Expense Budgeting at Bectochem Consultants & Engineers Pvt Ltd

- by Nagesh Kashyap 10Fn-064

Companies need financial professionals who know to communicate not only what a company spent but also how it consumed that spending and where it provided value and alignment to strategy. The financial skills that are needed are those which allow us to focus on the future as well as the past, with a common thread of creating value. - Ralph W Canter Bearing Point

Flow of Presentation
About the Company Problem statement Approach Job Costing Trend Analysis Competitor Analysis Working Capital Management Recommendations

About The Company

Bectochem Consultants & Engineers Pvt. Ltd. is one of the leading process equipment manufacturers in INDIA since 1978.It deals in pharmaceutical, active pharmaceutical ingredients, food and cosmetics and allied industries. It has a 500 + work force in INDIA. It has manufacturing setups at ANKALESHWAR (Gujarat) and PUNE (Maharashtra). The products of Bectochem are found in 5 continents of the world. Introducing barrier isolator technology to India in 2004, Bectochem is the acknowledged expert in the specialised and technically demanding field of design & manufacture of high specification barrier containment systems. The industries that are served are: API Manufacturing
VISION :

Think Different Engineer Smart

MISSION : To be a INR 1000 million company by 2011 VALUES : Passion Respect Integrity Diligence Ethical Values are enhanced through: Product People Process

Solids Formulations

Product portfolio
Dry syrup powder Paste/pulp Containment Material Handling Process Equipment
Sifter, Mixer, Miller Dryer, Blender, Coater Paste Preparation, Liquid Preparation Mixer, Homogenizer, storage/transfer

Isolator

Lifting, Tilting, Conveyer, Trolley, Bins

Reactors, Condensers, Heat Exchangers

Standard Operation Procedure

Kick off meeting Mumbai
Production Testing

Kick off Meeting Plant

Store

Installation

Design

Planning

Recording

The Problem

Introduction
Problem

The Objective of every business is to create value. Every organisation works for this objective but in its own unique method. Few Organisations focus on product innovation, few others focus on customer satisfaction. Whatever might be the approach organisations should timely review if they are spending right amount to create this value. The present project is one such attempt to review the financial health of the organisation under study.

Are the expenses incurred in different activities are relevant and creating value

Research Objective

To classify and estimate different expenses and compare their behaviour overtime and with competitors.

Scope of study

Ranges from as small as individual job cost study to annual expenses trend. Relates costs incurred in all functional departments, especially material and production.

Tools/Techniques used

Job Costing, ABC Costing, FSA (Horizontal, Vertical and Ratio), Working capital Management

Job Costing
Overhead breakup The annual expenses for the year 2010-11 are considered and classified under the following heads. The detailed expense are mentioned as a percentage of the sales. The aggregate overhead break up is as follows.

cost head material factory labour

Value (lakh Rs) 3,989 855 994

% 64.45 13.81 16.06

marketing
profit sales

368
466 6,189

5.94
7.53 100.00

Job Costing
Cost Head material cost Details Calculation

purchase stock
Transport

Taken from purchase order Taken from Purchase order Calculated as per transport cost manual Calculated as per manual Depends on volume of material and destination. 1.92 % of sales cost and CST on material are also added

purchase production distribution

Labour

Production In House Contractor Vendor CRM overhead

Factory Overhead Marketing Overhead

1.07% of sales cost is apportioned to account for the production engineers and managers salary and expenses
Bill is estimated from the previously charged bills by the contractor Bill is obtained from costing sheet 1.67% of sales cost to account for the employees salary, transport and accommodation Includes, expenses and overheads of labor, taken as 3.35% of sales cost Includes electricity, factory expenses, 40% indirect labor, consumables and maintenance charges. Taken as 8.03% Salary of sales staff, transport and other expenses and 25% of indirect labor. Taken as 5.74% of sales cost.

Job Costing
FBD Cost Head Details Predefined % Value % of cost of sale

material cost
purchase stock Total Material Cost Transport purchase production distribution Total Transport Cost Labour purchase freight production freight 1.92%+ delivery freight from cost sheet from cost sheet 3,03,979 2,28,462 5,32,441 33,714 1,529 33,662 68,905 36.71 27.59 64.30 4.07 0.18 4.07 8.32

Production
In House Contractor Vendor CRM overhead Total Labour Cost Factory Overhead

1.07%
R R Ind Shivam 1.67% 3.35% 8.03%

8,840
54,500 6,468 13,796 27,675 1,11,279 66,338

1.07
6.58 0.78 1.67 3.34 13.44 8.01

Marketing Overhead Cost of sale before profit

5.94%

49,072

5.93

8,28,035

100.00

Job Costing

Cost Head Material Labour Consumable overhead cost of sale profit selling price

Bectochem % 55% 10% 8% 17% 10%

FBD Bectochem System 532441 96807 77446 164573 871267 96807 968075

Job Costing 532441 111279 184315 828035 92004 920039

% Costing 58 12 20 10

Activity Based Costing

Summary
Average Overheads derived from job costing and annual ratio are
Cost Overhead % from p&l Average from 7 job costing

Material Transport Labour

Factory Marketing

64.45 5.21 16.06

8.03 5.94

66.52 5.72 13.33

8.29 6.13

Out of activities production activity costs 39% of net sales. Out of seven cases in 5 cases labour cost is estimated more in job costing

technique than traditional method. The job costing done in this particular year jobs will be in most of the cases less than traditional costing. The reason being that, in job costing the material cost is derived as 64% as per P&L break up(=> selling price = material/0.64), but traditional costing maintains material at 55% (=> selling price = material/0.55) Job costing expenses may be sometimes at par with traditional estimation. Sometimes the will be more than the traditional estimates.

Recommendations
As the behaviour of expenses is variable it is suggested to apply a detailed job

costing technique on a regular basis on randomly selected jobs to review if the traditional costing is estimating the price with a considerable margin.
As the job costing labour costing is more than traditional weightage in majority

cases, the labour having taken by analysing the billing of each contractor implies that the share of labour expense has to be increased in traditional costing to 13 to 15% this includes CRM also.
The lower bound of final price is estimated as 1.25% of material + labour cost in

traditional method; however the overheads ranged from a minimum of 27% and maximum of 30%. It is suggested to maintain overhead estimate in this range.
The activity based costing can be used to observe the expense pattern.

Suppose overtime, the cost of individual department increases, then the corresponding activity cost shares also increases. A deeper study easily identifies the variations caused.

Financial Performance
This is the second part of the research, in this the

financial reports of Bectochem are studied and the performance wrt time and peer companies is evaluated. The financial reports of past five years and those of praj and L&T are considered for analysis The study was further carried on management of working capital and the underlying problems

Horizontal Vertical Ratio

competitor
Horizontal Vertical Ratio

Cash conversion cycle Ratio

Time series

WC management

Financial Analysis
Horizontal Analysis In this financials of one year are maintained constant (=100) and the subsequent years values are mentioned proportionately Ratio Analysis Different performance, turnover liquidity ratios are applied and analyzed Vertical Analysis In this, if P&L is considered then sales is mentioned as 100 and other expenses are marked relatively, in balance sheet, total fund is taken as 100 and its constituents are apportioned similarly total assets are taken as 100 and the constituents are apportioned

Trend Analysis

Trend Analysis Summary

Sales, expenses and gross profit follow same trend and same level of variation, but net profit variation will be high for a given change in sales. A small increase in sales can increase the net profit by a greater value and same is the case with fall in sales. A reverse trend is observed in interest payment trend. It is increasing with fall in sales. In the capital structure, reserves are gradually falling where as loan is increasing. The cost of reserves will be lesser than cost of loan. The increase in loan is not a favourable symptom. In the application of funds, the net current assets have increased while the change in fixed assets is negative and small. From this it is understood that the loan procured is to address the working capital management. From Vertical analysis it is understood that there is an increase in profit and interest component while the expense component is slightly reduced. In the recent year (2009-10) there is a fall in profit and rise in interest. This is good symptom and also not following the trend. The trend observed in the capital structure from 2006-09 is disturbed in 2009-10. In the former the reserves were increasing while equity and loan were decreasing, in 2009-10 the loan has increased at the expense of reserves. This is bringing back to the structure that is observed in 2005-06. In the application part the net current assets are increasing while the investments and fixed assets are decreasing. Two critical observations from the ratio analysis are
The debtors value is 30% of sales and creditors are 47% of material purchased The interest paid is 33% of PBIT in 2009-10

These two symptoms indicate the risk resulted due to credit sale policy and the capital structure policy.

Competitor Analysis
In the horizontal Analysis the financial reports of

Bectochem and two of its peers for the year 200809 and 2009-10 are considered and the relative change in each element of the financial statements is recorded. These trend values are compared.
Vertical Analysis

Competitor Analysis Summary

There is an overall fall in income in the companies during 2008-10, the growth in expenses has been doubled in the peer companies this was not the case in Bectochem. The sales and expenses of peers have doubled within five years, but Bectochems growth is not at par. The equity capital remained constant whereas those of peers were increasing. Both the competitors are investing in fixed assets and the share allotted for investments is also increasing. This is constant in Bectochem. The current assets and liabilities have increased significantly in the peer companies compared to Bectochem. This is due to increased activity. From vertical Analysis, it is understood that the major share in expenses is material for Bectochem and Praj whereas it is manufacturing in LT. So as company grows material cost has to be reduced. Also personnel cost is relatively high at Bectochem. The financial expenses are also growing as compared to peer companies. The capital structure of peer companies consists of mainly reserves as major investment, this is not the case with Bectochem, debt and equity also have equal contribution compared to reserves. From ratio analysis it can be inferred that

Net margin is very low compared to peers Peers were investing in assets The activity growth in peers is high

Observation
From trend and competitor analysis it is observed that Bectochem has significant debt This was not used for expansion This is reducing PAT There are some symptoms leading to OVERTRADING Facts supporting this There is a sudden rise in activity in 2009-10 indicated by high level of inventory, material handled Though Current assets are capable of covering current liabilities, loan is procured to address operational expenses The average collection period, average payment period and inventory turnover period are very high

Overtrading
It is a term that is used to refer to a situation where an organisation aggressively increases its sales or business activities, especially where trading is made on credit sales without sufficient funds (capital) to support such increasing trading activities. This is where an organisation has increasing sales volume, usually with lots of customers credit sales. But the prolonged credit sales period (credit limit) implies that company may not have immediate or sufficient funds from its credit sales and may run the risk of not having sufficient funds to meet its operational expenses and possibly be faced with liquidation.

more orders require more investment and late payment to suppliers

Mission to aggressive sales

high inventory and high amount of debtors result in late payments

high level of orders high initial investment

This is often a big problem for small medium enterprise (SME) who focus on increasing sales and business at the inception of business, such that if they are caught up with poor (and inadequate) current account management policies, they run the risk of overtrading.

procurement of loan to address as cash in hand is less

Overtrading

The change in net profit is high for a given change in sales or gross profit. The sales have risen in 2010-11 Debt is increased indicating that funds are procured to meet expenses Inventory percentage has also increased considerably Receivables and payables experienced less change, ie the average accounts payable/receivable has been maintained at a constant level Debtors volume is 30% of sales Cash in hand/bank has been decreased The average collection period is 109 days and average payment period is 178 days and inventory conversion period is 86 days in 2009. These values are very high compared to the previous values Though current ratio is decent, quick ratio and cash ratio are not impressive

Cash Conversion Cycle

CCC = # days between disbursing cash and collecting cash in connection with undertaking a discrete of operations. = Inventory conversion period + Receivables conversion period Payables conversion period unit

200.00 178.99 162.64 150.00 147.10 131.63 115.73 100.00 79.02 50.00 94.31 60.56 27.84 -9.48 2007-08 29.85 23.05 102.88 109.81 92.23 148.42

54.60

13.65 0.00 2005-06 2006-07

2008-09 -15.70

2009-10

-13.48
-50.00 inventory cycle accounts receivable cycle

accounts payable period

cash conversion cycle

Recommendations
The high share of debtors and creditors has to be reduced (debtors 30% of

sales, creditors 47% of purchases). The presence of high amount of debtors and creditors may create liquidity issues. Hence it is suggested to control the values of each. The high value of inventory observed, is majorly work in progress the company carries job order production. The rise in inventory conversion period from 29 to 92 is a matter of concern. Because to procure this inventory money has to be invested, and the return on this inventory will be realised after a period which is equal to inventory conversion period + average collection period. Thus leads to liquidity problems. The profit margin (Gross Profit = 8% and net profit 5%) is significantly below the margin maintained by the peers. The ideal profit margin to be maintained is 15%. Besides these Personnel expenses are high compared to peers, the relative share of this expense has to be controlled. The loan component affects directly the profit; this has to be controlled by proper working capital management. The capital structure of peers has reserves as a major investing component. Also cost of reserves will be compared to cost of loan or equity. The activity pace should be enhanced which hints at capacity expansion as done by peers

Questions?

Thank You