working capital mgmt at ocil

8/8/2019 Working Capital Mgmt at OCIL

1/98


2/98

ACKNOWLEDGEMENT

I feel privileged in expressing profound sense of gratitude and indebt ness to Mr.

Pankaj Goyal (Finance Controller & Company Secretary) who have

generously provided me the chance to work in the esteemed organization

ORIENT CERAMICS AND INDUSTRIES LTD. His able guidance, constant

encouragement and inspiration were instrumental in the completion of this

project.

Also I would like to express my profound sense of gratitude to the entire staff of

ORIENT CERAMICS AND INDUSTIRES LIMITED for providing me with

their valuable time and constant support.

Lastly, I would like to thank my faculty guide at Apeejay School of Management,

Prof. Pankaj Varshney for his support and vital inputs without which the project

would have not been completed on time.


3/98

TABLE OF CONTENTS

EXECUTIVE SUMMARY4

RESEARCH METHODOLOGY..7

FINANCIAL AND COMPARATIVE ANALYSIS...19

FINDINGS AND OBSERVATIONS.76

BIBLIOGRAPHY...79


4/98

CHAPTER 1

EXECUTIVE SUMMARY


5/98

EXECUTIVE SUMMARY

The management of current assets deals with determination, maintenance, control

and monitoring the level of all the individual current assets. Current assets are

referred to as assets, which can normally be converted into cash within one year

therefore investment in current assets should be just adequate no more no less

to the needs of the business. Excessive investments in current assets should be

avoided, because it impairs firms profitability, as idle investment in current

assets and are non-productive and so they earn nothing, on the other hand

inadequate amount of working capital can threaten solvency of the firm, if it fails

to meet its current obligations.

Thus working capital is a qualitative concept as

1. It indicates the liquidity position of the company and,

2. It suggests the extent to which working capital needs may be financed by

permanent source of funds. Current assets should be sufficiently in excess

of current liabilities to constitute a margin or buffer for maturing

obligation within the ordinary operating cycle of business.

The basic learning objective behind the study was

1. Computation of Working Capital Management

2. Presentation of Credit Monetary Assessment (CMA)

3. Ratio Analysis

On the basis of above calculations following conclusions are made

Orient Ceramics as of now is following aggressive policy, which

means that company is maintaining lower ratio of current assets to fixed assets.

However, in 2006 the company has inclined towards a conservative approach.


6/98

The company has both long term as well as short term sources for

current assets financing. It implies that company follows matching principle

for raising funds.

Also, the company has high collection period as compared to its

competitors which show that money has been unnecessarily blocked with the

debtors.

So to overcome the above problems following are the recommendations

Increase the proportion of current assets over fixed assets to come to

proper proportion of current assets and fixed assets.

Company should shift from aggressive policy to conservative current

assets policy

Company should reduce its holding period.


7/98

CHAPTER 2

RESEARCH METHODLOGY


8/98

RESEARCH METHODOLOGY

PROJECT OBECTIVE

1. The project is aimed at evaluating the financial status of Orient Ceramics

and Industries Ltd. And then doing the comparative analysis with its

competitors i.e. Somany Ceramics Ltd. and Kajaria Ceramics Ltd.

2. Studying the working capital management at Orient Ceramics and

Industries Ltd. and estimating the working capital management for 2006-

07 and then forecasting for 2007-08.

METHODOLOGY

The methodology to be adopted for the project is explained as under

1. The initial step of the project was studying about the company and then

evaluating the financial position of the company on the basis of ratio

analysis.

2. Comparing the firms financial position with respect to its competitors i.e.

Somany Ceramics Ltd. and Kajaria Ceramics Ltd. with the help of

following ratios

Liquidity Ratios

Solvency/ Leveraging Ratios

Coverage Ratios

Activity/ Turnover Ratios

Profitability Ratios

3. The project focussed on the study of the overall working capital

management at the organization, for which the following study and

analysis was undertaken


9/98

Study of Credit Monetary Assessment (CMA) form and its

preparation for the current year.

It also included the ratio analysis of the financial statement so that

the profitability and liquidity trade-off could be analyzed.

SCHEDULE

The complete project was for duration of 8 weeks. The project had been divided

into two stages with approximate time period allotted to each stage. Both the

stages along with their approximate time were as follows

Stage 1 (approx 2 weeks):

The study of companys financial position by doing ratio analysis of the financial

statement so that the profitability and liquidity condition of the organization could

be studied closely and then comparing it with the financial statement of Somany

Ceramics Ltd. and Kajaria Ceramics Ltd.

Stage 2 (approx 6 weeks):

The study of the overall working capital management of the company was the

first step. Under this stage the operating plan was prepared and the study andanalysis of Credit Monetary Assessment (CMA) form was done. This included the

estimation of the working capital requirement for 2006-07 and then forecasting

for the year 2007-08.

SCOPE OF THE STUDY

Studying Working Capital Management of Orient Ceramics and Industries Ltd.

and benchmarking it with 2 of its competitors.


10/98

OVERVIEW OF TILE INDUSTRY

Total size of ceramic tile industry at present is more than $ 32 billion globally,

and it is growing at 7.7% CAGR with China being the largest producer,

accounting for close to a third of total world production. The size of Indian

ceramic tile industry is around Rs. 6300 crore. Indian ceramic tile industry grew

at an average rate of 12% in the three year period 2002-2005 and at around 16%

in the year 2006. It is expected to grow at 18% in the year 2007 and maintain a

rate close to 20% and above in the coming year because of the thrust on

development of commercial spaces, retail revolution in the country, housing and

rising middle class income.

In fact this spurt in construction activity has primarily pushed India at the 5 th

position in terms of tiles production. India has displaced Indonesia and has

become the 5th largest manufacturer of ceramic tiles after China, Spain, Italy and

Brazil, contributing about 4.2% to the world production.

The ceramic tiles industry in India has followed similar trends as the international

industry, which has characterized by excess capacities and falling margins.

Countries like Malaysia, Thailand, Indonesia, Sri Lanka and Vietnam are setting

up their own plants. China has emerged as a major competitor. Producers from

Spain and Italy have the advantage of lower transportation costs while exporting

to USA and Germany, which are major importing countries. The Indian industry

has developed an export market although at lower end. In volume it constitutes

half a percent of the global market. Presently Indian does not figure in the list of

major exporting countries. But this reality could change as Indian exports are

rising at the rate of 15% per annum. The top-end of the global export market is

presently dominated by Italy (40.8%) and Spain (26.4%).


11/98

Despite a strong growth in demand, the domestic tile industry has seen a

considerable decline in realizations over the past few years due to over capacity in

the domestic market, as well as increasing competition faced by the organized

segment from semi-organised and un-organised players and from cheap imports.

Further the industry is fuel incentive, the cost of which has also increased sharply

over the past few years and more so in year 2006. Thus declining realizations

coupled with increasing costs have put a pressure on profit margins of most

players in the industry.

Ceramic tile industry can be classified into three segments wall tiles segment,

floor tiles segment and vitrified & porcelain tiles segment. At present, in India the

market share of these segments are 42%, 45% and 13% respectively. Ceramic

tiles are produced both in organised as well as in unorganized sector.

The growing housing construction and replacement market along with the demand

for real estate from retail players over the next couple of years in malls etc would

create a huge demand for the tile industry in the country.

Over the long term, the prospect for the tile industry is encouraging as the ceramic

tile penetration is still very low. The per capita consumption in India is as low as

0.15 sq. mtr as compared to China (2 sq. mtr), Europe (6 sq. mtr), Brazil (2.5 sq.

mtr). Even a consumption of 1 SQM translates into six folds increase in the output

of Indian economy. The tile industry predominantly had two products in the form

of Mosaic and Ceramic tiles. Post liberalization, in 1993-94, a new technology

tile, vitrified tiles was introduced in the markets.


12/98

Vitrified tiles, which are the fastest growing segment worldwide, have also

become fastest growing segment in the Indian market. Vitrified tiles are primarily

used on floors and are fast replacing marble and granite, especially in large

projects like hotels and complexes. Current size of vitrified tile industry is Rs.

1500 crore.

The introduction of vitrified tiles in the Indian market has signaled a paradigm

shift, in terms of users preference. Vitrified tiles, which are terms as tiles of the

future are increasingly becoming popular and displacing the ceramic tiles.

Internationally these tiles are already the major sellers. The main factor which

drives the growth of vitrified tiles is the quality of the product as compared to

Ceramic tiles.

Pricing point of vitrified tiles has reached a state in India wherein it is easily

affordable and consequently, consumers are moving from ceramic to vitrified

tiles. If one goes to any commercial mall or complex, they find vitrified tiles that

have a high gloss value, shine and a larger format compared to ceramic tiles.

Per Ca

0.15

2

6

7


13/98


14/98

CERAMIC TILE INDUSTRY STATISTICS

1 World Production 6400 million sq. mt.

2 India's share 200 million sq. mt.

3 World Ranking ( in production) 7

4 Per capita consumption 0.15 sq. mt.

5 Global Industry Growth Rate 6%

6

Growth Rate (India Domestic

Market) 12%

7

Organised Industry Turnover

(India) INR 22.50 Billion

Glazed Wall Tile Share 40%

Glazed Floor Tile Share 46%

Unglazed Vitrified Tile Share 8%

Glazed Porcelain Tile Share 6%

Unorganized Industry TurnoverGlazed Wall Tile Share 57%

Glazed Floor Tile Share 35%

Unglazed Vitrified Tile Share 6%

Glazed Porcelain Tile Share 2%

8 Investment in last 5 years INR 20 Billion

9 Organised sector

Share of Production 56%

No. of units 15

Revenue (excise duty) INR 2.3 Billion per annum approx.

10 Unorganised Sector

Share of Production 44%

No. of units

200 approx. (70% based in Gujarat

region)

Revenue (excise duty) INR 0.7 Billion per annum or less


15/98

ORIENT TILES

Orient Ceramics And Industries Limited (OCIL), an ISO 14001 Company, was

incorporated as a Public Limited Company on 18th May, 1977 for themanufacture of ceramic tiles with an installed capacity of 5,000 TPA at

Sikandrabad, Distt. Bulandshahr (U.P.). It is located at a distance of approx.40

kms from Delhi.

In 1981, OCIL became a subsidiary of Somany-Pilkington's Ltd. (SPL), and as a

result of phased expansions, the manufacturing capacity was doubled from 5,000

Tons Per Annum (TPA) to 10,000 TPA.

By the end of 1993, OCIL was disassociated from SPL and Mr. Mahendra K.

Daga became Chairman & Managing Director. In 1994-95, OCIL's capacity was

further increased to 24,000 TPA. In 1996-97, another aggressive expansion

resulted in more than doubling of the plant capacity to 55,000 TPA.

OCIL's most recent expansion has increased its manufacturing capacity to 9

million square meters per annum.

The company today possesses the most state of the art technology, which enables

a finished tile to be packed untouched by hands within 2 hours from ceramic

powder. Orient Tiles are now sold in over 1200 outlets all over India, and

exported to Europe, South East Asia, Middle East and the SAARC countries.

As of 2006, the operating performance was satisfactory. The plant has increased

its capacity utilization during the financial year and running at peak level of

efficiency. The strengthening of marketing, which had positive impact and the

trend of increasing stock, has been arrested. Efforts are on to bring down the stock

and receivables to the desired level during the ensuing financial year. The

Company has maintained its market share and the volume of sales have increased.


16/98

Realization prices continued to be under tremendous pressure. The Company is

working on a new strategy of repositioning its products.

Orient Tiles with 500 strong loyal and dedicated dealers all over India and 2000

sub dealers have strong hold in North and East but is expanding sales steadily in

South and West region. A wide range of size starting from 100mmX100mm to

300mmX400mm and continuous introduction of new exciting designs, close

liaison with trade and loyal dealers and better service to customers is what

distinguishes it and has placed the company within a very short span in forefront.

Established branches are already at Delhi, Chandigarh, Bahadurgarh, Kolkata

Mumbai, Indore, Bangalore, Hubli and Ahmedabad and propose to set up many

more in the different regions of the country. The trends of last five years have

been increasing prices and customers are willing to pay a premium to companies

manufacturing high quality tiles. Even though there has been a reduction in the

excise duty, and the benefit has been passed on to the consumer, companies can

still increase price without an adverse effect on demand. There is no Govt. control

on pricing. Pricing is mostly a result of demand/supply forces, and depends a lot

on competition.


17/98

Future prospects for Orient Tiles

As one of the fastest growing economies in the world, India has witnessed an

unprecedented boom in the Construction and Retail Estate sector. Prices for

commercial and residential lands are at an all time highs. City skylines all over

India are dotted with hundreds of new construction projects. There is no doubt

that as a national player and an important part of the supply chain to the

construction sector, Orient Tiles has a wonderful opportunity to continue to

aggressively expand its market share over the next few years.

Tourism in India has been growing at a fast pace. There is an increasing demand-

supply gap of hotel rooms both for regular and seasonal tourists and for event

specific visitors such as to the Commonwealth Games 2010. As most leading

architects and builders have pre-approved Orient for use at their new projects, the

company expects to gain a significant share of this construction boom in the

hospitality sector.

Individual buyers across India are gaining rapid international exposure to new

building materials, designs styles and product applications. Keeping this in mind,

Orient Tiles is investing heavily in expanding its dealer network across India to

make its high quality products available at the best retail outlets. This will lead to

a direct increase in exposure of Orients brand to the individual home

owners/buyers who are in the market for world-class tiles.

Indias diverse demographics contribute to a huge market for attractive priced,

budget tiles. Orient is quickly capitalizing on this relatively untapped market by

expanding its product portfolio with the addition of outsourced tiles from Gujarat.

To stay ahead in the creative field of special design and effects, Orient with its

advances microprocessor controlled profile cutting technology to let their

designers create masterpieces that are worthy of anybodys imagination.


18/98


19/98

SWOT ANALYSIS OF ORIENT CERAMICS AND

INDUSTRIES LID.

STRENGTHS

The cost of production of tiles in India is 25-30 per cent lower compared with the

US and Europe, mainly owing to labour costs.

WEAKNESS

Among the major weaknesses identified are non-availability of standard raw

materials with uniform properties, manpower with low technical skills and limited

facilities for technical skills and for technical education in ceramics production.

OPPURTUNITIES AND THREATS

Ceramics industry in India could gain through the construction boom in India, and

the average growth rate of the ceramics sector at present stands at 12 per cent. A

growth rate of 15 per cent is expected within a few years.

Tourism in India has been growing at a fast pace. There is an increasing demand-

supply gap of hotel rooms both for regular and seasonal tourists and for event

specific visitors such as to the Commonwealth Games 2010.

This apart, Indian ceramics industry is highly fragmented with very few large

players and a big number of Small and Medium Enterprises (SMEs) face

problems of poor economies of scale.

Thirdly, unorganized tile sector in India accounts for 70% of the total production

in India, which in some way possess major threat to major players.

In spite of the odds, European players have invested in India in recent years and

plan to continue doing so. For European companies the time of market entry is

interesting as import duties have decreased and the trend is expected to continue.


20/98

CHAPTER 3

DATA ANALYSIS


21/98

FINANCIAL AND COMPARATIVE ANALYSIS

LIQUIDITY RATIO

Liquidity ratio measures the short-term solvency, i.e. the firms ability to pay its

current dues and also indicate the efficiency with which working capital is being

used. Commercial banks and short-term creditors may be basically interested in

the ratio under this group.

Current Ratio or Working Capital Ratio

Current Ratio is a relationship of current assets to current liabilities.

Current assets mean the assets that are either in the form of cash or cash

equivalents or can be converted into cash or cash equivalents in a short-time (say,

within a years time) like cash, bank balances, marketable securities, sundry

debtors, stock, bills receivable, prepaid expenses and short-term loans and

advances. Current Liabilities means liabilities repayable in a short time like

sundry creditors, bills payable, outstanding expenses and bank overdraft or cash

credit.

Computation: The ratio is calculated as follows:

Current Ratio = Current Assets

Current Liabilities

Objective: The objective of calculating current ratio is to assess the ability of the

enterprise to meet its short-term obligations promptly. In other words, it is used to

assess the short-term financial position of the enterprise. Hence, it indicates the

backing available to current liabilities in the form of current assets.

As such, higher the current ratio better will be the situation. It is generally

accepted that current assets should be two times the current liabilities, then only

will realization from current assets be sufficient to pay the current liabilities on

time and enable the firm to meet other day-to-day expenses. However, a blind


22/98

comparison of actual current ratio with the standard current ratio, may lead to

unrealistic conclusions. A very high ratio indicates idleness of funds, poor

investment policies of the management and poor inventory control, while a low

ratio indicates lack of liquidity and shortage of working capital.

Current Ratio 2002 2003 2004 2005 2006

Orient Tiles 1.145 1.126 1.057 1.234 1.538

Kajaria Tiles 2.02 1.99 1.543 1.043 1.211

Somany Tiles 1.132 1.036 1.037 1.528 1.55

C urrent Rat i

0

0.5

1

1.5

2

2.5

2002 2003 2004 2005 2006

Year

Rat io

Orien

Kajar

Soma

Intra firm interpretation

Current ratio of Orient Ceramics is showing an increasing trend after witnessing a

decline in 2004.

Inter firm interpretationOrient tile has the highest current ratio while Kajaria tile is witnessing a

continuous decline over the last 5 years. Somany tile has the highest figure for the

year 2006.


23/98

Quick Ratio or Acid-test Ratio

Quick ratio is a relationship of liquid assets with current liabilities. It is a fairly

stringent measure of liquidity.

Liquid assets are those assets which are either in the form of cash or cash

equivalents or can be converted into cash within a very short period. Liquid assets

are computed by deducting stock and prepaid expenses from total current assets.

Stock is excluded from liquid assets because it may take some time before it is

converted into cash. Similarly prepaid expenses do not provide cash at all and are

thus, excluded from liquid assets.

Computation: The ratio is calculated as under:

Liquid Ratio = Liquid Assets

Current Liabilities

Objective: The objective of computing liquid ratio is to assess the short-term debt

paying capacity of the firm. A part of the current assets are not readily realizable

or convertible into cash. Accordingly, the current ratio does not indicate

adequately the ability of the enterprise to discharge the current liabilities as and

when they fall due. Liquid ratio is considered as a refinement of current ratio asnon-liquid portion of current assets is eliminated to calculate the liquid assets.

Thus it is a better indicator of liquidity.

A higher liquidity ratio indicted that there is sufficient assets available with the

organization which can be converted in the form of cash almost immediately to

pay off current liabilities. Hence, higher the liquid ratio better will be the

situation. A quick ratio of 1:1 is considered standard and ideal, since for every

rupee of current liabilities, there is a rupee of quick assets. A decline in the liquid

ratio indicates over-trading, which, if serious, may land the company in

difficulties.


24/98

Quick Ratio 2002 2003 2004 2005 2006

Orient Tiles 0.34 0.36 0.28 0.34 0.47

Kajaria Tiles 0.77 0.68 0.59 0.35 0.43

Somany Tiles 0.33 0.26 0.3 0.48 0.55

Q u i c k R

00 . 2

0 . 4

0 . 6

0 . 8

1

2 0 0 2 2 0 0 3 2 0 0 4 2 0 0 5 2 0 0 6

Y e a

R a t i

O r i e

K a j a

S o m


Quick ratio of Orient Tiles had decreased in 2004 but since then has been on the

rise. The year 2006 has the highest current ratio which also means that the

liquidity of the firm is increasing which is mainly due to the increase in sundry

debtors.

Inter firm interpretation

Somany Tiles has the highest quick ratio in the year 2006 and is expected to rise

in the future whereas for Kajaria Tiles the trend for the last 5 years shows a

considerable decline.


25/98

Cash Ratio

Cash ratio is a relationship of cash and marketable securities to current liabilities.

Trade investment or marketable securities are equivalent of cash. Therefore,

they are included in the computation of cash ratio.


Cash Ratio = Cash & Bank Balance + Marketable Securities

Current Liabilities

Objective: Since cash is the most liquid asset, an enterprise must have to keep a

high amount of cash and its equivalent to current liabilities.

Cash Ratio 2002 2003 2004 2005 2006

Orient Tiles 0.05 0.02 0.02 0.03 0.02

Kajaria Tiles 0.07 0.06 0.04 0.03 0.05

Somany Tiles 0.08 0.04 0.03 0.06 0.07

C a s h Ra

0

0.02

0.04

0.06

0.08

0 .1

20 02 2003 2 00 4 200 5 20 06

Yea

R a t i

O r i e n

K aja r

S o m


26/98


Cash ratio is showing a decreasing trend. It is influenced by the decrease in cash

and bank balances and increase in current liabilities. Since the marketable

securities are nil it has no effect on the cash ratio.


Cash ratio for Somany Tiles is decreasing but it still has the highest cash ratio in

the year 2006. Orient Tiles has the lowest cash ratio of all the three companies.


27/98

Net Working Capital Ratio

Net Working Capital is used as a measure of firms liquidity. The difference

between current assets and current liabilities excluding short-term bank

borrowings is called net working capital.

Computation: The ratio is calculates as follows:

Net Working Capital Ratio = Net Working Capital

Net Assets

Net WorkingCapital Ratio 2002 2003 2004 2005 2006

Orient Tiles 0.15 0.13 0.06 0.23 0.35

Kajaria Tiles 1.02 1.00 0.54 0.04 0.21

Somany Tiles 0.13 0.04 0.04 0.53 0.56

N e t W o r king C a p it al

0

0.2

0.4

0.6

0.8

11.2

2002 2003 2004 2005 2006

Y e a r

R a t i

O r i e

K aj a

Soma


28/98


The net working capital ratio had decreased to 0.06 in 2004 but then has risen

sharply to 0.35 by the end of financial year 2006.


Somany Tiles has the highest net working capital ratio which indicates that in

comparison to the other two companies it has a greater ability to meet its current

obligations.


29/98

LEVERAGE/SOLVENCY RATIO

The term solvency implies ability of an enterprise to meet its long-term

indebtedness and thus, solvency ratios convey the long-term financial prospects of

the company. The shareholders, debenture-holders and other lenders of long-term

finance/term loans may be basically interested in the ratio falling under this

group. Following are the different solvency ratios:

Debt-Equity Ratio

The debt-equity ratio is worked out to ascertain soundness of the long-term

financial policies of the firm. This ratio expresses a relationship between debt

(external equity) and the equity (internal equity).

Debt means long-term loans, i.e. debentures, public deposits, loans (long term)

from financial institutions. Equity means shareholders funds, i.e. preference

share capital, equity share capital, reserves less losses and fictitious assets like

preliminary expenses.

Computation: The ratio is calculated as follows:Debt-Equity Ratio = Long-term Debt

Shareholders Equity

Objective: The objective of debt-equity ratio is to arrive at an idea of the amount

of capital supplied to the concern by the proprietors and of asset cushion or

cover available to its creditors on liquidation of the organization. This ratio is

sufficient to assess the soundness of long-term financial position. It also indicates

the extent to which the firm depends upon outsiders for its existence. In other

words, it portrays the proportion of total funds acquired by a firm by way of

loans.


30/98


31/98


Debt equity ratio of the firm is showing a decreasing trend. The ratio is decreasing

due to decrease in secured loans and also due to increase in equity. In 2002, the

firm had satisfactory debt equity ratio but since now it is decreasing the firm can

afford to take more debts, without taking much risk.


Of all the three companies Somany Ceramics has the highest debt equity ratio i.e.

2.41:1 as compared to Orient ceramics and Kajaria Ceramics which means that

Orient ceramics and Kajaria ceramics can afford to take debt more freely and

without taking much risk as compared to Somany Ceramics Ltd.


32/98

Debt Ratio

Debt ratio is a relationship of Debt of a firm to its Capital Employed.

Computation: This ratio is calculated as follows:

Debt Ratio = Total Debt

Capital Employed

Objective: This ratio shows the proportion of interest bearing debt (also called

funded debt) in the capital structure.

Debt Ratio 2002 2003 2004 2005 2006

Orient 1.47 1.54 1.56 1.56 1.63

Kajaria 1.67 1.79 1.79 1.8 1.76

Somany 1.61 1.52 1.51 1.45 1.44

D e b t R a

0

0 . 5

1

1 . 5

2

2 0 0 2 2 0 0 3 2 0 0 4 2 0 0 5 2 0 0 6

Y e a

R a t i

O r i e

K a j a

S o m


33/98


This ratio is showing an increasing trend due to decrease in net working capital of

the firm. In 2002 there was 47% debt in the capital structure which has now

increased to 63%.


Kajaria ceramics has the highest debt ratio as compared to its competitors which

means that it has maximum funded debt in its capital structure where as Somany

ceramics has the minimum funded debt in its capital structure as compared to its

competitors.


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35/98

Interest Cover age Rati

0

1

2

3

4

2002 2003 2004 2005 2006

Year

Ratio

Orien

Kajari

Soman


It can be seen that the companys interest coverage ratio is just about satisfactory

and it is expected to rise further in the coming years, which is a good indicator for

the company. This ratio though is not very appropriate measure of interest

coverage because the source of interest payment is the cash flow before the

interest and taxes, not the profit before interest and taxes. This indicates that the

cash available for repayment of the interest will be more than the profit, as

depreciation will also be added in profit (because it is a non-cash expense).


Of all the four companies Kajaria ceramics has the highest interest coverage ratio

whereas Somany ceramics has the lowest.


36/98

ACTIVITY (TURNOVER OR PERFORMANCE) RATIO

Turnover indicates the speed with which capital employed is rotated in the

process of doing business. Activity ratio measures the effectiveness with which a

concern uses resources at its disposal. The following are the important activity

(turnover or performance) ratios:

Inventory Turnover Ratio

Inventory turnover ratio indicates the efficiency of the firm in producing and

selling its product.


Inventory Turnover Ratio = Cost of Goods Sold

Average Inventory

Objective: This ratio indicates the efficiency of management in turning over the

company's inventory and can is often used to compare with other companies in

the same field.

InventoryTurnover Ratio 2002 2003 2004 2005 2006

Orient 6.33 5.33 4.59 4.3 4.76

Kajaria 5.22 5.07 5.76 6.28 6.07

Somany 4.29 3.6 3.55 3.48 3.96


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Invento ry T urnover R

0

1

2

3

4

5

6

7

2002 2003 2004 2005 2006

Year

R a t i

Orie

Kajar

Soma


The ratio (no. of times) had the highest figure in 2002 which was indicative of a

good inventory management as compared to its competitors in the same year.

Now in 2006, the figure is increasing indicating the increase in efficiency in the

management of the inventory. This shows that the company is having sufficient

amount of sales.


Kajaria ceramics has the highest inventory turnover ratio and Somany ceramics

has the lowest. This indicates that Kajaria ceramics has the most efficient

inventory management system as compared to its other two competitors.


38/98

Inventory Holding Period

When the number of days in a year (taken as 360) is divided by the inventory

turnover ratio, we obtain Inventory Holding Period.


Inventory Holding Period = 360

Inventory Turnover

Objective: It shows how rapidly the inventory is turning into receivables through

sales. A high inventory turnover is indicative of good inventory management.

InventoryHolding Period 2002 2003 2004 2005 2006

Orient 56.87 67.54 78.43 83.72 75.63

Kajaria 68.96 71 62.5 57.32 59.3

Somany 83.91 100 101.4 103.44 90.9

Inventory Holding Period

0

20

40

60

80

100

120

2002 2003 2004 2005 2006

Year

No. of Days

Ori ent

Kajari

Soman


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40/98

Debtors Turnover Ratio

When a firm extends credit to its customers, debtors are created. The liquidity

position of the firm depends on the quality of the debtors to a great extent.

Computation: This ratio is calculated a follows:

Debtors Turnover Ratio = Credit Sales

Average Debtors

Objective: It indicates the number of times debtors turnover each year. The higher

the value of debtors turnover, the more efficient is the management of credit.

Debtor TurnoverRatio 2002 2003 2004 2005 2006

Orient 9.41 8.42 7.79 7.66 7.11

Kajaria 4.69 5.12 5.67 6.54 7.6

Somany 10.15 9.22 8.89 7.62 7.6

Debtors Turnover Rat i

0

2

4

6

8

10

12

2002 2003 2004 2005 2006

Year

Ratio

Orient

Kajari

Soman


41/98


Higher value of debtor turnover is indicative of efficient management of credit.

However, for the firm the value is continuously declining over the past 5 years

suggesting that the firm has a lenient policy of credit which has resulted in this

decline.


Among the three, only Kajaria ceramics has witnessed an increase every year as a

result of better credit granting policies given to its customers and this trend is

expected to increase further. It is only for the other two companies that the figure

has declined every year.


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The firm should try to reduce its debtors holding period which is slightly high. By

this the funds which are blocked with the customers, and hence are becoming idle,

can be reduced and that the money can be utilized for other profitable purposes.


Kajaria and Somany have a satisfactory holding period that indicates that not

much of funds are blocked with the customers in comparison to the other

company. Both these companies share the same holding period. Secondly, only

Kajaria ceramics seems to bring down this value by a constant rate every year

indicating an effective credit policy.


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Fixed Assets Turnover Ratio


Fixed Assets Turnover Ratio = Sales

Net Assets

Fixed Assets include net fixed assets, i.e. fixed assets after providing for

depreciation.

Fixed AssetTurnover Ratio 2002 2003 2004 2005 2006

Orient 0.94 0.86 0.89 0.94 1.07

Kajaria 0.87 0.9 0.97 0.92 0.94

Somany 0.9 0.83 0.82 0.79 0.96

F i x e d A ss e t s T u r n o v e r

0

0.5

1

1.5

2002 2003 2004 2005 2006

Y ea

R a t i

O r i e

K a ja

Soma


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Current Assets Turnover Ratio


Current Assets Turnover Ratio = Net Sales

Current Assets

Current AssetTurnover Ratio 2002 2003 2004 2005 2006

Orient 2.59 2.23 2.21 1.96 1.96

Kajaria 1.87 1.94 2.15 2.47 2.39

Somany 2.22 2.19 2.3 2.09 2.17

C urrent A ssets T urnover R ati

0

0.5

1

1.5

2

2.5

3

2002 2003 2004 2005 2006Year

Ratio

Orien

Kajari

Soma

Objective: A high assets turnover ratio (fixed assets and current assets) indicates

the capability of the organization to achieve maximum sales with the minimum

investment in assets. It indicates that the assets are turned over in the form of sales

more number of times. As such, higher the ratio better will be the situation.


Fixed asset turnover has increased in comparison to last year. It is mainly due to

increase in sales, and also due to the decrease in fixed assets. For current assets

turnover the ratio has marginally decreased. However it indicates that the firm is


46/98

able to achieve maximum sales with minimum investment in the assets and the

assets are turned over in the form of sales more number of times.


Orient ceramics have the highest fixed assets turnover whereas Kajaria ceramics

have the highest current assets turnover in comparison to its competitors.


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PROFITABILITY RATIO

Profit as compared to the capital employed indicates profitability of the concern.

A measure of profitability is the overall measure of efficiency. The different

profitability ratios are as follows:

Gross Profit Ratio

The gross profit ratio establishes the relationship of gross profit on sales to net

sales of a firm, which is calculated in percentage.

Gross Profit is the difference between net sales on one hand and either of the

following on the other hand:

a) Manufacturing cost or factory cost or production cost in case of

manufacturing concerns.

b) Cost of purchase, expenses directly related to purchase and the

adjustments for stock variations if any, in case of trading concerns.

Computation: This ratio is calculated by the following formula:

Gross Profit Ratio = Gross Profit x 100

Net Sales

Objective: Gross Profit ratio is a reliable guide to the adequacy of selling prices

and efficiency of trading activities. This ratio should be adequate to cover the

administration and marketing expenses and to provide for fixed charges,

dividends and building up of reserves. Following are the objectives of calculating

this ratio:

a) To determine the selling price so that there is adequate gross profit to

cover the operating expenses, fixed charges, dividends and building to

reserves.

b) To determine how much the selling price per unit may decline without

resulting in losses on operations of the firms.


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c) Gross Profit Ratio, when compared to earlier years, if significantly

different is a reason for the management to investigate the change.

A high gross profit ratio may indicate that the organization is able to produce or

purchase at a relatively lower cost. As such, a higher ratio will be desirable.

Gross ProfitRatio 2002 2003 2004 2005 2006

Orient 13% 14.35% 11.21% 12.64% 12.8%

Kajaria 6.98% 9.68% 11.32% 15.36% 15.42%

Somany 7.51% 3.43% 3.43% 4.74% 6.01%

G r o s s P r o f i t M

0

5

10

15

20

2002 2003 2004 2005 2006

Y e a

P e r c e n t

Or ie

K aj a

Soma


The gross profit ratio for the year ending March 2006 has increased as compared

to the last two years. This is due to the fact that the company now has a 100%utilization rate of its production plant as compared to 97% a year ago. It is

expected that the gross profit ratio will increase very significantly in the coming

years.


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Kajaria ceramics has the highest gross profit ratio as compared to Orient and

Somany ceramics respectively which indicates that the operating expenses of

Kajaria ceramics is less. Thus Orient and Somany ceramics should try to increase

its gross profit ratio.


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Net Profit Ratio

The net profit ratio establishes the relationship between net profit and net sales,

expressed in percentage form.

Net Profit is derived by deducting administrative expenses and marketing

expenses, finance charges and making adjustments for non-profit expenses and

incomes.


Net Profit Ratio = Profit after tax x 100

Net Sales

Objective: The net profit ratio determines the overall efficiency of the firm.

Net Profit Margin 2002 2003 2004 2005 2006

Orient 3.07% 2.57% 1.77% 2.98% 3.11%

Kajaria 1.15% 4.15% 5.02% 8.49% 8.01%

Somany 2.16% -1.2% -0.82% -0.56% 1.08%

Net Profit Margin

-2

0

2

4

6

8

10

2002 2003 2004 2005 2006

Year

Per centage

Ori ent

Kajari

Somany


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Net profit ratio has increased significantly over the last two years. The reason for

this being that the company has achieved 100% production efficiency of its plant.

This ratio is expected to rise in the coming years as the firm expects higher net

sales and high increase in profit in the fiscal 2007.


Of all the three companies Kajaria ceramics seems to increase its net profit

margin drastically which however went down a little in 2006. It can also be

noticed that the percentage change in net profit ratio is more than the percentage

change in the gross profit ratio which however indicates that for the company

apart from raw materials other expenses have also increased. Somany ceramics

registered a sharp decline in 2003 and continued to remain so till 2005.


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Return on Equity (ROE)


Return on Equity = Profit after Tax

Shareholders Equity

Objective: ROE is calculated to see the profitability of the owners investments.

Return onEquity 2002 2003 2004 2005 2006

Orient 9.12% 11.13% 15.48% 9.09% 8.24%

Kajaria 31.35% 9.10% 7.30% 4.65% 4.81%

Somany 14.77% -16.44% -31.95% -26.63% 16.29%

Return On Equity

-40

-30

-20

-10

0

10

20

30

40

2002 2003 2004 2005 2006

Year

Percentage

Orient

Kajaria

Soman


ROE has been on a decline since 2005, which indicates that the firm is not using

resources effectively. Since this ratio is of great interest to the present and

prospective shareholders and also of great concern to the management that has the

responsibility to maximize the owners welfare.


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Somany ceramics after a relatively poor performance for the past three

consecutive years has registered a stupendous growth indicating the efficiency in

managing the resources. On the other hand, Kajaria ceramics have the lowest

ratio.


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Return on Capital Employed (ROCE)

Return on Capital Employed measures the profitability of the capital employed in

the business. A high ROCE indicates a better and profitable use of long term

funds of owners and creditors. As such, a high ROCE will always be preferred.

Computation: The ratio is calculated as:

Return on Capital Employed = Profit after tax + Interest on fixed liabilities x 100

Capital Employed

Return on

CapitalEmployed 2002 2003 2004 2005 2006

Orient 14.48 13.37 7.91 11.34 15.81

Kajaria 11.39 13.66 15.22 18.02 16.75

Somany 10.06 5.18 5.45 6.54 9.72

R e tur n o n C a p i t al E

0

5

10

15

20

2002 2003 2004 2005 2006

Y e a

R a t i o ( i n

Or i

K aj

Som


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Return on Capital Employed shows an increasing trend due to increase in PBIT

(profit before interest and tax). It is expected to grow significantly for the year

2006-07. As such, a high ROCE is always preferred as it increases the value of

capital employed by the firm for its business operations.


Barring Kajaria ceramics, the other two firms are showing increasing trend due to

increase in their PBIT respectively. Orient ceramics has the highest ROCE

followed by Somany and Kajaria respectively.


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Earnings Per Share

EPS is a widely used ratio to measure the profits available to the equity

shareholders on a per share basis. EPS is calculated on the basis of current profit

and not on the basis of retained profits.


Earnings Per Share = Profit After Tax (PAT)

No. of Equity Shares

Objective: As such, increasing EPS may indicate the increasing trend of current

profits per equity shares. However, EPS does not indicate how much of the

earnings are paid to the owners by the way of dividends and how much of the

earnings are retained in the business.

Earnings PerShare 2002 2003 2004 2005 2006

Orient 6.54 5.47 4 7.44 9.06

Kajaria 1.79 6.6 8.94 16.83 3.73

Somany 6.43 0 0 0 4.49

Earnings Per Shar

0

5

10

15

20

2002 2003 2004 2005 2006

Year

Orient

Kajari

Soman


57/98


Earnings per Share has shown a steep rise which is mainly due to increase in

profits offered to shareholders on a per share basis or increase in retained earnings

in the business. Therefore the firm should try to continue with its increase in EPS.


Kajaria Ceramics has shown the sharpest decline in EPS as compared to its other

two competitors. Since Somany ceramics posted a net loss for three consecutive

years therefore EPS is zero. Orient ceramics is able to maintain its increasing

trends.


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CONCEPTS OF WORKING CAPITAL

There are two concepts of Working Capital Gross and Net.

Gross Working Capitalrefers to the firms investment in current assets. Current

Assets are the assets which can be converted into cash within an accounting year

and include cash, short-term securities, debtors, bills receivable (accounts

receivable or book debt) and stock (inventory).

Net Working Capitalrefers 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 (accounts

payable), bills payable and outstanding expenses. Net working capital can be

positive or negative. A positive net working capital will arise when current assets

exceed current liabilities. A negative new working capital occurs when current

liabilities are in excess of current assets.

Focusing on management of Current Assets

The gross working capital concept focuses attention on two aspects of current

assets management:

1. How to optimize investment in Current Assets?

2. How should Current Assets be financed?

The consideration of the level of investment in current assets should avoid two

danger points excessiveorinadequate investments in current assets. Investment

in current assets should be just adequate to the needs of the business firm.

Excessive investment in current assets should be avoided because it impairs the

firms profitability, as idle investment earns nothing. On the other hand,

inadequate amount of working capital can threaten the solvency of the firm


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because of its inability to meet its current obligations. It should be realized that

the working capital needs of the firm may be fluctuating with changing business

activity. The management should be prompt to initiate an action and correct

balances.

Another aspect of the gross working capital points to the need of arranging funds

to finance current assets. Whenever a need for working capital fund arises due to

the increasing level of business activity or for any other reason, financing

arrangements should be made quickly. Similarly, if suddenly, some surplus funds

arise they should not be allowed to remain idle, but should be invested in short

term securities. Thus, the financial manager should have knowledge of the

sources of working capital funds as well as investment avenues where idle funds

may be temporarily invested.

Focusing on management of Liquidity

Net working capital is a qualitative concept. It indicated the liquidity position of

the firm and suggests the extent to which working capital needs may be financed

by permanent sources of funds. Current assets should be sufficiently in excess of

current liabilities to constitute margin or buffer for maturing obligations within

the ordinary operating cycle of business. In order to protect their interests, short-

term creditors always like a company to maintain current assets twice the level of

current liabilities. However, the quality of current assets should be considered in

determining the level of current assets vis--vis current liabilities. A weak

liquidity position posses a threat to the solvency of the company and makes it

unsafe and unsound. A negative working capital means a negative liquidity, and

may be harmful for the companys reputation. Excessive liquidity is also bad it

may be due to mismanagement of current assets. Therefore, prompt and timely

action should be taken by the management to improve and correct the imbalances

in the liquidity position of the firm.


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OPERATING AND CASH CONVERSION CYCLE

A firm should aim at maximizing the wealth of its shareholders, so the firm

should earn sufficient returns on its operations. Earning a steady amount of profit

requires successful sales activity. The firm has to invest enough funds in current

assets for generating sales. Current assets are needed because sales do not convert

into cash instantaneously. There is always an Operating Cycle involved in the

conversion of sales into cash.

There is difference between current and fixed assets in terms of their liquidity. A

firm requires many years to recover the initial investment in fixed assets such as

plant and machinery or land and building. On the contrary, investment in current

assets is turned over many times a year. Investment in current assets such as

inventories and debtors (accounts receivables) is realized during the firms

operating cycle that is usually less than one year.

Operating cycle is the time duration required to convert sales, after the conversion

of resources into inventories, into cash.

The operating cycle of manufacturing company involves three phases:

Acquisition of resources such as raw material, labour, power and fuel.

Manufacture of the product which includes conversion of raw materials

into work-in-progress into finished goods.

Sale of the producteither for cash or on credit. Credit sales create account

receivable for collection.

These phases affect cash flows, which most of the time, are neither synchronized

nor certain. They are not synchronized because cash flows usually occur before

cash inflows. Cash inflows are uncertain because sales and collections which give

rise to cash inflows are difficult to forecast accurately. Cash outflows, on the


62/98

other hand, are relatively certain. The firm is, therefore, required to invest in

current assets for smooth, uninterrupted functioning. It needs to maintain liquidity

to purchase raw materials and pay expenses such as wages and salaries, other

manufacturing, administrative and selling expenses and taxes as there is hardly a

matching between cash inflows and outflows. Cash is also held to meet any future

exigencies. Stock of raw materials and work-in-progress are kept to ensure

smooth production and to guard against non-availability of raw material and other

components. The firm holds stock of finished goods to meet the demand of

customers on continuous basis and sudden demand from some customers. Debtors

are created because goods are sold on credit for marketing and competitive

reasons. Thus, a firm makes adequate investment in inventories, and debtors, for

smooth, uninterrupted production and sale.

Length of Operating Cycle

The length of the operating cycle can be calculated in two ways:

a) Gross Operating Cycle

b) Net Operating Cycle

a) Gross Operating Cycle

The Gross Operating Cycle of a manufacturing concern is the sum of Inventory

Conversion Period and Debtor (receivable) Conversion Period. Thus, Gross

Operating Cycle is given as follows:

Gross Operating Cycle = Inventory Conversion Period + Debtors Conversion Period

Inventory Conversion Period is the total time needed for producing and selling the

product. It is the sum of (1) raw material conversion period (2) work-in-progress

conversion period (3) finished goods conversion period.


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Raw Material Conversion Period it is the average time period taken to

convert material into work-in-progress. Raw material conversion period

depends on (a) raw material consumption per day, and (b) raw material

inventory. Raw material consumption per day is given by the total raw

material consumption divided by the number of days in the year (say 360).

The raw material conversion period is obtained when raw material inventory

is divided by raw material consumption per day.

Raw Material Conversion Period = Raw Material Inventory

[Raw Material Consumption] /360

Work-in-progress Conversion Period it is the average time taken to

complete the semi-finished or work-in-process. It is given by the following

formula:

Work-in-process Conversion Period = Finished Goods Inventory

[Cost of Production] / 360

Finished Goods Conversion Period it is the average time taken to sell

the finished goods. It can be calculated as follows:

Finished Goods Conversion Period = Finished Goods Inventory

[Cost of goods sold] / 360

Debtors Conversion Period it is the average time taken to convert debtors

into cash. It represents the average collection period. It is calculated as

follows:

Debtors Conversion Period = Debtors

[Credit sales] / 360


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b) Cash Conversion or Net Operating Cycle

Net operating cycle is the difference between Gross Operating Cycle and

Creditors (payables) Deferral period.

Credit Deferral Period it is the average time taken by the firm in paying its

suppliers. It is calculated as follows:

Creditors Deferral Period = Creditors

[Credit Purchases] / 360

In practice, a firm may acquire resources (such as raw materials) on credit and

temporarily postpone payment of certain expenses. Payables, which a firm can

defer, are Spontaneous Sources of Capital to finance investment incurrent

assets, the Creditors Deferral Period is the length of time the firm is able to defer

payments n various resource purchases.

Net Operating Cycle is also referred to as Cash Conversion Cycle. It is the net

time interval between cash collections for sale of the product and cash payments

for resources acquired by the firm. It also represents the time interval over which

additional funds, called working capital, should be obtained in order to carry out

the firms operations. The firm has to negotiate working capital from sources such

as commercial banks. The negotiated sources of working capital financing are

called Non-spontaneous sources. If net operating cycle of a firm increases, it

means further need for negotiated working capital.

There are two ways of calculation of cash conversion cycle. One is that

depreciation and profit should be excluded in the computation of cash conversion


65/98

cycle since the firms concern is with cash flows associated with conversion are

cost; depreciation is a non-cash item and profits are not costs.

A contrary view is that a firm has to ultimately recover total costs and make

profits; therefore the calculation of operating cycle should include depreciation,

and even the profits.

The above operating cycle concepts related to a manufacturing firm. Non-

manufacturing firms such as wholesalers and retailers will not have the

manufacturing phase. They will acquire stock of finished goods and convert them

into debtors and debtors into cash. Further, service and financial enterprises will

no have inventories of goods (cash will be their inventory). Their operating cycles

will be the shortest. They need to acquire cash, then lend (create debtors) and gain

convert lending into cash.


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Determinants of Working Capital

Nature of Business

The working capital requirement of the firm is closely related to the nature of its

business. A service firm, like an electricity undertaking or a transport corporation,

which has a short operating cycle and which sells predominantly on cash basis,

has a modest working capital requirement. On the other hand, a manufacturing

concern like a machine tools unit, which has a long operating cycle and which

sells largely on credit, has a very substantial working capital requirement.

Seasonality of Operations

Firms, which have marked seasonality in their operations usually, have high

fluctuating working capital requirements. If the operations are smooth and even

through out the year the working capital requirement will be constant and will not

be affected by the seasonal factors.

Production Policy

A firm marked by pronounced seasonal fluctuations in its sales may pursue a

production policy, which may reduce the sharp variations in working capital

requirements.

Market Conditions

The market competitiveness has an important bearing on the working capital

needs of a firm. When the competition is keen a large inventory of finished goods

is required to promptly serve customers which may not be inclined to wait

because other manufacturers are ready to meet their needs. In view of competitive

conditions prevailing in the market, the firm may have to offer liberal credit terms

to the customers resulting in higher debtors. Thus, the capital requirements tend to

be high because of greater investment in finished goods inventory and accounts

receivable. On the other hand, a monopolistic firm may not require larger working


67/98

capital. It may ask customer to pay in advance or to wait for some time after

placing the order.

Condition of Supply

The time taken by the supplier of raw material, goods, etc. after placing an order,

also determines the working capital requirement. If goods as soon as or in a short

period after placing an order, then the purchaser will not like to maintain a high

level of inventory of that good. Otherwise, larger inventories should kept e.g. in

case of imported goods.

Business Cycle Fluctuations

Different phases of business cycle i.e. boom, recession etc. also affect the working

capital requirement. In case of recession period there is usually dullness in

business activities and there will be an opposite effect on the level of working

capital requirement. There will be a fall in inventories and cash requirement etc.

Credit Policy

The credit policy means the totality of terms and conditions on which goods are

sold and purchased. A firm has to interact with two types of credit policies at a

time. One, the credit policy of the supplier of raw materials, goods, etc., and two,

the credit policy relating to credit which it extends to its customers. In both the

cases, however, the firm while deciding the credit policy has to take care of the

credit policy of the market. For example, a firm might be purchasing goods and

services on credit terms but selling goods only for cash. The working capital

requirements of this firm will be lower than that of a firm, which is purchasing

cash but has to sell on credit basis.

Operating Cycle

Time taken from the stage when cash is put into the business up to the stage when

cash is realized. Thus, the working capital requirement of a firm is determined by

a host of factors. Every consideration is to be weighed relatively to determine the


68/98

working capital requirement. Further, the determination of working capital

requirement is not once a while exercise; rather a continuous review must be

made in order to assess the working capital requirement in the changing situation.

There are various reasons, which may require the review of the working capital

requirement e.g., change in credit policy, change in sales volume, etc.

Issues in Working Capital Management

Working capital management refers to the administration of all components of

working capital cash, marketable securities, debtors (receivables), and stock

(inventories) and creditors (payables). The financial manager must determine

levels and composition of current assets. He must see that right resources are

tapped to finance current assets, and that current liabilities are paid in time.

There are many aspects of Working capital management which make it an

important function of the financial manager.

Time working capital management requires much of the financial

managers time. Investment working capital represents a large portion of the total

investment in assets. Actions should be taken to curtail unnecessary

investment in current assets.

Criticality - working capital management has great significance for all

firms but it is very critical for small firms. Small firms in India face a

severe problem if collecting their dues debtors. Further, the role of current

liability is more significant in case of small firms as, unlike large firms,

they face difficulty in raising long-term finances.

Growth the need for working capital is directly related to the firms

growth. As sales grow, the firm needs to invest more in inventories and

debtors. Continuous growth in sales may also require additional

investment in fixed assets.


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Liquidity vs. Profitability; Risk-Return Trade-off

A larger investment in current assets under certainty would mean a low rate of

return on investment for the firm, as excess investment in current assets will not

earn enough return. A smaller investment in current assets, on the other hand,

would mean interrupted production and sales, because of frequent stock-outs and

inability to pay creditors in time due to restrictive policy.

Given a firms technology and production policy, sales and demand conditions,

operating efficiency etc., its current assets holdings will depend upon its working

capital policy. It may follow a conservative or an aggressive policy. These

policies involve risk-return trade-offs. A conservative policy means lower return

and risk, while an aggressive policy produces higher return and risk.

The two important aims of the Working capital management are:profitability and

solvency, used in the technical sense, refers to the firms continuous ability to

meet maturing obligations. If the firm maintains a relatively large investment in

current assets, it will have no difficulty in paying claims of creditors when they

become due and ill be able to fill all sales orders and ensure smooth production.

Thus, a liquid firm has less risk of insolvency; that is, it will hardly experience a

cash shortage or a stock-out situation. However, there is a cost associated with

maintaining a sound liquidity position. A considerable amount of the firms funds

will be tied up in current assets, and to the extent this investment is idle, the firms

profitability will suffer.

To have higher profitability, the firm may sacrifice solvency and maintain a

relatively low level of current assets. When the firm does so, its profitability will

improve as fewer funds are tied up in idle current assets, but its solvency would

be threatened and would be exposed to greater risk of cash shortage and stock-

outs.


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Estimating Working Capital Needs

Current Assets Holding Period: To estimate working capital requirements

on the basis of average holding period of current assets and relating them to

costs based on the companys experience in the precious years. This method is

essentially based on the operating cycle concept.

Ratio of Sales: To estimate working capital requirements as a ratio of sales

on the assumption that current assets change with sales.

Ratio of Fixed Investments: To estimate working capital requirements as a

percentage of fixed investment.

Policies for Financing Fixed Assets

A firm can adopt different financing policies vis--vis current assets. Three types

of financing may be distinguished:

Long-term Financing: The sources of long term financing include

ordinary share capital, preference share capital, debentures, long-term

borrowings from financial institutions and reserves and surplus (retainedearnings).

Short-term Financing: The short-term financing is obtained for a short

period less than one year. It is arranged in advance from banks and other

suppliers of short-term finance in the money market. It includes working

capital funds of banks, public deposits, commercial papers, factoring of

receivables etc.

Spontaneous Financing: It refers to the automatic sources of short-term

funds arising in the normal course of a business. Trade (suppliers) credit and

outstanding expenses are examples of spontaneous financing.


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The real choice of financing current assets, once the spontaneous financing have

been fully utilized, is between the long-term and short-term sources of finance.

Depending on the mix of short-term and long-term financing, the approach

followed by a company may be referred to as:

Matching Approach

Conservative Approach

Aggressive Approach

Matching Approach

The firm following matching approach (also known as Hedging approach) adopts

a financial plan which matches the expected life of the sources of funds raised to

finance assets. For e.g., a ten-year loan may be raised to finance a plant with an

expected life of ten years. The justification for the exact matching is that, since

the purpose of financing is to pay for assets, the source of financing and the assets

should be relinquished simultaneously. Using long-term financing for short-term

assets is expensive, as funds will not be utilized for the full period. Similarly,

financing long-term assets with short-term financing is costly as well as

inconvenient as arrangement for the new short-term financing will have to be

made on a continuing basis.


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Aggressive Approach

An aggressive policy is said to be followed by the firm when it uses more short-

term financing than warranted by the matching plan. The firm finances a part of

its permanent current assets with short-term financing. The relatively more use of

short-term financing makes the firm more risky.


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THE OPERATING CYCLE AND WORKING CAPITAL

The working capital management of a firm depends, to a great extent up on the

operating cycle of the firm. The operating cycle may be defined as the time

duration starting from the procurement of goods or raw materials and ending with

the sales realization. The length and nature of the operating cycle may differ from

one firm to another depending on the size and nature of the firm.

The investment in working capital is influenced by four key events in the

production and sales form:

Purchase of raw materials

Payment of raw materials

Sale of finished goods

Collection of cash for sales

(Source: http://www.ediindia.org/)
http://www.ediindia.org/http://www.ediindia.org/


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Operating Cycle Period: the firm begins with the purchase of raw material,

which are paid for after a delay, which represents the accounts payable period.

The firm converts raw material into finished goods and then sell the same. The

time that, elapses between the purchase of raw material and the collection of cash

for the sales is referred to as the operating cycle. The length or time duration of

the operating cycle of any firm can be defined as the sum of its inventory

conversion period and the receivable conversion period.

1. Inventory Conversion Period (ICP): The time tag between the purchase of

raw material and sale of finished goods is the inventory conversion period. In

the manufacturing firm the ICP consists of Raw Material Conversion Period

(RMCP), Work-in-Process Conversion Period (WPCP), and the Finished

Goods Conversion Period (FGCP). RMCP refers to the period for which the

raw material is generally kept in stores before it is used to the production

department. The WPCP refers to the period for which the raw material

remains in the production process before it is taken out as a finished unit. The

FGCP refers to the period for which finished goods remain in the stores before

sold to a customer.

2. Receivables Conversion Period (RCP): It is the time required to convert

the credit sales into cash realization. It refers to the period between the

occurrence of credit sales and collection from debtors.


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The total of ICP and RCP is also known as Total Operating Cycle Period (TOCP).

The firm might be getting some credit facilities from the supplier of raw material,

wage earners, etc. This period for which the payment of these parties are deferred

or delayed is known as Deferral Period (DP). The Net Operating Cycle (NOC) of

the firm is arrived at by deducting the DP from the TOCP. NOC is also known as

Cash Cycle.

RMCP = (Avg. raw material stock/total raw material stock)*360

WPCP = (Avg. work-in-process/ total work-in-process)*360

FGCP = (Avg. finished goods/ total cost of goods sold)*360

RCP = (Avg. receivables/ total credit sales)*365

DP = (Avg. creditors/ total credit purchases)*365

In respect of these formulations, the following points are noteworthy:

a) The Average value in the numerator is the average of opening balance

and closing balance of the respective item. However, if only the closing

balance is available, then even the closing balance may be taken as the

Average.

b) The figure 360 represents the number of days in a year. It is taken for

the purpose of ease in calculation.


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c) The total figure in the denominator refers to the total value of the item in

a particular year.

d) In the calculation of RMCP, WPCP, and FGCP, the denominator is

calculated at cost-basis and the profit margin has been excluded. The

reason being that there is no investment of funds in profits as such.

The working capital is calculated for the Orient Ceramics and Industries Ltd.

on the next page and final holding month for the inventories, debtors and

creditors are given in the table on page 92 (done as a part of formulation of

Credit Monetary Assessment).


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TOTAL OPERATING PLAN


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BALANCE SHEET

31-Mar-06 31-Mar-05 31-Mar-04 31-Mar-03 31-Mar-02

I Sources of Funds

1 Shareholders' Funds

a) Share Capital 46800000 46800000 46800000 46800000 46800000

b) Reserves & Surplus 311632842 277571085 254965420 246926239 232175126

358432842 324371085 301765420 293726239 278975126

2 Loan Funds

a) Secured Loans 341631793 422226436 459714381 536449132 579635839

b) Unsecured Loans 65277612 65126016 51565966 40002966 49747966

406909405 487352452 511280347 576452098 629383805

3 Deferred Tax Liability (Net) 69799835 86020167 95925572 103375725 96016225

TOTAL 835142082 897743704 908971339 973554062 1004375156

II Application of Funds

1 Fixed Assets

a) Gross Block131446594

8 1296783214124499393

9122137232

0 1186214360

b) Less: Accumulated Dep. 796866805 691936142 587870273 488980150 401851403

c) Net Block 517599143 604847072 657123666 732392170 784362957

d) Capital Work-in-progress 12367553 5979234 15874166

517599143 604847072 669491219 738371404 800237123

2 Current Assets, Loans & Advances

a) Inventories 302581377 286356858 270348448 209654699 175637720b) Sundry Debtors 218613540 175249922 137327170 145360133 98373292

c) Cash & Cash Balances 7529947 13521928 9036845 7249883 15735703

d) Other Current Assets 234831 329229 692168 423453 1094048

e) Loans and Advances 129762563 89759465 37929382 44930951 50184855

658722258 565217402 455334013 407619119 341025618

Less: Current Liabilities & Provisions

a) Current Liabilities 244656371 223127082 181714829 156776859 126267997

b) Provisions 96522948 48193688 34139064 15659602 12878223

341179319 271320770 215853893 172436461 139146220

Net Current Assets 317542939 293896632 239480120 235182658 201879398

Miscellaneous Expenditure 2258635TOTAL

835142082 898743704 908971339 973554062 1004375156


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PROFIT AND LOSS ACCOUNT

31-Mar-06 31-Mar-05 31-Mar-04 31-Mar-03 31-Ma

INCOME Sales

Less: Excise Duty recovered on sales 1400620319 1196455422 1101150054 1026231178 100411

Net Sales 103250837 83240148 93974937 116341703 12219535

EXPENDITURE Other Income 1297369482 1113215274 1007175117 909889475 881916

Increase/(Decrease) in stocks 12766478 20373228 13191274 34754088 153283

4679684 42870378 20595033 37258673 319057

1314815644 1176458880 1040961424 981902236 929150

Purchases (Traded Goods)

Manufacturing and Other Expenses 8421836 18915277 14618602 9753542 173523

PROFIT Finance Charges (Net) 1076315188 960573288 856757422 752977082 704170

Depreciation 50907926 45734377 46210407 71841563 771264

105717715 105443182 103456929 102027589 808135

1241362665 1130666124 1021043360 936599776 879462

Profit before tax

Add: Provision for Current Tax 73452979 45792756 19918064 45302460 496880

Add: Provision for Deferred Tax[charges/(releases)] 44000000 19,000,000 7900000 9200000 450000

Add: Provision for Fringe benefit tax -17220332 -8905405 -7450153 9684387 145665

Add: Profit after Tax 3200000

Add: Adjustments in respect of Fixed Assets sold 43473311 35698161 19468217 26418073 306214

Adjustments in respect of Revaluation Reserve 186050

Income Tax adjustments for earlier years 9396679

APPROPRIATION Prior Period Adjustments (Net) -111413 46765 -2978325 -2835239

Balance Brought Forward -761949 -4672673 -1059236 171984 101746

98470394 85864729 82825548 107065526 917925

Profit available for Appropriation

141070343 116936982 98256204 140217023 123617

Proposed Dividend

Provision for Tax on Dividend 7488000 7488000 6552000 6552000 655200Transfer to General Reserve 1050192 978588 839475 839475

Surplus carried to Balance Sheet 10000000 10000000 5000000 50000000 100000

122532151 98470394 85864729 82825548 107065

Basic/Diluted Earnings Per Share (Rs.) 141070343 116936982 98256204 140217023 123617

9.1 6.64 3.3 7.08 6.54


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CREDIT MONETARY ASSESSMENT


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Opening Statement

31.03.05 31.03.06 31.03.07 31.03.08

audited Audited projctns projctns

GROSS SALES

Domestic sales 115.98 136.17 163.86 242.21

Export sales 2.69 2.73 4.00 6.00

Trading Sales 0.98 1.16 34.00 79.60

Total 119.65 140.06 201.86 327.81

Less excise duty 8.32 10.32 12.43 18.39

Deduct other items

Net sales ( item 1 - item 2 ) 111.33 129.74 189.43 309.42

% age rise (+) or fall (-) in net 10.53 16.54 46.01 63.34sales compared to previous

year (annualised)

Cost of Sales

Raw materials (including 40.84 42.55 73.64 136.16

stores and other items used

in the process of manufacture)

(a) imported 3.21 5.69 6.85 10.13

(b) Indigenous 37.63 36.86 66.79 126.03

Other spares 9.86 11.45 13.14 18.44

(a) Imported 1.54 1.24 1.49 2.20

(b) Indigenous 8.32 10.21 11.65 16.24

Power and fuel 17.96 19.58 23.14 35.36

Direct labour 3.80 4.04 5.61 9.18

(Factory wages & salary)

Other mfg. Expenses 2.21 1.47 1.80 2.33

Depreciation 10.54 10.57 9.24 11.25

SUB TOTAL (I TO VI) 85.21 89.66 126.57 212.72

ADD: Opening stocks-in-

Process 1.29 1.41 0.97 1.10

Sub-total 86.50 91.07 127.54 213.82

Form II : Sheet 2 31.03.05 31.03.06 31.03.0731.03.0

8

0 audited Audited projctns projctns

Deduct : Closing stocks-in-


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process 1.41 0.97 1.10 1.66

Cost of Production 85.09 90.10 126.44 212.16

Add : Opening stock of

finished goods 12.93 17.08 17.99 18.91

SUB-TOTAL 98.02 107.18 144.43 231.07

Deduct closing stock of

finished goods 17.08 17.99 18.91 29.88

SUB-TOTAL ( Total cost 80.94 89.19 125.52 201.19

of sales)

Selling general and administrtive

expenses 23.28 29.39 47.02 81.14

SUB-TOTAL (5+6) 104.22 118.58 172.54 282.33

Operating profit before interest 7.11 11.16 16.89 27.09

( 3-7 )

Interest 4.57 5.09 6.64 10.06

Operating profit after interest 2.54 6.07 10.25 17.03

( 8-9 )

Add other non-operating income

(a) Misc. Income 1.89 1.15 1.36 2.00

(b)Export Incentives 0.15 0.13 0.19 0.29

(c) Sale of Key Man Policy - - - -

(d)

Sub-total ( income ) 2.04 1.28 1.55 2.29

Deduct other non-operating expenses

(a)Prior Period Adj. 0.46 0.09 - -

Sub-total ( expenses ) 0.46 0.09 - -

Net of other non-operating 1.58 1.19 1.55 2.29

income/expenses

Profit before tax/loss[10+11(iii)] 4.12 7.26 11.80 19.32

Provision for taxes 1.01 3.00 4.06 7.26

Net profit/loss ( 12-13 ) 3.11 4.26 7.74 12.06

(a) Equity dividend paid-amt

(Already paid+ B.S. provision) 0.85 0.85 1.06 1.06

(b) Dividend Rate 16.00 16.00 20.00 20.00Retained profit ( 14-15 ) 2.26 3.41 6.68 11.00

Retained profit/Net profit (% age) 72.67 80.05 86.30 91.21


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Liabilities Statement

(Rs. in Crores)

31.03.05 31.03.06 31.03.07 31.03.08

audited Audited projctns projctns

CURRENT LIABILITIES

1 Short-term borrowings from

banks(including bills purchased,

discounted & excess borrowing

placed on repayment basis)

(i.) From applicant banks 25.83 27.73 33.00 48.00

(ii.) From other banks

(iii) Of which BP & BD

SUB TOTAL 25.83 27.73 33.00 48.00

2 Short term borrowings from

others

3 Sundry Creditors (Trade) 13.21 13.37 17.13 26.46

4 Advance payments from custo- 2.46 2.61 3.76 6.11

mers/deposits from dealers

5 Provision for taxes

6 Dividend payable 0.85 0.85 1.06 1.06

7 Other statutory liabilities 1.51 1.48 2.13 3.46

(due within one year)

8 Deposits/instalments of term 10.70 5.88 12.30 9.25

loans/DPGs/Debentures,etc.


9 Other current liabilities &

provisions(due within 1 Yr)

(specify major items) 6.41 8.40 8.13 9.44

EXPENCE PAYABLE

E OTHERS 6.41 8.40 8.13 9.44

Deffered payment for sales tax.


SUB-TOTAL (B) 35.14 32.59 44.51 55.78

TOTAL CURRENTLIABILITIES 60.97 60.32 77.51 103.78


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Assets Statements

(Rs. in Crores)

31.03.05 31.03.06 31.03.07 31.03.08

ASSETS audited audited projctns Projctns

26 Cash and bank balances 1.07 0.29 1.37 1.27

27 Investment (other than long 0.28 0.46 0.50 0.60

term investment)

(i) Government & other

Trustee Securities

(ii) Fixed Deposits with Banks 0.28 0.46 0.50 0.60

28 (i) Receivables other than 14.27 19.52 33.65 54.64

deferred & exports (include

bills purchased and

discounted by Banks)

(ii) Export receivables(include

bills purchased and

discounted by banks)

29 Instalments of deferred

receivables(due with in one yr.)

30 Inventory: 28.63 30.26 33.29 50.44

(i)Raw materials(including stores 5.47 6.44 7.80 11.22

& other items used in the

working capital mgmt at ocil

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