRENT ASSETS 45,595 2,18 8,348 1 12,639 1,75 8,719 3 49,388 4,45 4,689 CURRENT LIABILITIES Short-term Borrowings Current Portion of Long Term loan Trade Creditors Dues to Related Parties Provisions - Tax Other Payables 3 40,867 1 47,493 1,17 1,301 4 49,842 1,21 7,574 1 96,786 2,92 1,799 4 59,404 2,14 2,770 52,319 5,77 3,078 9 00,676 1 84,717 3,01 3,726 2,043 27,422 1,53 3,552 67,900 7,70 2,727 1 60,412 2,77 3,635 2 14,325 7 25,857 11,64 4,857 2,04 9,745 4 98,801 5,15 4,023 23,504 1 82,064 3,48 9,970 5 62,828 12,54 3,178 3 73,118 1,27 5,523 1 91,658 5 12,228 15,45 8,533 1,43 6,567 6,84 0,688 31,073 1 75,183 6,65 2,454 1 43,351 20,19 4,201 5 63,989 1,42 2,625 3 16,956 3 36,700 22,97 7,822 2,01 5,753 1,50 3,569 10,29 3,795 1,49 9,973 4 02,530 6,94 8,035 1,892,3 72 13,437,9 81 724,1 45 2,274,6 90 4,632,7 89 99,2 43 23,061,2 19 553,8 12 2,188,4 46 6,186,8 54 420,9 00 922,4 51 5,588,5 69 2005 2006 2007 2008 2009
TOTAL CURRENT LIABILITIES NET WORKING CAPITAL - (A-B)
3,32 7,077 1,127,612
5,66 2,135 110,943
11,39 8,106 246,751
15,13 5,965 322,568
22,66 3,655 314,167
15,861,0 31 7,200,188
CAPITAL TREND ANALYSIS
Trend analysis is an improvement over the year to year analysis. When a comparison of Financial Statements covering more than 3 years is undertaken, the year to year analysis becomes cumbersome. In trend analysis, the changes are calculated for several successive years instead of two or three years. Therefore the trend analysis is a company's financial position over a long period of time. Trend analysis is important as it may point to basic changes in the nature of business and also helps in drawing meaningful conclusions regarding the operating performance over several years and the financial position of the enterprise. It is based on the idea that what has happened in the past gives an idea of what will happen in the future. In working capital analysis the direction at changes over a period of time is of crucial importance. Working capital is one of the important fields of management. It is therefore very essential for an annalist to make a study about the trend and direction of working capital over a period of time. Such analysis enables as to study the upward and downward trend in current assets and current liabilities and it’s effect on the working capital position. In the words of S.P. Gupta “The term trend is very commonly used in day-today conversion
trend, also called secular or long term need is the basic tendency of population, sales, income, current assets, and current liabilities to grow or decline over a period of time”. According to R.C.Galeziem “The trend is defined as smooth irreversible movement in the
series. It can be increasing or decreasing.” Emphasizing the importance of working capital trends, Man Mohan and Goyal have pointed out that “analysis of working capital trends provide as base to judge whether the practice and privilege policy of the management with regard to working capital is good enough or an important is to be made in managing the working capital funds. Further, any one trend by it self is not very informative and therefore comparison with Illustrated their ideas in these words, “An upwards trends coupled with downward trend or sells, accompanied by marked increase in plant investment especially if the increase in planning investment by fixed interest obligation”
One of the main goals of trend analysis is to forecast future values of the series. It allows a researcher to look at a pattern of change over a long period of time rather than at a single discrete point in time or over a short time so that better conclusions can be drawn. Table 6.2 – Working Capital Variance Analysis.
ANALYSIS OF VARIANCE OF WORKING CAPITAL YEARS TOTAL CURRENT ASSETS TOTAL CURRENT LIABILITIES NET WORKING CAPITAL - (A-B) W-C VARIATION –in % 2004 4,454,689 3,327,077 1,127,612 100% 2005 5,773,078 5,662,135 110,943 9.84% 2006 11,644,857 11,398,106 246,751 21.88% 2007 15,458,533 15,135,965 322,568 28.61% 2008 22,977,822 22,663,655 314,167 27.86% 2009 23,061,219 15,861,031 7,200,188 638.53%
100 X Index Year Amount / Base Year Amount”)
Chart-6.1- Working capital index
WORKING CAPITAL INDEX
TOTAL CURRENT ASSETS TOTAL CURRENT LIA BILITIES NET WORKING CAPITAL - (A-B) W-C V ARIATION –in %
0 2004 2005 2006 2007 2008 2009
Table 6.3-Working capital size
ANALYSIS OF VARIANCE OF WORKING CAPITAL YEARS TOTAL CURRENT ASSETS TOTAL CURRENT LIABILITIES NET WORKING CAPITAL - (A-B) W-C VARIATION –in % 2004 4,454,689 3,327,077 1,127,612 100% 2005 5,773,078 5,662,135 110,943 9.84% 2006 11,644,857 11,398,106 246,751 21.88% 2007 15,458,533 15,135,965 322,568 28.61% 2008 22,977,822 22,663,655 314,167 27.86% 2009 23,061,219 15,861,031 7,200,188 638.53%
The computation of a series of Index Numbers requires the choice of a base year that will for all times have an index number of 100. The base period should be a normal year with regard to business conditions, since the base year used as a reference should be representative. Generally, the earliest year is selected as a base year. However, where the earliest year is selected as the normal year
then another year is chosen. All Index numbers are computed with reference to the base year using this formula 1.2.1 OBSERVATIONS
It was observed that major source of liquidity problem is the mismatch between current payments and current receipts from the Comparison of funds flow statements of AI LLC for six years. It was observed that in the year 2005 current assets increased by around 29.6% compared to 2004 and current liabilities increased by 70.18% which affect as working capital reduced by 9.84% in the year 2005 compared to 2004.because the net working capital was OMR 1,127,612/- in 2004 but in 2005 it was reduced to OMR 110,943/- in the year 2005 due to the increase in current liability of 70% compared to 2004. In 2004 current liability was OMR 3,327,077, where as in 2005 it was increased by OMR 2,335,058/-; a total liability of OMR 5,662,135/- in 2005.
In the year 2006, 2007, 2008 a tremendous increase we can see in current liability by 172.4%, 112.35%, and 226.26% res. and current asset also increased accordingly compared to 2004 like 131.8%, 85.61% and 168.79% during the year 2006, 2007, 2008. In the year 2009 we can see the growth of current asset is very less compared to 2004 with a percentage of only 1.87% where as in the current liability we can see there is a slop of -2004.46% compared to 2004, where as an increase in current asset for 73.478% compared to 2004 and a good nest asset (WC reserve) is with the firm for an increased percentage of 638.53% in the year 2009.
The position of working capital is very good in 2009 because the bank balance in 2008 was only 143,351/- OMR where as in 2009 it is increased to OMR 1,892,372/-; ie. 1220% compared to 2008, which is quite good and also we can see that there is receivable from related parties is 4,632,789/- in the year 2009, where as in 2008 it was only OMR 316,956/-; that means an increase is for 1361% in the year 2009 compared to 2008. That means the fund position is quite good for 2009.
While compared to 2004 current assets have been increased by 417.68% and current liabilities have been increased by 376.73%. But compared to 2008 and 2009 there is a short fall of -30.02% in current liabilities, where as an increase in current asset is only an increase of .36%. The bank balance is increased to OMR 1,892,372/- in 2009 from OMR 143,351/- in the year 2008.It shows that management is using only it’s own fund for the short term requirements and WC has been increased to
OMR 7,200,186/- in the year 2009-A growth of 638.53%. This two together pushed down the net working capital to the present level. The increase in working capital is a clear indication that the company is utilizing its own funds and resources with efficiency. Table 6.4 –Variance Analysis of Current Asset and Current Liability.
OBSERVATION OF WORKING CAPITAL
TOTAL CURRENT ASSETS YEARLY VARIATION GROWT COMPARED TO 2004 YEARLY GROWTH IN %
529853 100 100 100
686666 156813 29.60 29.60
1385071 698405 131.81 101.71
1838680 453609 85.61 32.75
2733045 894365 168.79 48.64
2742964 9920 1.87 0.36
TOTAL CURRENT LIABILITIES YEARLY VARIATION GROWTH COMPARED TO 2004 YEARLY GROWTH IN % NET WORKING CAPITAL - (A-B) WORKING CAPITAL SIZE TOTAL CURRENT ASSETS VARIATION COMPARED TO 2004 TOTAL CURRENT LIABILITIES VARIATION COMPARED TO 2004
395732 395732 100 100 134121 100 100 100 100 100
673470 673470 70.18 70.18 13196 9.84 156812.76 29.6 277738.2 70.18
1355722 1355722 172.40 101.30 29349 21.88 855218.25 161.41 959990.265 242.59
1800313 1800313 112.35 32.79 38367 28.61 1308827.295 247.02 1404581.445 354.93
2695677 2695677 226.26 49.73 37368 27.86 2203192.035 415.81 2299945.455 581.19
1886554 1886554 (204.46) (30.02) 856410 638.53 2213111.565 417.68 1490822.82 376.73
A balance sheet item which equals the sum of cash and cash equivalents, accounts receivable, inventory, marketable securities, prepaid expenses, and other assets that could be converted to cash in less than one year. A company's creditors will often be interested in how much that company has in current assets, since these assets can be easily liquidated in case the company goes bankrupt. In addition, current assets are important to most companies as a source of funds for day-to-day operations. Table 6.5-Current Asset Size
CURRENT ASSET 2004 CURRENT ASSET - A Bank Balances / Deposits Trade Debtors (Net of Provisions) Inventory Work in Progress Dues from Related Parties Other Receivables 46,198 2,2 17,269 1 14,127 1,7 81,962 3 54,006 19 9,387 2,96 0,413 46 5,475 2,17 1,088 5 3,010 6 8,798 7,80 4,526 16 2,532 2,81 0,291 21 7,158 73 5,450 5 70,267 12,7 08,947 3 78,049 1,2 92,380 1 94,191 5 18,997 145,245 20, 461,085 571,443 1, 441,426 321,144 341,150 1,9 17,381 13,6 15,576 7 33,715 2,3 04,752 4,6 94,015 1 00,555 2005 2006 2007 2008 2009
TOTAL CURRENT ASSETS CURRENT ASSET INDEX
4,5 13,561 100
5,84 9,374 129.60
11,79 8,754 261.41
15,6 62,831 347.02
23, 281,494 515.81
23,3 65,993 517.68
Chart 6.2- Current Asset Index.
C URRE ASSE INDE NT T X
600 500 400
300 200 261.41 100 0 2004 2005 2006
515.81 347.02 100 129.60 2007 2008
C URR NT E ASSE T INDE X
Composition of current assets
Analysis of current assets components enable one to examine in which components the working capital fund has locked. A large tie up of funds in inventories affects the profitability of the business or the major portion of current assets is made up cash alone, the profitability will be decreased because cash is non earning asset
Table 6.6-Composition of Current Assets
CURRENT ASSET COMPOSITION 2004 CURRENT ASSET - A Bank Balances Trade Debtors Inventory Work in Progress Dues from Related Parties Other Receivables CURRENT ASSET INDEX 1.02 49.12 2.53 39.48 7.84 100 3.41 50.61 7.96 37.12 0.91 100 0.58 66.15 1.38 23.82 1.84 6.23 100 3.64 81.14 2.41 8.25 1.24 3.31 100 0.62 87.89 2.45 6.19 1.38 1.47 100 8.21 58.27 3.14 9.86 20.09 0.43 100 2005 2006 2007 2008 2009
Chart 6.3- Current Asset Components
C R E TAS E C M O IT N U RN S T O P S IO O rR the eceivab s le
100% 80% 60%
In nto ve ry D es fro R lated u m e P artie s W rk in P re o rog ss
VARIATION IN %
T de D bto (N t ra e rs e o P f rovisio ns)
B nk B a alan s / ce D po e sits
0% 2004 2005 2006
YE S AR
1.3.2 Observations It was observed that the size of current assets is increasing with increases in the sales. The excess of current assets is showing positive liquidity position of the firm but it is not always good because excess current assets then required, it may adversely affects on profitability.. We can see in each year there is tremendous growth in current asset. Compared to 2007 the growth in current asset in 2008, there is a growth of 48.64%, where as in 2009 the growth rate is only .36%. The reason is that the debtors receivable in 2008 is 20,461,085 but in 2009 it has been reduced to 13,615,576/-, a drop of OMR 6,845,509/- ie. 33.46%. These shows that the a good cash collection from receivables in 2009 which shows a good working capital reserve of OMR 6,845,509/- which used to pay back the current liabilities of sundry creditors, other payables and due to related parties.
Compared to 2008 in 2009 the bank balance also increased to OMR 1,917,381/-from OMR 145,245/in the year 2008. Cash balance of the company increased in the year 2009 because company had done good in it’s collection process, which provides a good financial position in 2009. Current assets components show sundry debtors are the major part in current assets it indicates that the efficiency in collection management. Over investment in the debtors may affects liquidity of firm for that company has raised funds from other sources like short term loan which incurred the interest. Other main achievement is that, if we compare the purchase level with inventory, we can see that inventory level is not increased as compared to the volume of purchase. But same time we can see that the receivable from related parties and work in progress has been increased substantially. These show the proper utilization of materials and resources. 1.4 Current liabilities
Current liabilities are debts, accounts payable, interest due, trade credit, loans, and other obligations that are due and payable within one year. Current liabilities are calculated and identified on a business' balance sheet. Current liabilities as a total are information that is used as one measure of the financial condition of a company, especially in association with current assets to calculate the level of working capital.
Table 6.7-Current liabilities size
2004 CURRENT LIABILITIES - B Short-term Borrowings Current Portion of Long Term Debt Trade Creditors Dues to Related Parties Provisions - Tax Other Payables TOTAL CURRENT LIABILITIES VARIATION IN CURRENT LIABILITIES IN % 345,371 149,443 1,186,780 455,788 0 1,233,665 3,371,047 100.000
912,579 187,158 3,053,555 2,070 27,784 1,553,819 5,736,965 170.183
2,076,834 505,393 5,222,137 23,814 184,470 3,536,092 11,548,742 342.586
0 1,455,553 6,931,094 31,484 177,498 6,740,372 15,336,000 454.933
2,042,393 1,523,440 10,429,836 1,519,796 407,850 7,039,860 22,963,175 681.188
561,131 2,217,368 6,268,619 426,463 934,642 5,662,426 16,070,649 476.726
Chart 6.4- Current Liability Index
VARIATION IN CURRENT LIABILITIES
800 700 600
VARIATION IN CURRENT LIABILITIES
500 400 300 200 100 0 2004 2005 2006
170.183 100 2007 2008 2009
Current liabilities show a tremendous growth till 2008, because company creates the credit in the market by good transaction. To get maximum credit from supplier which is profitable to the company it reduces the need of working capital of firm. As the current liability increase in the year 2007, 2008 by 455% and 682 % res. it increases the working capital size in the same year. But subsequently it the liability has been reduced to 477%. But due to the good collection process the change in working capital is not affected much and the company enjoyed good credit terms over creditors which may include indirect cost of credit terms. From the graph we can see that the requirementof working capital has been increased drastically during the year 2006-2007-2008and it has been paid and cleared n 2009, and still the firm is having a good reserve in it’s working capital. This shows the efficiency in it’s collection policy. 1.5 Changes in working capital The excess of current assets over current liabilities is referred to as the company’s working capital. The difference between the working capital for two given reporting periods is called the change in working capital.
1.5.1 Benefit Changes in working capital is included in cash flow from operations because companies typically increase and decrease their current assets and current liabilities to fund their ongoing operations. When a company increases its current assets, it’s a cash outflow: The company had to shell out money to buy the extra assets. Likewise, when a company increases its current liabilities, it’s a cash inflow: The added liabilities, such as short-term debt, provide money. Changes in working capital simply shows the net affect on cash flows of this adding and subtracting from current assets and current liabilities. When changes in working capital is negative, the company is investing heavily in its current assets, or else drastically reducing its current liabilities. When a change in working capital is positive, the company is either selling off current assets or else raising its current liabilities. 1.5.2 Origin
This information is found in the Statement of Cash Flow of the company’s financial statement. 1.5.3 For the Processing: For many growing companies, changes in working capital is a little like capital spending: It’s money the company is investing—in things like inventory—in order to grow. To get a true picture of the cash a company is generating before investment, one can add back changes in working capital to cash flow from operations. Another point: A negative value for changes in working capital could mean the company is investing heavily in growth, or that something’s gone wrong. If a company is having trouble selling its goods, inventories will balloon, and changes in working capital will turn sharply negative. There are so many reasons to changes in working capital as follows:1. CHANGES
IN SALES AND OPERATING EXPANSES:-
The changes in sales and operating expanses may be due to three reasons A) There may be long run trend of change e.g. The price of row material say steel may constantly raise necessity the holding of large inventory. B) Cyclical changes in economy dealing to ups and downs in business activity will influence the level of working capital both permanent and temporary. C) Changes in seasonality in sales activities 2. Policy changes:The second major case of changes in the level of working capital is because of policy changes initiated by management. The term current assets policy may be refined as the relationship between current assets and sales volume. 3. Technology changes:The third major point if changes in working capital are changes in technology because change sin technology to install that technology in our business more working capital is required A change in operating expanses rise or full will have similar effects on the levels of working following working capital statement is prepared on the base of balance sheet of last two year.
“Net change in working capital is the difference in working capital levels from one year to the next. When more cash is tied up in working capital than the previous year, the increase in working capital is treated as a cost against free cash flow” . Table 6-8-Changes in Working Capital
CHANGES IN WORKING CAPITAL 2008 CURRENT ASSET - A Bank Balances / Deposits Trade Debtors (Net of Provisions) Inventory Work in Progress Dues from Related Parties Other Receivables TOTAL CURRENT ASSETS-A 145,2 45.00 20,461,0 85.20 571,4 43.05 1,441,4 26.10 321,1 44.40 341,1 49.80 23,281,4 93.55 CURRENT LIABILITIES - B Short-term Borrowings Current Portion of Long Term Debt Trade Creditors Dues to Related Parties Provisions - Tax Other Payables TOTAL CURRENT LIABILITIES-B NET WORKING CAPITAL - (A-B) NET INCREASE IN WC 2,042,3 93.10 1,523,4 39.50 10,429,8 36.45 1,519,7 96.30 407,8 49.80 7,039,8 59.55 22,963,1 74.70 318,3 18.85 6,977,0 25.85 1,917, 381.20 13,615, 575.65 733, 714.95 2,304, 751.80 4,694, 014.80 100, 554.85 23,365, 993.25 561, 131.00 2,217, 367.90 6,268, 618.95 426, 462.55 934, 641.80 5,662, 426.35 16,070, 648.55 7,295, 344.70 1,4 03.12 ( 38.47) 32.66 68.88 1,5 65.90 ( 81.10) ( 83.40) 52.38 ( 45.88) ( 82.73) 1 48.54 ( 22.50) 1,772,1 36.20 162,2 71.90 863,3 25.70 4,372,8 70.40 #VALUE! 1,481,2 62.10 4,161,2 17.50 1,093,3 33.75 1,377,4 33.20 6,845,5 09.55 240,5 94.95 693,9 28.40 526,7 92.00 6,977,0 25.85 2009 changes in % INCREASE CHANGES IN W C DECREASE
Chart 6.5- Changes in Working Capital
C AN E INW R IN C IT H GS O K G AP AL
7 00 00 ,0 ,0 6 00 00 ,0 ,0 5 00 00 ,0 ,0 4 00 00 ,0 ,0 3 00 00 ,0 ,0 2 00 00 ,0 ,0 1 00 00 ,0 ,0 2 0 0 8
YE S AR DC E E E R AS IN R AS CE E
1.5. Observ ations
Working capital has been increased in the year 2008 to 2009 because:
Trade Receivables in the year 2008, for OMR 20,461085/- has been reduced to OMR
13,615,575/-, ie. 33.45% less, compared to 2008. That means there was a good cash collection effected in 2009, and therefore the bank balance also has been increased from OMR 145,245/- to OMR 1,917,381/-, an increase of 1220%, where cost of raw material purchased increased by 28.4%.
When the trade receivable has reduced in 2009, simultaneously there was a decrease in trade
creditors also. In 2008 trade creditors was 10,429,836/-, but in 2009 it has been reduced to OMR 6,268,618/-, a reduction of 39.9%. That means an increase in Working Capital is OMR 4,161,217/-. Same way, Due to related parties; it was OMR 1,519,796/- in the year of 2008, but it has been reduced to OMR 426,462/. A reduction of 71.9%. That means the there is an increase in Working Capital for OMR.1, 093,333/-.
In the case of short-term borrowing; in the year 2008 the short-term borrowing was OMR
2,042,393/-. But in 2009 it has been reduced to 561,131/-. There is a decrease of 72.5%. That means there is an in crease in working capital for 1,481,262/-. Even though the trade receivables and other receivables are reduced the fund received from receivables has been utilized to clear the liabilities. This leads to show a good performance and result in it’s working capital.
OPERATING CYCLE OR WORKING CAPITAL
Working capital is also known as revolving capital and a circular path of conversion/recon version takes place. This revolution of cycle is called as the Operating Cycle Available cash tends to be tied up in what is known as the Working Capital Cycle (WCC). Every business, regardless of what they do operates this cycle. To start any business cash is required; this cash is then used to purchase stock in order to generate a sale. When the stock is sold it is either by way of a cash sale or is charged to an account, creating a debtor. When the debt is collected the WCC continues on. In a service industry the stock is client base or the service provided. The need of working capital arrived because of time gap between production of goods and their actual realization after sale. This time gap is called “Operating Cycle” or “Working Capital Cycle”. The operating cycle of a company consist of time period between procurement of inventory and the collection of cash from receivables. The operating cycle is the length of time between the company’s outlay on raw materials, wages and other expanses and inflow of cash from sales of goods.
Thus a revolution or cycle from cash to raw materials to Work-in-Progress, to finished goods, to debtors, and back to cash takes place. This revolution is called as operating cycle. While waiting for cash to to return, more stock has to be purchased to keep the business operating and to do so, many businesses use their overdraft facility which is costing them money. If there is no overdraft they are using credit funds that could be better utilised elsewhere. The faster you can turn the WCC the faster the dollar returns and the less overdraft or credit funds you have to use. This is where efficiency in debt collection and stock turnover is the key. Managing cash in any business is important. Many profitable businesses end up closing down simply because they could not get the cash to carry them in the short term. Beyond Survival Workshops emphasize the difference between cash flow and profits, constructs a cash flow budget for a business and analyses where does all the cash go. It will demonstrate the importance on the efficient operation of the working capital cycle, how to improve debtor collection and stock turnover to help increase cash holdings and reduce the overdraft limit.
Thus, the term operating cycle, otherwise called as cash cycle refers to the length of time necessary to complete the following cycle of events: 1 2 3 Conversion of cash into inventory Conversion of inventory into debtors Conversion of debtors into cash
Stage 1: Cash to Inventory – In this stage, cash first gets converted into raw materials, then work-in progress and then finished goods in a typical manufacturing concern. As regards non-manufacturing concerns, when the goods are purchased, cash gets converted into inventory . Stage 2: Inventory to Debtors – The inventory thus produced or purchased, gets converted into debtors or receivables upon credit sales. Stage 3: Debtors to Cash -The debtors or accounts receivables get in turn converted back into cash when they make payment
OF OPERATING CYCLE:
When raw materials remain in store pending issue for production for a less duration, when raw materials gets converted into WIP in a short duration, when finished goods remain in warehouse pending for sales for a short duration only, and when cash realizations out of sales are made quickly and finally when payment to creditors is made slowly, the operating cycle would be smaller and consequently the working capital will also be reasonable. Thus shorter duration of operating cycle indicates an efficient working capital management. Operating cycle is an important concept in management of cash and management of cash working capital. The operating cycle reveals the time that elapses between outlays of cash and inflow of cash. Quicker the operating cycle less amount of investment in working capital is needed and it improves profitability. The duration of the operating cycle depends on nature of industries and efficiency in working capital management.
OR WORKING CAPITAL
According to this approach, the requirements of working capital depend upon the operating cycle of the business. The operating cycle begins with the acquisition of raw materials and ends with the collection of receivables It may be broadly classified into the following four stages viz. 1. Raw materials and stores storage stage. 2. Work-in-progress stage. 3. Finished goods inventory stage. 4. Receivables collection stage.
To calculate the operating cycle of AI LLC, used last five year data. Operating cycle of the AI LLC vary year to year as changes in policy of management about credit policy and operating control. The duration of the operating cycle for the purpose of estimating Working capital requirements is equivalent to the sum of the durations of each of these stages less the credit period allowed by the suppliers of the firm. Symbolically the duration of the working capital cycle can be put as follows: -
The gross operating cycle of a firm is equal to the length of the inventories and receivables conversion periods. Therefore Gross Operating Cycle = RMCP + WIPCP + FGCP + RCP - CPP
RMCP WIPCP FGCP RCP CPP
= = = = =
Raw Material Conversion Period Work–In-Process Conversion Period Finished Goods Conversion Period Receivables Conversion Period Creditors Payment Period
However, a firm may acquire some resources on credit and thus defer payments for certain period. In that case, Net Operating Cycle Period can be calculated as below: Net Operating Cycle Period = Gross Operating Cycle Period – Payable Deferral period
Further, following formula can be used to determine the conversion periods. Each of the components of the Operating Cycle can be calculated as follows: Raw Material Conversion Period = Average Stock of Raw Material / Raw Material Consumption per day Work in process Conversion Period = Average Stock of Work-in-Progress / Total Cost of Production per day Finished Goods Conversion Period = Average Stock of Finished Goods / Total Cost of Goods sold per day Receivables Conversion Period = Average Accounts Receivables / Net Credit Sales per day Payable Deferral Period = Average trade Creditors / Average Credit Purchase per day After computing the period of one operating cycle, the total number of operating cycles that can be computed during a year can be computed by dividing 365 days with number of operating days in a cycle. The total expenditure in the year when year when divided by the number of operating cycles in a year will give the average amount of the working capital requirement.
OPERATING CYCLE/WORKING CAPITALCYCLE
IF THE FIRMCollect receivables (debtors) faster Collect receivables (debtors) slower Get better credit (in terms of duration or amount) from suppliers Shift inventory (stocks) faster Move inventory (stocks) slower CASH CONVERSION CYCLE OR NET OPERATING CYCLE
THEN THE FIRM WILLRelease cash from the cycle Receivables soak up cash Increase THE cash resources Free up cash Consume more cash
Operating cycle and cash cycle are two important components of working capital management.
Together they determine the efficiency of a firm regarding working capital management. While the operating cycle is the time period from inventory purchase until the receipt of cash, the cash cycle is the time period from when cash is paid out, to when cash is received. Refers to the delay between the buying of raw materials and the receipt of cash from sales proceeds. In other words, operating cycle refers to the number of days taken for the conversion of cash to inventory through the conversion of accounts receivable to cash. It indicates towards the time period for which cash is engaged in inventory and accounts receivable. If an operating cycle is long, then there is lower accessibility to cash for satisfying liabilities for the short term. Operating cycle takes into consideration the following elements: accounts payable, cash, accounts receivable, and inventory replacement. The following formula is used for calculating operating cycle: (1) Disregarding the capacity to defer payables, the cash conversion cycle is the length of time between the payment of cash for inventory and receipt of cash from accounts receivable. (a) If a firm holds its inventory 50 days and collects its accounts receivable in 30 days, then it would take 80 days for the original investment to be converted back into cash. (b) However, if the firm has the option of creating an accounts payable for 20 days, the cash conversion cycle can be reduced from 80 days to 60 days. (2) The cash conversion cycle is equal to the inventory conversion period, plus the receivables collection period, minus the payables deferral period. (a) The inventory conversion period is the average time between buying inventory and selling the goods. We have: inventory conversion period = inventory/(cost of sales/365) = 365/(inventory turnover). (b) The receivables collection period, or days' sales outstanding (DSO), is the average number of days that it takes to collect on accounts receivable. We have: receivables collection period = receivables/ (sales/365) = 365/receivables turnover. (c) The payables deferral period is (the accounts payable + wages, benefits, and payroll taxes payable) / ([the cost of sales + selling, general, and administrative expenses]/365). Table 6.9- Operating cycle (No. of Days)
YEARS Days Debtors Days Inventory Days Payable Chart 6.6- Net Operating Cycle
2006 83 80 75
2007 78 45 66
2008 136 18 84
2009 96 17 55
N T OP R E E ATING C YCLE
100% 90% 80% 70% 60%
18 80 45
17 Days Payable Days Inventory Days Debtors
50% 40% 30% 20% 10% 0%
136 83 78
THE FIRMS GROSS OPERATING PROFIT (GOC) CAN BE DETERMINED AS:INVENTORY CONVERSIONPERIOD (ICP) + DEBTORS CONVERSION PERIOD (DCP).
Observations Operating cycle of AI LLC shows the numbers of day are decreasing in recent year it is reflect the efficiency of management. Days of operating cycle shows period of lack of funds in current assets, if no of day are more than it increases the cost of funds as taken from outside of the business. In 2008/09 shows the high no. of days because of reduced of creditors holding period. 1.7 WORKING
CAPITAL LEVERAGE OR GEARING OF
In finance, leverage (also known as gearing or levering) refers to the use of debt capital to supplement equity capital. Companies usually leverage to attempt to increase returns on equity capital, as it can increase the scope for gains or losses. The temporary increases in stock prices due to leverage at some
banks have been blamed for the unusually high overall remuneration for top executives during the financial crisis of 2007–2010, since gains in stock prices were often rewarded regardless of how they were achieved. Deleveraging is the action of reducing borrowings. In macroeconomics, a key measure of leverage is the debt to GDP ratio.
One of the important objectives of working capital management is by maintaining the optimum level of investment in current assets and by reducing the level of investment in current assets and by reducing the level of current liabilities the company can minimize the investment in the working capital thereby improvement in return on capital employed is achieved. The term working capital leverage refers to the impact of level of working capital on company’s profitability. The working capital management should improve the productivity of investment in current assets and ultimately it will increase the return on capital employed. Higher level of investment in current assets than is actually required means increase in the cost of Interest charges on short term loans and working capital finance raised from banks etc. and will result in lower return on capital employed and vice versa. Working capital leverage measures the responsiveness of ROCE (Return on Capital Employed) for changes in current assets. It is measures by applying the following formula,
The working capital leverage reflects the sensitivity of return on capital employed to changes in level of current assets. Working capital leverage would be less in the case of capital intensive capital employed is same working capital leverage expresses the relation of efficiency of working capital management with the profitability of the company.
WORKING CAPITAL LEVERAGE = % CHANGES IN ROCE / % CHANGES IN CURRENT ASSETS
ON CAPITAL EMPLOYED
– (ROCE) = EBIT / TOTAL
Table 6.10- Calculation of working capital leverages.
YEARS ROCE WC LEVERAGE 2006 630% 3.37 2007 1650% 3.23 2008 1960% 3.14 2009 2460% 1.8
Chart 6.7- Working Capital Leverage
W R IN C P A L V R G O K G A IT L E E A E
2 .0 % 5 0 1 .6 % 9 0 1 .5 % 6 0 1 .0 % 5 0
2 .6 % 4 0
2 .0 % 0 0
RC OE W L V RG C E E A E
%C A G S HN E
1 .0 % 0 0 6 0 .3 % 5 0 .0 % 3 7 .3 % 3 3 .2 % 3 4 .1 % 1 0 .8 % 0 0 .0 % 20 06 20 07 YA S ER 20 08 20 09
Working capital leverage of the company has decreased in the year 2009 as compare to the year 2006, and increase in working capital shows the efficient current assets management. In the year 2006 and 2007 the current assets has increased by high rate of 261% and 347% respectively. It tends to increase ROCE, which increased at the rate of 6.3% and 16.5% respectively, that resulted in push down the working capital leverage to 3.37% and 2.32% respectively. When investment in current assets and fixed asset will help the firm to run with sufficient fund without any overdraft or interrupt in it’s fund flow.
CHAPTER V1I 106
1) Introduction 2) Role of ratio analysis 3) Limitations of ratio analysis 4) Classifications of ratios 5) Efficiency ratio 6) Liquidity ratio
FINANCIAL RATIO ANALYSIS – ARABIAN INDUSTRIES LLC
Financial ratios are one of the most common tools of managerial decision making. Financial ratios involve the comparison of various figures from the financial statements in order to gain information about a company's performance. It is the interpretation, rather than the calculation, that makes
financial ratios a useful tool for business managers. Ratios may serve as indicators, clues, or red flags regarding noteworthy relationships between variables used to measure the firm's performance in terms of profitability, asset utilization, liquidity, leverage, or market valuation. Financial statement analysis is a judgmental process. One of the primary objectives is identification of major changes in trends, and relationships and the investigation of the reasons underlying those changes. The judgment process can be improved by experience and the use of analytical tools. Probably the most widely used financial analysis technique is ratio analysis, the analysis of relationships between two or more line items on the financial statement. Financial ratios are usually expressed in percentage or times. Generally, financial ratios are calculated for the purpose of evaluating aspects of a company's operations and fall into the following categories: Ratio analysis is the powerful tool of financial statements analysis. A ratio is define as “the indicated quotient of two mathematical expressions” and as “the relationship between two or more things”. The absolute figures reported in the financial statement do not provide meaningful understanding of the performance and financial position of the firm. Ratio helps to summaries large quantities of financial data and to make qualitative judgment of the firm’s financial performance
OF RATIO ANALYSIS
Ratio analysis helps to appraise the firms in the term of there profitability and efficiency of performance, either individually or in relation to other firms in same industry. Ratio analysis is one of the best possible techniques available to management to impart the basic functions like planning and control. As future is closely related to the immediately past, ratio calculated on the basis historical financial data may be of good assistance to predict the future, the ratio analysis may be able to locate the point out the various arias which need the management attention in order to improve the situation. E.g. Current ratio which shows a constant decline trend may be indicate the need for further introduction of long term finance in order to increase the liquidity position. As the ratio analysis is concerned with all the aspect of the firm’s financial analysis liquidity, solvency, activity, profitability and overall performance, it enables the interested persons to know the financial and operational characteristics of an organization and take suitable decisions. 7.3 LIMITATIONS
OF RATIO ANALYSIS
The basic limitation of ratio analysis is that it may be difficult to find a basis for making the
Normally, the ratios are calculated on the basis of historical financial statements. An
organization for the purpose of decision making may need the hint regarding the future happiness rather than those in the past. The external analyst has to depend upon the past which may not necessary to reflect financial position and performance in future. 3 The technique of ratio analysis may prove inadequate in some situations if there is differs in
opinion regarding the interpretation of certain ratio.
As the ratio calculates on the basis of financial statements, the basic limitation which is
applicable to the financial statement is equally applicable In case of technique of ratio analysis also i.e. only facts which can be expressed in financial terms are considered by the ratio analysis.
The technique of ratio analysis has certain limitations of use in the sense that it only highlights
the strong or problem arias, it dose not provide any solution to rectify the problem arias. Ratio analysis is very important for the franchisor to establish norms and seek patterns of financial operations over a period of time. Unfortunately, few franchisors (or any kind of business) use ratio analysis -- it is estimated that just two percent compute financial ratios and use them in managing their businesses. The franchisor can use ratio analysis also to obtain a bank loan. There are different financial ratios which may 1 2 3 4 7.4 liquidity ratios, leverage ratios, operating ratios, and profitability ratios
OF WORKING CAPITAL RATIO
Working capital ratio means ratios which are related with the working capital management e.g. current assets, current liabilities, liquidity, profitability and risk turnoff etc. these ratio are classified as follows 7.4.1 EFFICIENCY
The ratios compounded under this group indicate the efficiency of the organization to use the various kinds of assets by converting them the form of sale. This ratio also called as activity ratio or assets management ratio. As the assets basically categorized as fixed assets and current assets and the current assets further classified according to individual components of current assets viz. investment and receivables or debtors or as net current assets, the important of efficiency ratio as follow
1) Working capital turnover ratio 2) Inventory turnover ratio 3) Receivable turnover ratio 4) Current assets turnover ratio 7.4.2 LIQUIDITY
The ratios compounded under this group indicate the short term position of the organization and also indicate the efficiency with which the working capital is being used. The most important ratio under this group is follows 1. Current ratio 2. Quick ratio 3. Absolute liquid ratio 7.5 7.5.1 EFFICIENCY WORKING
CAPITAL TURNOVER RATIO
It signifies that for an amount of sales, a relative amount of working capital is needed. If any increase in sales contemplated working capital should be adequate and thus this ratio helps management to maintain the adequate level of working capital. The ratio measures the efficiency with which the working capital is being used by a firm. It may thus compute net working capital turnover by dividing sales by working capital. Working Capital Turnover Ratio = Sales / Net Working Capital This ratio maker a comparison between net sales and net working capital in order to find the working capital turnover ratio the working capital turnover ratio for the year 2004-2009. We can see an increase in working capital turnover ratio for the next 5 year has increased in a gradual way in the last year the net sales has been increased and the working capital in being similarly that of previous year hence the working that of previous year hence the working that capital turnover ratio is 27.63 in 200 but 1.59 in 2009 after clearing all bills payables. Table 7-1 Working Capital Turnover Ratio
YEAR GROSS SALES Cost of Goods sold
NET SALES NET WORKING CAPITAL WC TURN OVER RATIO
Chart 7-1 Working Capital Turnover
WORKING CAPITAL TURNOVER
18000000 16000000 14000000 WC TURNOVER 12000000 10000000 8000000 6000000 4000000 2000000 0 2004 2005 2006 YEARS 2007 2008 2009
WC TURN OVER RATIO NET WORKING CAPITAL NET SALES YEAR
Observations High working capital ratio indicates the capability of the organization to achieve maximum sales with the minimum investment in working capital. Company’s working capital ratio shows mostly more than two, except for the year 2005-06 because of excess of cash balance in current assets which occurred due to encashment of deposits. In the year 2004 and 2008 The ratio was above 3, it indicates that the capability of the company to achieve maximum sales with the minimum investment in working capital. But in the year 2009 the WC graph has gone down to 1.59% from 27.63 % in 2008. In 2009 wecan see that the payables are also gone down. That means after clearing all bills payables, still AI LLC is having a good working capital reserve. 7.5.2 INVENTORY TURNOVER RATIO: Inventory turnover ratio, defined as how many times the entire inventory of a company has been sold during an accounting period, is a major factor to success in any business that holds inventory. It shows how well a company manages its inventory levels and how frequently a company replenishes its inventory. In general, a higher inventory turnover is better because inventories are the least liquid form
of asset. Inventory turnover ratio explanations occur very simply through an illustration of high and low turnover ratios. Despite this, many businesses do not survive due to issues with inventory. Average inventory and cost of goods sold are the two elements of this ratio. Average inventory is calculated by adding the stock in the beginning and at the and of the period and dividing it by two. In case of monthly balances of stock, all the monthly balances are added and the total is divided by the number of months for which the average is calculated. A low inventory turnover ratio shows that a company may be overstocking or deficiencies in the product line or marketing effort. It is a sign of ineffective inventory management because inventory usually has a zero rate of return and high storage cost. Higher inventory turnover ratios are considered a positive indicator of effective inventory management. However, a higher inventory turnover ratio does not always mean better performance. It sometimes may indicate inadequate inventory level, which may result in decrease in sales. Although the first calculation is more frequently used, COGS (cost of goods sold) may be substituted because sales are recorded at market value, while inventories are usually recorded at cost. Also, average inventory may be used instead of the ending inventory level to minimize seasonal factors. This ratio should be compared against industry averages. A low turnover implies poor sales and, therefore, excess inventory. A high ratio implies either strong sales or ineffective buying. High inventory levels are unhealthy because they represent an investment with a rate of return of zero. It also opens the company up to trouble should prices begin to fall.
(a) [Inventory Turnover Ratio = Cost of goods sold / Average inventory at cost] (b) [Inventory Turnover Ratio = Net Sales / Average Inventory at Cost] (c) [Inventory Turnover Ratio = Net Sales / Average inventory at Selling Price] (d) [Inventory Turnover Ratio = Net Sales / Inventory]
Table 7-2- Inventory Turnover
YEAR COST OF GOODS SOLD AVERAGE INVENTORY INVENTORY TURNOVER 2004
5 ,939,978 1 ,896,089
9 ,866,566 2 ,636,564
21 ,708,552 2 ,972,822
33 ,554,054 1 ,670,429
35 ,055,556 2 ,012,869
52,0 42,769 3,0 38,467
Chart 7-2 Inventory Turnover Ratio
IN E T R T R O E R T V N O Y U N V R A IO 5 ,0 0 0 0 0 ,0 0 4 ,0 0 0 5 0 ,0 0 4 ,0 0 0 0 0 ,0 0 INVENTORY 3 ,0 0 0 5 0 ,0 0 3 ,0 0 0 0 0 ,0 0 2 ,0 0 0 5 0 ,0 0 2 ,0 0 0 0 0 ,0 0 1 ,0 0 0 5 0 ,0 0 1 ,0 0 0 0 0 ,0 0 5 0 ,0 0 ,0 0 0 0 20 04 20 05 20 06 Y A S E R 20 07 20 08 20 09 C S O OT F G OS O D S L OD A E A E V RG IN E T R V NO Y IN E T R V NO Y TROE UN V R
It was observed that Inventory turnover ratio indicates maximum sales achieved with the minimum investment in the inventory. As such, the general rule high inventory turnover is desirable but high inventory turnover ratio may not necessary indicates the profitable situation. An organization, in order to achieve a large sales volume may sometime sacrifice on profit, inventory ratio may not result into high amount of profit. The result represents the turnover or inventory or how many times inventory was used and then again replaced. This number is representative for a one year time period. If the value of the inventoryturnover ratio is low, then it indicates that the management team doesn't do its job properly in managing inventories. Importance of Inventory Turnover: If the company can quickly sell its inventory, then the Inventory Turnover will be higher. Conversely, if the company cannot sell its inventory very well, then the Inventory Turnover will be low. We have to watch this figure closely - if the Inventory Ratio climbs too high, then the company may be keeping too little inventory. This could cause lost profits due to customer orders that had to wait until inventory arrived. 7.5.3 RECEIVABLE
Debtors turnover ratio or accounts receivable turnover ratio indicates the velocity of debt collection of a firm. In simple words it indicates the number of times average debtors (receivable) are turned over during a year. Formula of Debtors Turnover Ratio:
[Debtors Turnover Ratio = Net Credit Sales / Average Trade Debtors] The two basic components of accounts receivable turnover ratio are net credit annual sales and average trade debtors. The trade debtors for the purpose of this ratio include the amount of Trade Debtors & Bills Receivables. The average receivables are found by adding the opening receivables and closing balance of receivables and dividing the total by two. It should be noted that provision for bad and doubtful debts should not be deducted since this may give an impression that some amount of receivables has been collected. But when the information about opening and closing balances of trade debtors and credit sales is not available, then the debtors turnover ratio can be calculated by dividing the total sales by the balance of debtors (inclusive of bills receivables) given. and formula can be written as follows. [Debtors Turnover Ratio = Total Sales / Debtors] The derivation of this ratio is made in following way Receivable turnover ratio = Gross sales/Average account receivables Average receivable calculate by opening plus closing balance divide by 2. Increasing volume of receivables without a matching increase in sales is reflected by a low receivable turnover ratio. It is indication of slowing down of the collection system or an extend line of credit being allowed by the customer organization. The latter may be due to the fact that the firm is loosing out to competition. A credit manager engage in the task of granting credit or monitoring receivable should take the hint from a falling receivable turnover ratio use his market intelligence to find out the reason behind such failing trend. Debtor turnover indicates the number of times debtors turnover each year. Generally the higher the value of debtor’s turnover, the more is the management of credit. Debtor’s turnover ratio = 365 days/Receivable turnover ratio Table 7-3- Debtor’s Turnover Ratio
YEAR GROSS SALES AVERAGE ACCOUNT RECEIVABLE
2004 6 ,927,072 2 ,217,269
2005 11 ,279,759 3 ,697,475
2006 24, 739,046 6, 862,676
2007 39,1 65,363 14,1 58,999
2008 43,8 50,144 22,9 39,489
2009 63 ,664,311 27 ,268,874
RECEIVABLE TURNOVER RATIO
Table 7-3- Receivable Turnover Ratio
R EIVABLE T R O EC U N VER R IO AT 90,000,000 80,000,000 70,000,000 TURNOVER 60,000,000 50,000,000 40,000,000 30,000,000 20,000,000 10,000,000 2004 2005 2006 YEAR S 2007 2008 2009 R EIVABLE EC T R O U N VER R IO AT AVER E AG AC O N C U T R EIVABLE EC G O SALES R SS
Observations It was observed from receivable turnover ratio that receivables turned around the sales were less than 4 times. The actual collection period was more than normal collection period allowed to customer. It concludes that over investment in the debtors which adversely affect on requirement of the working capital finance and cost of such finance. Significance of the Ratio: Accounts receivable turnover ratio or debtors turnover ratio indicates the number of times the debtors are turned over a year. The higher the value of debtors turnover the more efficient is the management of debtors or more liquid the debtors are. Similarly, low debtors turnover ratio implies inefficient management of debtors or less liquid debtors. It is the reliable measure of the time of cash flow from credit sales. There is no rule of thumb which may be used as a norm to interpret the ratio as it may be different from firm to firm. 7.5.4 CURRENT ASSETS
Current assets are a major component of the balance sheet and represent assets that are expected to be sold or used, typically within the next 12 months. They are also an important measure of a companies liquidity position. Current assets have become a very important factor in evaluating the financial strength of a company, in the event of a weak economic environment or one of lower demand. Many
of the popular financial ratios will utilize the current assets when performing analysis to gauge financial performance and stability. Current Assets Turnover ratio, shows the productivity of the company's current assets. The formula is the following: = turnover / average (current assets, other + stocks + debtors + cash & equivalents) Current assets turnover ratio is calculate to know the firms efficiency of utilizing the current assets. Current assets includes the assets like inventories, sundry debtors, bills receivable, cash in hand or bank, marketable securities, prepaid expenses and short term loans and advances. This ratio includes the efficiency with which current assets turn into sales. A higher ratio implies a more efficient use of funds thus high turnover ratio indicate to reduced the lock up of funds in current assets. An analysis of this ratio over a period of time reflects working capital management of a firm. Current assets TOR= Sales / Current assets Table 7.-4-Calculation of Current Assets Turnover Ratio
YEAR SALES TOTAL CURRENT ASSETS CURRENT ASSET TOR
2004 6 ,927,072 8 ,673,117 0.80
2005 11 ,279,759 11 ,645,737 0.97
2006 24,7 39,046 22,6 44,900 1.09
2007 39 ,165,363 30 ,612,473 1.28
2008 43 ,850,144 45 ,900,693 0.96
2009 63,6 64,311 41,9 37,417 1.52
Chart No.7-4-Current assets Turnover Ratio
C R E TA S TT R O E R T U R N S E U N V R A IO
6 ,0 0 0 0 0 ,0 0 5 ,0 0 0 0 0 ,0 0 4 ,0 0 0 0 0 ,0 0 3 ,0 0 0 0 0 ,0 0 2 ,0 0 0 0 0 ,0 0 1 ,0 0 0 0 0 ,0 0 20 04 20 05 20 06 20 07 20 08 20 09
S L S AE
T TL OA CRE T URN A S T S ES CRE T URN A S TT R S E O
YA S ER
Observations It was observed that current assets turnover ratio does not indicate any trend over the period of time. Turnover ratio was 0.80 in the year 2004 and increase to 1.09 and 1.28 in the year 2006 and 2007 respectively, but it decreased in the year 2008, because of high cash balance. Cash did not help to increase in sales volume, as cash is non earning asset. In the year 2006-07 company increased its sales
with increased investment in current assets, thus current assets turnover ratio increased to 1.28 from 1.09 in the year 2006. 7.6 7.6.1 LIQUIDITY
CURRENT RATIO Current ratio may be defined as the relationship between current assets and current liabilities. This ratio is also known as "working capital ratio". It is a measure of general liquidity and is most widely used to make the analysis for short term financial position or liquidity of a firm. It is calculated by dividing the total of the current assets by total of the current liabilities. The ratio is mainly used to give an idea of the company's ability to pay back its short-term liabilities (debt and payables) with its short-term assets (cash, inventory, receivables). 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. The current ratio can give a sense of the efficiency of a company's operating cycle or its ability to turn its Product into cash. Companies that have trouble getting paid on their receivables or have long inventory turnover can run into liquidity problems because they are unable to alleviate their obligations. Because business operations differ in each industry, it is always more useful to compare companies within the same industry. This ratio is similar to the acid-test ratio except that the acid-test ratio does not include inventory and pre paid as assets that can be liquidated. The components of current ratio (current assets and current liabilities) can be used to derive working capital (difference between current assets and current liabilities). Working capital is frequently used to derive the working capital ratio, which is working capital as a ratio of sales. [Current Ratio = Current Assets / Current Liabilities] Or [Current Assets: Current Liabilities] Components: The two basic components of this ratio are current assets and current liabilities. Current assets include cash and those assets which can be easily converted into cash within a short period of time, generally, one year, such as marketable securities or readily realizable investments, bills receivables, sundry debtors, (excluding bad debts or provisions), inventories, work in progress, etc. Prepaid expenses
should also be included in current assets because they represent payments made in advance which will not have to be paid in near future. Current liabilities are those obligations which are payable within a short period of tie generally one year and include outstanding expenses, bills payable, sundry creditors, bank overdraft, accrued expenses, short term advances, income tax payable, dividend payable, etc. However, some times a controversy arises that whether overdraft should be regarded as current liability or not. Often an arrangement with a bank may be regarded as permanent and therefore, it may be treated as long term liability. At the same time the fact remains that the overdraft facility may be cancelled at any time. Accordingly, because of this reason and the need for conversion in interpreting a situation, it seems advisable to include overdrafts in current liabilities. Limitations of Current Ratio: This ratio is measure of liquidity and should be used very carefully because it suffers from many limitations. It is, therefore, suggested that it should not be used as the sole index of short term solvency. 1 2 It is crude ratio because it measures only the quantity and not the quality of the current assets. Even if the ratio is favorable, the firm may be in financial trouble, because of more stock and
work in process which is not easily convertible into cash, and, therefore firm may have less cash to pay off current liabilities. 3 Valuation of current assets and window dressing is another problem. This ratio can be very
easily manipulated by overvaluing the current assets. An equal increase in both current assets and current liabilities would decrease the ratio and similarly equal decrease in current assets and current liabilities would increase current ratio.
YEAR TOTAL CURRENT ASSETS TOTAL CURRENT LIABILITIES CURRENT RATIO 2004
11 ,798,754 13 ,384,679
15 ,662,831 15 ,336,000
23 ,281,494 22 ,963,175
2 3,365,993 1 6,070,649
Chart No. 7.5 Current Ratio
CURRENT ASSET RATIO
25,000,000 20,000,000 15,000,000 10,000,000 5,000,000 2004 2005 2006
1.60 1.40 1.20 1.00 0.80 0.60 0.40 0.20 0.00 2007 2008 2009 TOTAL CURRENT ASSETS TOTAL CURRENT LIABILITIES CURRENT RATIO
Observations The current ratio indicates the availability of funds to payment of current liabilities in the form of current assets. A higher ratio indicates that there were sufficient assets available with the organization which can be converted in cash, without any reduction in the value.: Generally, the higher the ratio, the more liquid the company is. This means the company would have a better short-term financial standing to meet its debt obligations. A low current ratio is can often be supported by a strong operating cash flow. On the other hand, if a company is able to operate with a low current ratio, it means that the company is more efficient about using its capital. Therefore, a low current ratio can lead to higher return of assets. Generally speaking, the more liquid the current assets, the smaller the current ratio can be without cause for concern. For most industrial companies, 1.5 is an acceptable current ratio 7.6.2 QUICK
The quick ratio, defined also as the acid test ratio, reveals a company's ability to meet short-term operating needs by using its liquid assets. It is similar to the current ratio, but is considered a more reliable indicator of a company’s short-term financial strength. The difference between these two is that the quick ratio subtracts inventory from current assets and compares the quick asset to the current liabilities. Similar to the current ratio, value for the quick ratio analysis varies widely by company and
industry. In theory, the higher the ratio is, the better the position of the company is. However, a better benchmark is to compare the ratio with the industry average. Quick ratios are often explained as measures of a company’s ability to pay their current debt liabilities without relying on the sale of inventory. Compared with the current ratio, the quick ratio is more conservative because it does not include inventories which can sometimes be difficult to liquidate. For lenders, the quick ratio is very helpful because it reveals a company’s ability to pay off under the worst possible condition. Although the quick ratio gives investors a better picture of a company’s ability to meet current obligations the current ratio, investors should be aware that the quick ratio does not apply to the handful of companies where inventory is almost immediately convertible into cash. Quick Ratio Formula Quick Ratio = (Current assets – Inventories) / Current liabilities Or Quick assets / Current liabilities Or (Cash + Accounts Receivable + Cash equivalents) / Current liabilities Quick Ratio Calculation
Quick ratio calculation is a useful skill for any business that may face cash flow issues. Quick assets include those current assets that presumably can be quickly converted to cash at close to their book values. It normally includes cash, marketable securities, and some accounts receivables. The quick ratio, sometimes called the acid-test, is a more stringent test of liquidity than the current ratio. This is because it removes inventory from the equation. Inventory is the least liquid of all the current assets. A business has to find a buyer if it wants to liquidate inventory, or turn it into cash. Finding a buyer is not always easy. Quick ratios establish the relationship between quick or liquid assets and liabilities. An asset is liquid if it can be converting in to cash immediately or reasonably soon without a loss of value. Cash is the most liquid asset .other assets which are consider to be relatively liquid and include in quick assets are debtors and bills receivable and marketable securities. Inventories are considered as less liquid. Inventory normally required some time for realizing into cash. Their value also be tendency to fluctuate. The quick ratio is found out by dividing quick assets by current liabilities
Table 7-.6- Quick Ratio
YEAR TOTAL CURRENT ASSETS INVENTORY LIQUID CURRENT ASSET TOTAL CURRENT LIABILITIES QUICK RATIO 2004 4,513 ,561 114 ,127 4,399 ,434 3,903 ,540 1.13 2005 5,84 9,374 46 5,475 5,38 3,899 6,26 4,607 0.86 2006 11,798, 754 162, 532 11,636, 222 13,384, 679 0.87 2007 15,662, 831 378, 049 15,284, 782 15,336, 000 1.00 2008 23,281, 494 571, 443 22,710, 051 22,963, 175 0.99 2009 23,365, 993 733, 715 22,632, 278 16,070, 649 1.41
Chart No.7-.6 Quick ratio
45,000,000 40,000,000 35,000,000 30,000,000
VALUES QUICK RATIO
25,000,000 20,000,000 15,000,000 10,000,000 5,000,000 2004 2005 2006 YEARS 2007 2008 2009
TOTAL CURRENT LIABILITIES LIQUID CURRENT ASSET
Observations Quick ratio indicates that the company has sufficient liquid balance for the payment of current liabilities. In some ways, the quick ratio is a more conservative standard. If the quick ratio is greater than one, there would seem to be no danger that the firm would not be able to meet its current obligations. If the quick ratio is less than one, but the current ratio is considerably above one, the status of the firm is more complex. In this case, the valuation of inventories and the inventory turnover are obviously in a better stage. The liquid ratio of 1:1 is suppose to be standard or ideal. In the year 2007 and 2009 company had Rs.1.40 cash for every 1 rupee of expenses; such a policy is called conservative policy of finance for working capital, Rs.0.90 is the ideal investment which affects on the cost of the fund and returns on the funds. 7.6.3 ABSOLUTE
Absolute liquid ratio is the ratio, which expresses the relationship between Absolute Liquid Assets and Quick Liabilities. Components of Absolute Liquid Assets Absolute Liquid assets
1. Cash in Hand and at Bank
2. Readily Marketable Securities Quick Liabilities 1. Outstanding Expenses 2. Bills Payable 3. Sundry Creditors 4. Short- term Advances 5. Income Tax payable 6. Dividends Payable Expression of Absolute liquid ratio Absolute Liquid Ratio = Absolute Liquid assets / Quick Liabilities Significance of Absolute liquid ratio The ratio shows very clearly whether a concern is liquid or not. In other words, it is the real measure of the liquidity or short-term solvency of a concern Even though debtors and bills receivables are considered as more liquid then inventories; it can not be converted in to cash immediately or in time. Therefore the while calculation of absolute liquid ratio only the absolute liquid assets as like cash in hand cash at bank, short term marketable securities are taken in to consideration to measure the ability of the company in meeting short term financial obligation. It calculates by absolute assets dividing by current liabilities. Table 7.7- Absolute Liquid Ratio
YEAR Current Assets BANK/CASH OTHER RECEIVABLES TOTAL LIQUID ASSET CURRENT LIABILITIES ABSOLUTE LIQUID RATIO 46,1 98 354,0 06 400,2 03 3,371,0 47 0.119 199, 387 53, 010 252, 397 5,736, 965 0.044 68 ,798 735 ,450 804 ,248 11,548 ,742 0.070 570,2 67 518,9 97 1,089,2 64 15,336,0 00 0.071 145,2 45 341,1 50 486,3 95 22,963,1 75 0.021 1,91 7,381 10 0,555 2,01 7,936 16,07 0,649 0.126 2004 2005 2006 2007 2008 2009
Chart No.7.7- Cash and bank to current liabilities
ABSOLUTE LIQUID RATIO 25,000,000
2008 ABSOLUTE LIQUID RATIO CURRENT LIABILIT IES
2006 TOT AL LIQUID ASSET
5,000,000 2004 2004 2004
2005 2009 2008 2008 2009
Y RS EA
Observations Absolute liquid ratio indicates the availability of cash with company is sufficient because company also has other current assets to support current liabilities of the company. In the year 2007 and 2008,absolute liquid ratio increased because of company carry more cash balance, as a cash balance is ideal assets company has to take control on such availability of funds which is affect on cost of the funds. The absolute liquid ratio is the best for three years like 2007/2008/2009, and the cash balances as to the current liability has improved for the firm. Firm has large resources in cash and bank balances. While large resources in cash and bank balances may seem to affect the revenue the firm could have earned by investing it elsewhere as maintenance of current assets as cash and in near cash assets may increase the liquidity position but not the revenue or profit earning capacity of the firm.
1) Introduction 2) Receivables Management 3) Inventory Management 4) Cash Management 5) Working Capital Finance and Estimation 6) Source of Working Capital 7) Estimation of working capital
Decisions relating to working capital and short term financing are referred to as working capital management. These involve managing the relationship between a firm's short-term assets and its shortterm 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.
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.
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.
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
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". 8.2 RECEIVABLES MANAGEMENT Receivables or debtors are the one of the most important parts of the current assets which is created if the company sells the finished goods to the customer but not receive the cash for the same immediately. Trade credit arises when firm sells its products and services on credit and dose not receive cash immediately. It is essential marketing tool, acting as bridge for the movement of goods through production and distribution stages to customers. Trade credit creates receivables or book debts which the firm is expected to collect in the near future. The receivables include three characteristics
1) It involve element of risk which should be carefully analysis. 2) It is based on economic value. To the buyer, the economic value in goods or services passes immediately at the time of sale, while seller expects an equivalent value to be received later on. 3) It implies futurity. The cash payment for goods or serves received by the buyer will be made by him in a future period. 125
The sales of goods on credit basis are an essential part of the modern competitive economic system. The credit sales are generally made up on account in the sense that there are formal acknowledgements of debt obligation through a financial instrument. As a marketing tool, they are intended to promote sales and there by profit. However extension of credit involves risk and cost, management should weigh the benefit as well as cost to determine the goal of receivable management. Thus the objective of receivable management is to promote sales and profit until that point is reached where the return on investment in further funding of receivables is less .than the cost of funds raised to finance that additional credit Table 8.1-Size of receivables
YEAR TRADE RECEIVABLES RECEIVABLE INDEX 2004 2,217 ,269 100 2005 2,960, 413 134 2006 7,804, 526 352 2007 12,708 ,947 573 2008 20,461,08 5 923 2009 13,615,5 76 614
Chart 8.1-Receivable Index
SIZ OF RECEIVABLES E 20,000,000 18,000,000 16,000,000 14,000,000
1000 20085 900 800 700 2007 4 2009 6 600 500 INDEX 2006 3 400 300 2005 2 200 100 0 2004 2005 2006
Y RS EA
12,000,000 10,000,000 8,000,000 6,000,000 4,000,000 2,000,000 2004 1
T rade Debtors
The average collection period measures the quality of debtors since it indicate the speed of there collection. The shorter the average collection period, the better the quality of the debtors since a short collection period implies the prompt payment by debtors. The average collection period should be compared against the firm’s credit terms and policy judges its credit and collection efficiency. The collection period ratio thus helps an analyst in two respects.
In determining the collect ability of debtors and thus, the efficiency of collection efforts. In ascertaining the firm’s comparative strength and advantages related to its credit policy and performance. The debtor’s turnover ratio can be transformed in to the number of days of holding of debtors.
Table 8.2- Average Collection Period
YEAR GROSS SALES TRADE RECEIVABLES RECEIVABLE TURNOVER AVERAGE COLLECTION PERIOD
2004 6,927,072 2,217,269 3.12 116.83
2005 11,279,759 2,960,413 3.81 95.80
2006 24,739,046 7,804,526 3.17 115.15
2007 39,165,363 12,708,947 3.08 118.44
2008 43,850,144 20,461,085 2.14 170.31
2009 63,664,311 13,615,576 4.68 78.06
Chart No.8.2 Average Collection Period
AVERAGE COLLECTION PERIOD
180.00 160.00 140.00
120.00 100.00 80.00 60.00 40.00 20.00
AVERAGE COLLECTION PERIOD
3.12 0.00 2004
3.17 2006 YEARS
3. Observations The size of receivables are staidly increasing it indicates that the company was allowing more credit year to year, but it was not bad signal because as receivables were supporting to the increase in the sales. Average collection period are reducing to present situation, but as compare with the normal collection period allowed to customer by JISL of 90 day’s, it was clear that the company required to increase our efficiency of collection of receivables. All the above factors directly or indirectly affects in the debtors turnover ratio, current ratio and working capital ratio. For effective management of credit, the firm should lay down clear cut guidelines and procedure for granting credit to individual
customers and collecting individual accounts should involve following steps: (1) Credit information (2) Credit investigation (3) Credit limits (4) Collection procedure. 8.3 INVENTORY MANAGEMENT Inventory management is primarily about specifying the size and placement of stocked goods. Inventory management is required at different locations within a facility or within multiple locations of a supply network to protect the regular and planned course of production against the random disturbance of running out of materials or goods. The scope of inventory management also concerns the fine lines between replenishment lead time, carrying costs of inventory, asset management, inventory forecasting, inventory valuation, inventory visibility, future inventory price forecasting, physical inventory, available physical space for inventory, quality management, replenishment, returns and defective goods and demand forecasting. Balancing these competing requirements leads to optimal inventory levels, which is an on-going process as the business needs shift and react to the wider environment. Inventory management involves a retailer seeking to acquire and maintain a proper
merchandise assortment while ordering, shipping, handling, and related costs are kept in check. Systems and processes that identify inventory requirements, set targets, provide replenishment
techniques and report actual and projected inventory status.
Handles all functions related to the tracking and management of material. This would include
the monitoring of material moved into and out of stockroom locations and the reconciling of the inventory balances. Also may include ABC analysis, lot tracking, cycle counting support etc. Management of the inventories, with the primary objective of determining/controlling stock
levels within the physical distribution function to balance the need for product availability against the need for minimizing stock holding and handling costs The term ‘inventory’ is used to designate the aggregate of those items of tangible assets which are:1) Finished goods (‘saleable’) 2) Work-in-progress (‘convertible’) 3) Material and supplies (‘consumable’) In financial view, inventory defined as the sum of the value of raw material and supplies, including spares, semi-processed material or work in progress and finished goods. The nature of inventory is
largely depending upon the type of operation carried on. For instance, in the case of a manufacturing concern, the inventory will generally comprise all three groups mentioned above while in the case of a trading concern, it will simply be by stock- in- trade or finished goods. 1. OBJECTIVE
OF INVENTORY MANAGEMENT
In company there should be an optimum level of investment for any asset, whether it is plant, cash or inventories. Again inadequate disrupts production and causes losses in sales. Efficient management of inventory should ultimately result in wealth maximization of owner’s wealth. It implies that while the management should try to pursue financial objective of turning inventory as quickly as possible, it should at the same time ensure sufficient inventories to satisfy production and sales demand. The objectives of inventory management consist of two counterbalancing parts: To minimize the firms investment in inventory To meet a demand for the product by efficiently organizing the firms production and sales
operation. This two conflicting objective of inventory management can also be expressed in term of cost and benefits associated with inventory. That the firm should minimize the investment in inventory implies that maintaining an inventory cost, such that smaller the inventory, the better the view point .obviously, the financial manager should aim at a level of inventory which will reconcile these conflicting elements. Some objectives are as follows:To have stock available as and when they are required. To utilize available storage space but prevents stock levels from exceeding space available. To maintain adequate accountability of inventories assets. To provide, on item – by- item basis, for re-order point and order such quantity as would
ensure that the aggregate result confirm with the constraint and objective of inventory control. Table 8.3-Size of inventory
YEAR INVENTORY WORK PROGRESS IN 2004 114,1 27 1,781,9 62 1,896,0 89 100 2005 465,4 75 2,171,0 88 2,636,5 64 139 2006 162,5 32 2,810,2 91 2,972,8 22 157 2007 378,0 49 1,292,3 80 1,670,4 29 88 2008 571 ,443 1,441 ,426 2,012 ,869 106 2009 733 ,715 2,304 ,752 3,038 ,467 160
TOTAL INVENTORY INVENTORY INDEX
Chart No. 8.3 - Inventories index
IN VENT ORY IND EX
180 160 140 120 100
V LUES A
80 60 40 20 2004 100
157 139 106 88
INVENT ORY INDEX
Y RS EA
The manufacturing firm’s inventory consists following components:I) II) Inventory Work- in-progress
To analyze the level of raw material inventory and work in progress inventory held by the firm on an average it is necessary to examine the efficiency with which the firm converts raw material inventory and work in progress into finished goods. Table No. 8.4-Components of inventories
YEAR INVENTORY WORK IN PROGRESS
465 ,475 2,171 ,088
162 ,532 2,810 ,291
378 ,049 1,292 ,380
571,4 43 1,441,4 26
733,7 15 2,304,7 52
Chart No. 8.4-Components of inventories
INVENTORY COMPONENTS 3,000,000
INVENT ORY WORK IN PROGRESS
2004 2005 2006
The reciprocal of inventory turnover gives average inventory holding in percentage term. When the numbers of days in year are divided by inventory turnover, we obtain Days of Inventory Holding (DIH). Inventory management involves a retailer seeking to acquire and maintain a proper merchandise assortment while ordering, shipping, handling, and related costs are kept in check. Systems and processes that identify inventory requirements, set targets, provide replenishment techniques and report actual and projected inventory status.
Formula to calculate number of days inventory: Number of Days Inventory = 365 days / inventory turnover ratio. Number of day’s inventory ratio definition and explanation: The number of day’s inventory is also known as average inventory period and inventory holding period. A high number of days inventory indicates that, their is a lack of demand for the product being sold. A low days inventory ratio (inventory holding period) may indicate that the company is not keeping enough stock on hand to meet demands. The number of days inventory and inventory turnover ratios are included in the financial statement ratio analysis spreadsheets highlighted in the left column, which provide formulas, definitions, calculation, charts and explanations of each ratio. Table - 8. 5- Inventory Turnover Ratio
INVENTORY TURNOVER RATIO DAYS OF INVENTORY HOLDING Cost of Goods sold Inventory RAW MAT. TURN OVER RAW MAT. HOLDING PERIOD
3.1 117.74 5,939 ,978 114 ,127 52.05 7.01
3.7 98.65 9,866, 566 465, 475 21.20 17.22
7.3 50.00 21,708, 552 162, 532 133.56 2.73
20.1 18.16 33,554, 054 378, 049 88.76 4.11
17.4 20.98 35,055, 556 571, 443 61.35 5.95
17.1 21.35 52,042, 769 733, 715 70.93 5.15
Chart No. 8.5 – Inventory Turnover Ratio
INVENTORY TURNOVER RATIO
20.1 10 7.3 3.1 3.7
1 2004 2005 2006 YEARS INVENTORY TURNOVER RATIO 2007 2008 2009
Table - 8.6-Inventory holding Period
YEAR INVENTORY TURNOVER RATIO DAYS OF INVENTORY HOLDING COST OF GOODS SOLD INVENTORY WORK IN PROGRESS TOTAL INVENTORY RAW MAT. TURN OVER RAW MAT. HOLDING PERIOD
2004 3.1 117.74 5,939 ,978 114 ,127 1,781 ,962 1,896 ,089 3.13 116.51
2005 3.7 98.65 9,86 6,566 46 5,475 2,17 1,088 2,63 6,564 3.74 97.54
2006 7.3 50.00 21,70 8,552 16 2,532 2,81 0,291 2,97 2,822 7.30 49.98
2007 20.1 18.16 33,55 4,054 37 8,049 1,29 2,380 1,67 0,429 20.09 18.17
2008 17.4 20.98 35,055 ,556 571 ,443 1,441 ,426 2,012 ,869 17.42 20.96
2009 17.1 21.35 52,042,76 9 733,71 5 2,304,75 2 3,038,46 7 17.13 21.31
Chart- 8.6-Inventory holding Period
R AW M AT. H OLD ING P RIOD E 116.51 120.00 100.00 80.00 49.98 VALU S E 60.00 40.00 20.00 0.00 2004 2005 2006 2007 YE ARS 2008 2009 20.96 21.31 RAW M AT. HOLD ING PR E IOD 18.17 97.54
4. Observations Size of inventory of AI LLC, was increasing gradually with the increase the sales. The inventory size was increasing because of increment in the finished goods stock; it indicates that the company reduced the liquidity of finished goods. High inventory turnover ratio is showing that the maximum sales turnover is achieved with the minimum investment in the inventories. Raw material turnover has increased in the year 2007 it indicates that company are investing more in raw material purchasing; thus raw material holding period has reduced in the same year to 18 days from 49 days in the previous year 2006. Overall inventory holding period has reduced because of increases in the inventory turnover and sales volume. 8.4 MANAGEMENT
Cash is money that is easily accessible either in the bank or in the business. It is not inventory, it is not accounts receivable, and it is not property. These might be converted to cash at some point in time, but it takes cash on hand or in the bank to pay suppliers, to pay the rent, and to meet the payroll. Profit growth does not always mean more cash.
Profit is the amount of money you expect to make if all customers paid on time and if your expenses were spread out evenly over the time period being measured. However, it is not your day-to-day
reality. Cash is what you must have to keep the doors of your business open. Over time, a company's profits are of little value if they are not accompanied by positive net cash flow. You can't spend profit; you can only spend cash. Cash Flow refers to the flow of cash into and out of a business over a period of time. The outflow of cash is measured by the money you pay every month to salaries, suppliers, and creditors. The inflows are the cash you receive from customers, lenders, and investors. 1. POSITIVE CASH FLOW If the cash coming into the business is more than the cash going out of the business, the company has a positive cash flow. A positive cash flow is very good and the only concern here is managing the excess cash prudently. 2. NEGATIVE CASH FLOW If the cash going out of the business is more than the cash coming into the business, the company has a negative cash flow. A negative cash flow can be caused by a number of problems that result in a shortage of cash, such as too much or obsolete inventory, or poor collections on accounts receivable. If the company doesn't have money in the bank or can't borrow additional cash at this point, it may be in serious trouble.
A Cash Flow Statement is typically divided into three components so that you can see and understand both the internal and external sources and uses of cash. 3. OPERATING CASH FLOW (INTERNAL) Operating cash flow, often referred to as working capital, is the cash flow generated from internal operations. It is the cash generated from sales of the product or service of your business. Because it is generated internally, it is under your control. 4. INVESTING CASH FLOW (INTERNAL) Investing cash flow is generated internally from non-operating activities. This component would include investments in plant and equipment or other fixed assets, nonrecurring gains or losses, or other sources and uses of cash outside of normal operations. 5. FINANCING CASH FLOW (EXTERNAL)
Financing cash flow is the cash to and from external sources, such as lenders, investors and shareholders. A new loan, the repayment of a loan, the issuance of stock and the payment of dividend are some of the activities that would be included in this section of the cash flow statement.
CASH MANAGEMENT MEANS:
Knowing when, where, and how your cash needs will occur, Knowing what the best sources are for meeting additional cash needs; and, Being prepared to meet these needs when they occur, by keeping good relationships with bankers and other creditors. Daily cash, and Long-term (annual, 3-5 year) cash flow projections to help firms to develop the necessary capital strategy to meet their business needs. They also prepare and use historical cash flow statements to gain an understanding about where all the money went. 7. PRECAUTIONARY MOTIVE
Cash flows are somewhat unpredictable, with the degree of predictability varying among firms and industries. Unexpected cash needs at short notice may also be the result of following:
1) Uncontrollable circumstances such as strike and natural calamities. 2) Unexpected delay in collection of trade dues. 3) Cancellation of some order for goods due unsatisfactory quality. 4) Increase in cost of raw material, rise in wages, etc.
The higher the predictability of firm’s cash flows, the lower will be the necessity of holding this balance and vice versa. The need for holding the precautionary cash balance is also influenced by the firm’s capacity to have short term borrowed funds and also to convert short term marketable securities into cash.
Speculative cash balances may be defined as cash balances that are held to enable the firm to take advantages of any bargain purchases that might arise. While the precautionary motive is defensive in nature, the speculative motive is aggressive in approach. 9. ADVANTAGES
OF CASH MANAGEMENT
Cash does not enter in to the profit and loss account of an enterprise, hence cash is neither profit nor losses but without cash, profit remains meaningless for an enterprise owner. A sufficient of cash can keep an unsuccessful firm going despite losses An efficient cash management through a relevant and timely cash budget may enable a firm to
obtain optimum working capital and ease the strains of cash shortage, fascinating temporary investment of cash and providing funds normal growth.
Cash management involves balance sheet changes and other cash flow that do not appear in
the profit and loss account such as capital expenditure. Table 8.7-Size and index of cash
YEAR BANK/CASH CASHINDEX 2004
Chart No. 8.7-Cash Index
C S IN E AH DX
1 ,0 0 0 0 0 ,0 0
1 0 ,0 0 ,0 0 0
10 0 0 ,0 0
1 ,0 0 0 0
B N /C S AK AH
IN E DX
1 0 ,0 0
C S IN E AH DX
1 20 04 20 05 20 06 20 07 20 08 20 09
The cash conversion cycle is simply the duration of time it takes a firm to convert its activities requiring cash back into cash returns. The cycle is composed of the three main working capital components: Accounts Receivable outstanding in days (ARO), Accounts Payable outstanding in days (APO) and Inventory in days (IOD). The Cash Conversion Cycle (CCC) is equal to the time is takes to sell inventory and collect receivables less the time it takes to pay your payables, OR CCC = IOD + ARO – APO Cash Cycle is very important, because it represents the number of days a firm's cash remains tied up within the operations of the business. It is also a powerful tool for assessing how well a company is
managing its working capital. The lower the cash conversion cycle, the more healthy a company generally is. If you compare the results of the cycle over time and see a rising trend it is often a warning sign that the business may be facing a cash flow crunch.
CASH CONVERSION Understanding the components of the cycle
When evaluating cash flow, those factors directly affecting profit, revenue and expenses, are easy to understand and their affect on cash is straight forward; decreases in costs or increases in profit margin results in less cash going out or more cash coming in, and increased profits. However, the working capital components of the CCC are a little more complex. In simple terms, an increase in the amount of time accounts receivables are outstanding uses up cash, a decrease provides cash; an increase in the amount of inventory uses cash, a decrease provides cash; an increase in the amount of time it takes you to pay your payables provides cash, a decrease uses cash.
The Operating Cycle consists of 3 phases:Phase 1 In Phase 1, Cash gets converted into Inventory. This includes purchase of Raw Material, Conversion of Raw Material into Work-in-Progress, Finished Goods and finally the transfer of goods to stock at the end of the manufacturing process. In the case of Trading Companies, this phase is shorter as there would be no manufacturing activity and cash is directly converted into Inventory. This Phase is of course totally absent in the case of Service Organizations. Phase 2
In Phase 2 of the cycle, the Inventory is converted into Receivables as Credit Sales are made to customers. Firms which do not sell on Credit obviously don't have the Phase 2 of the operating Cycle. Phase 3 The Last Phase i.e. Phase 3 of the Operating Cycle, represents the stage when Receivables are collected. This phase completes the operating cycle. Thus, the firm has moved from cash to inventory, to receivables and to cash again. Table 8.8-Operating Cycle
YEAR DAYS OF INVENTORY HOLDING AVERAGE COLLECTION PERIOD CREDITORS PAYMENT PERIOD CASH CONVERTION CYCLE
2004 117 117 70 163
2005 98 96 75 118
2006 50 115 65 100
2007 18 118 70 67
2008 21 170 85 106
2009 21 78 55 44
Chart No. 8.8-Cash Conversion Cycle
CASH CONVERSION CYCLE 250
200 117 163 150
AVERAGE COLLECTION PERIOD
DAYS OF INVENTORY HOLDING 100 115 106 170 85 7011867 55 78 44 CASH CONVERTION CYCLE
100 70 50 117 98 75
CREDITORS PAYMENT PERIOD
50 0 2004 2005 2006
The size of the cash in the current assets of the company indicates the good cash management of the company. After 2004, the cash balance in the year 2006 and 2008 was extremely increased; because of the good collection from Debtors. Company failed to proper investment of available cash. After the study of cash management it mentioned above it can be conclude that management of cash involve three things: a) Managing cash flow into and out of the firm. b) Managing cash inflow within the firm, c) Financial deficit or investing surpluses cash and thus controlling cash balance at a point of a time. The firm should hold an optimum balance of cash and invest any temporary excess amount in short term bank deposits and inter corporate deposit. The high portion of cash balance in the current assets it adversely affected on profitability of the company as cash is ideal asset; it reduced the working capital leverage. 8.5 WORKING CAPITAL FINANCE Introduction Corporate finance is an area of finance dealing with financial decisions business enterprises make and the tools and analysis used to make these decisions. The primary goal of corporate finance is to maximize corporate value while managing the firm's financial risks. Although it is in principle different from managerial finance which studies the financial decisions of all firms, rather than corporations alone, the main concepts in the study of corporate finance are applicable to the financial problems of all kinds of firms. The discipline can be divided into long-term and short-term decisions and techniques. Capital investment decisions are long-term choices about which projects receive investment, whether to finance that investment with equity or debt, and when or whether to pay dividends to shareholders. On the other hand, the short term decisions can be grouped under the heading "Working capital management". This subject deals with the short-term balance of current assets and current liabilities; the focus here is on managing cash, inventories, and short-term borrowing and lending (such as the terms on credit extended to customers). The terms corporate finance and corporate financier are also associated with investment banking. The typical role of an investment bank is to evaluate the company's financial needs and raise the appropriate type of capital that best fits those needs. After determine the level of working capital, a firm has to consider how it will finance. Following are sources of working capital finance. 8.6 SOURCES
OF WORKING AND
1) Trade credit 2) Bank Finance 3) Letter of credit 1. Trade credit Trade credit is an arrangement between businesses to buy goods or services on account, that is, without making immediate cash payment. The supplier typically provides the customer with an agreement to bill them later, stipulating a fixed number of days or other date by which the customer should pay. It can be viewed as an essential element of capitalization in an operating business because it can reduce the required capital investment required to operate the business if it is managed properly. Trade credit is the largest use of capital for a majority of business to business (B2B) sellers in most of the countries, and is a critical source of capital for a majority of all businesses. 2. BANK
FINANCE FOR WORKING CAPITAL
Banks are main institutional source of working capital finance in India. After trade credit, bank credit is the most important source of financing working capital in India. A banks considers a firms sales and production plane and desirable levels of current assets in determining its working capital requirements. The amount approved by bank for the firm’s working capital is called credit limit. Credit limit is the maximum funds which a firm can obtain from the banking system. In practice banks do not lend 100% credit limit; they deduct margin money. Forms of bank finance:1) Over Draft 2) Term Loan 3) Cash credit 4) Purchase or discounting of bills Overdraft An overdraft occurs when withdrawals from a bank account exceed the available balance. In this situation a person is said to be "overdrawn". If there is a prior agreement with the account provider for an overdraft protection plan, and the amount overdrawn is within this authorized overdraft limit, then interest is normally charged at the agreed rate. If the balance exceeds the agreed terms, then fees may be charged and higher interest rate might apply. 2) Term Loan
While the four prior debt instruments address cyclical working capital needs, term loans can finance medium-term no cyclical working capital. A term loan is a form of medium-term debt in which principal is repaid over several years, typically in 3 to 7 years. Since lenders prefer not to bear interest rate risk, term loans usually have a floating interest rate set between the prime rate and prime plus 300 basis points, depending on the borrower’s credit risk. Sometimes, a bank will agree to an interest rate cap or fixed rate loan, but it usually charges a fee or higher interest rate for these features. Term loans have a fixed repayment schedule that can take several forms. Level principal payments over the loan term are most common. In this case, the company pays the same principal amount each month plus interest on the outstanding loan balance. Cash credit In practice, the operations in cash credit facility are similar to those of those of overdraft facility except the fact that the company need not have a formal current account. Here also a fixed limit is stipulated beyond which the company is not able to withdraw the amount. 4) Bills purchased / discounted This form of assistance is comparatively of recent origin. This facility enables the company to get the immediate payment against the credit bills / invoice raised by the company. The banks hold the bills as a security till the payment is made by the customer. The entire amount of bill is not paid to the company. The company gets only the present worth of amount of bill from of discount charges. On maturity, bank collects the full amount of bill from the customer. 3. LETTER
A standard, commercial letter of credit is a document issued mostly by a financial institution, used primarily in trade finance, which usually provides an irrevocable payment undertaking. The letter of credit can also be source of payment for a transaction, meaning that redeeming the letter of credit will pay an exporter. Letters of credit are used primarily in international trade transactions of significant value, for deals between a supplier in one country and a customer in another. They are also used in the land development process to ensure that approved public facilities (streets, sidewalks, storm water ponds, etc.) will be built. The parties to a letter of credit are usually a beneficiary who is to receive the money, the issuing bank of whom the applicant is a client, and the advising bank of whom the beneficiary is a client. Almost all letters of credit are irrevocable, i.e., cannot be amended or canceled without prior agreement of the beneficiary, the issuing bank and the confirming bank, if any. In executing a
transaction, letters of credit incorporate functions common to General Inter bank Recurring Order and Traveler's cheques. Typically, the documents a beneficiary has to present in order to receive payment include a commercial invoice, bill of lading, and documents proving the shipment were insured against loss or damage in transit. However, the list and form of documents is open to imagination and negotiation and might contain requirements to present documents issued by a neutral third party evidencing the quality of the goods shipped, or their place of origin. Chart No. 8.-9-Cash Conversion Cycle
YEAR SHORTTERM BORROWINGS INTEREST @8.5% 2004 3 45,371 25,903 2005 9 12,579 68,443 2006 2,07 6,834 15 5,763 2007 2008 2,0 42,393 1 53,180 2009 561 ,131 42 ,085
Chart No. 8.9-Cash Conversion Cycle
WOR G C KIN APIT LOAN AN IN ER AL D T EST
2,000,000 1,800,000 1,600,000 1,400,000
SH T ER OR T M BO R R OWIN GS IN ER T EST @ 8.5%
1,200,000 1,000,000 800,000 600,000 400,000 200,000 2004 2005 2006
Y RS EA
Observations Arabian Industries LLC, takes only very low working capital loan to fulfill the requirement of working capital, thus company saved a lot from paying interest, on working capital loan. Company raised the funds for working capital through term loan from bank.. We can see that in 2007 firm doesn’t have any kind of loan. The supplier extending trade credit incurs cost in the form of opportunity cost of funds invested in accounts receivable. The annual opportunity cost of forgoing cash discount can be very high. Therefore AI LLC, should compare the opportunity cost of trade credit with the cost of other sources of credit while making its financial decisions. 8.7 Estimation of working capital
After considering the various factors affecting the working capital needs, it is necessary to forecast the working capital requirements. For this purpose, first of all estimate of all current assets should be made, these should be followed by the estimation of all current liabilities. Difference between the estimated current assets and estimated current liabilities will represent the working capital requirements. The estimation of working capital requirement of Arabian Industries LLC is based on few assumptions such as follows. · Gross sales will increase by 40% · Receivables collection period will be 90 day as per standards fixed by company. · Unnecessary balance of Cash may reduce by finance management. · For working capital finance company can use maximum trade credit. · Inventory holding period can be 60 days instead of present 95
ESTIMATED BALANCE SHEET OF ARABIAN INDUSTRIES LLC FOR THE YEAR 2010
2005 CURRENT ASSET -A BANK BALANCE TRADE DEBTORS INVENTORY WORK IN PROGRESS DUE FROM RELATED PARTIES OTHER RECEIVABLE TOTAL CURRENT ASSETS 199 ,387 2,960 ,413 465 ,475 2,171 ,088 53 ,010 5,849 ,374 CURRENT LIABILITIES - B SHORT TERM LOAN CURRENT PORTION OF TERM LOAN TRADE CREDITORS DUE TO RELATED PARTIES PROVISION FOR TAX OTHER PAYABLES TOTAL CURRENT LIABILITIES NET WORKING CAPITAL - (A-B) 912 ,579 187 ,158 3,053 ,555 2 ,070 27 ,784 1,553 ,819 5,736 ,965 112 ,409 68, 798 7,804, 526 162, 532 2,810, 291 217, 158 735, 450 11,798, 754 2,076, 834 505, 393 5,222, 137 23, 814 184, 470 3,536, 092 11,548, 742 250, 012 570, 267 12,708, 947 378, 049 1,292, 380 194, 191 518, 997 15,662, 831 1,455, 553 6,931, 094 31, 484 177, 498 6,740, 372 15,336, 000 326, 831 145, 245 20,461, 085 571, 443 1,441, 426 321, 144 341, 150 23,281, 494 2,042, 393 1,523, 440 10,429, 836 1,519, 796 407, 850 7,039, 860 22,963, 175 318, 319 1,917, 381 13,615, 576 733, 715 2,304, 752 4,694, 015 100, 555 23,365, 993 561, 131 2,217, 368 6,268, 619 426, 463 934, 642 5,662, 426 16,070, 649 7,295, 345 383 ,476 2,723 ,115 146 ,743 460 ,950 938 ,803 20 ,111 112 ,226 443 ,474 1,253 ,724 85 ,293 186 ,928 1,132 ,485 2,300,857 16,338,691 880,458 2,765,702 5,632,818 120,666 28,039,192 673,357 2,660,841 7,522,343 511,755 1,121,570 6,794,912 19,284,778 8,754,414 2006 2007 2008 2009 20% 2010
Table 8-10-Estimation of the Working Capital For the year 2010 For AI LLC. Chart 8-10-Estimation of the Working Capital For the year 2010 For AI LLC.
ESTIMATION OF WORKING CAPITAL FOR 2010 30,000,000
25,000,000 T OTAL CURRENT ASSETS T OTAL CURRENT LIABILITIES NET WORKING CAPITAL - (A-B)
2005 2006 2007 2008
Y RS EA
Observations Arabian Industries LLC has good credit in the market because it is No. 1 Engineering and Manufacturing Contracting Company in Sultanate of Oman, and 3rd position in entire GCC countries. Company took benefit of such position to raise the funds for working capital finance. In the year 2006 and 2008, term loan from bank was the major source of finance, but it reduced by 250% in the subsequent year, which shows the paying capacity due to the efficient financial management and also it ndicate that company changed the finance policy to get benefit sources like term credit (export package credit) which is not directly affect on cost of finance. In the year 2006 and 08 company used latter of credit but after that company not used such facility from third person.. Company mainly used term loan and letter of credit for the working capital requirement and clearing the debt for import within the year itself. For working capital finance company use cash credit facility provided by scheduled banks and national banks. Company required such huge amount for working capital finance because liquidity of the company locked in debtors. Company had around 50 % receivables account of total current assets. Company fixed normal collection period of 90 days, but collection system of the company was not able to collection from debtors within credit term. Company has receivable but not liquidity to payment of creditors thus company took cash credit and credit term, which increased the interest on working capital finance by around 126% from year 2006 compared to 2005, but in 2007 it become 126% and it reduced to 38.5 % in the year 2009. Cash management of the company is more efficient and conservative thus company carry huge amount in terms of liquid assets.
1-Findings 3-Conclusions 4-Recommendations
Working capital management is important aspect of financial management. The study of working capital management of Arabian Industries LLC, has revealed that the current ratio was as per the standard industrial practice but the liquidity position of the company showed an increasing trend. The study has been conducted on working capital ratio analysis, working capital leverage, working capital components which helped the company to manage its working capital efficiency and affectively.
1. Working capital of the company was increasing and showing positive working capital each
year. It shows good liquidity position. 2. Positive working capital indicates that company has the ability of payments of short terms liabilities. 3. Working capital increased because of increment in the current assets is more than increase in the current liabilities.
4. Company’s current assets were always more than requirement and it affected on profitability
of the company. 5. Current assets are more than current liabilities indicate that company used long term funds for short term requirement, where long term funds are most costly then short term funds. 6. Current assets components shows sundry debtors were the major part in current assets it shows that the efficient receivables collection management. 7. In the year 2009 working capital decreased because of increased the expenses as manufacturing expenses and increase the price of raw material as increased in the inflation rate. 8. Inventory was supporting to sales, thus inventory turnover ratio was increasing, but company increased the raw material holding period. 9. Study of the cash management of the company shows that company have a good control on cash management in the year 2009, where cash came from receivables and short term funds. 10. When comparing Working capital is compared with net sales it is in increasing trend indicating the effective utilization of the net working capital. 11. The decrease in figures of sources and applications from the year 20004- to the year 20009 makes at clear that the company is doing activity increasing or standardizing of its operations.
Working Capital is the lifeline of every industry, irrespective of whether it’s a manufacturing industry, services industry. Working Capital is the prime and most important requirement for carrying out the day to day operations of the business. Working Capital gives the much-needed liquidity to the business. Working Capital Finance reduces the overall fund requirement, required to build up the Current Assets, which in turn help you improve your Turn Over Ratio.
The company is performing exceptionally well due to the up wising in the global market followed by the domestic market. It is an up coming one with good and innovative ideas and believed in improving all the areas of its operations. The company has a good liquidity position and does not delay its commitment in case of both its creditors and debtors. The company being mostly dependent on the working capital facilities, it is maintaining very good relationship with their banks and their working capital management is well balanced.
1. The working capital position of the company is sound and the various sources through which
it is funded are optimal.
2. The company has used its dividend policy, purchasing, financing and investment decisions to
good effect can be seen from the inferences made earlier in the project.
3. The returns have been affected by a marked growth in working capital and 2009 return on
investment is good, but it got reduced as compared to 2008.
4. The various ratios calculated are an indicator as to the fact that the profitability of the firm and
sales are on a rise and also the deletion of the inefficiencies in the working capital management.
5. The firm has not compromised on profitability despite the high liquidity is commendable.
6. Arabian Industries has reached a position where the default costs are as low as negligible and
where they can readily factor their accounts receivables for availing finance is noteworthy. 9.3 SUGGESTIONS
Suggestions can be use by the firm for the betterment increased of the firm after study and analysis of project report on study and analysis of working capital. The suggestions are:1. Company should raise funds through short term sources for short term requirement of funds, which comparatively economical as compare to long term funds. 2. Company should take control on debtor’s collection period which is major part of current assets. 3. Company has to take control on cash balance because cash is non earning assets and increasing cost of funds. 4. Company should reduce the inventory holding period with use of zero inventory concepts. 5. The current assets should be managed more effectively so as to avoid unnecessary blocking of capital that could be used for other purposes. 6. There are various global challenges that are faced by every company n the present competitive environment and AI LLC is not any exemption. To face the present global challenges the human resources department should be develop to improve various skills among the employees specially the motivational skills and having the regular training for the employees about various developments in the market. Over all company has good liquidity position and sufficient funds to repayment of liabilities. Company has accepted conservative financial policy and thus maintaining more current assets balance. Company is increasing sales volume per year which supported to company for sustain 2nd position in Sultanate of Oman and 3rd position in GCC Countries. Summarizing the overall project work done during these 2 months, it can be said that the project was a good learning experience. The entire staff of finance department was very cooperative and they helped in all the phases of this project. It was an opportunity to learn about inventory management at the same time problems faced by the Company. These two months has given an opportunity to conceptualize and implement a new initiative. There we could learn how to interpret working capital and ratio analysis with the help of guidance given by the Finance Manager. There were lot of difficulties in the beginning of the project but slowly it got the grip on the road towards future.