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Summer Training Project Report

On

A Study of Financial Statements of MINDA CORPORATION

Submitted in Partial Fulfillment for the Award of the

Degree of Master in Business Administration 2009-2011

Under the Guidance of: Submitted By:

Ms Sanam Sharma Rishabh Jain

02914803909

Department of Management

Maharaja Agrasen Institute of Technology

Affiliated to Guru Gobind Singh Indraprastha University, Delhi

PSP Area, Plot No. 1, Sector 22, Rohini, Delhi 110086


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STUDENT DECLARATION

This is to certify that I have completed the Summer Project titled A STUDY OF FINANCIAL

STATEMENTS OF MINDA CORPORATION in MINDA CORPORATION LIMITED

under the guidance of Mr. J K Gupta in partial fulfillment of the requirement for the award of

Degree of Master of Business Administration at Maharaja Agrasen Institute of Technology,

Delhi. This is an original piece of work & I have not submitted it earlier elsewhere.

Date: Signature:

Place: New Delhi Name: Rishabh Jain

University Enrollment No.: 02914803909


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CERTIFICATE FROM THE INSTITUTE GUIDE

This is to certify that the summer project titled A Study Of Financial Statements of MINDA

CORPORATION is an academic work done by Rishabh Jain submitted in the partial

fulfillment of the requirement for the award of the degree of Master Of Business Administration

from Maharaja Agrasen Institute of Technology, Delhi, under my guidance & direction.

To the best of my knowledge and belief the data & information presented by him/her in the

project has not been submitted earlier.

Signature :

Name of the Faculty : Ms Sanam Sharma

Designation :


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ACKNOWLEDGEMENT

With limitless humility, I would like to praise and thank God, the supreme and the merciful,

who blessed me with all favorable circumstances and supports to go through the gigantic task.

His constant moral encouragement has always been a source of inspiration for me to pursue for

excellence.

I am highly indebted to my esteemed advisorMr. J.K GUPTA, Head, Finance and Accounts,

Minda Corporation Ltd. whose dynamic guidance, sublime suggestions, hearted support,

constant encouragement helped me immensely during the course of this training and preparation

of this manuscript.

It is proud privilege for me to express my profound regards and deep sense of gratitude to Mr.

Gajjela Sridhar, Minda Corporation Ltd. and other members of Finance and Accounts, Minda

Corporation Ltd. for their willing help, sympathetic interest and exquisite suggestions given by

them during the course of this training.

Last But Not the least I would like to thank MINDA Corporation Ltd. for their cooperation

enabling me to understand the subject practically and providing facilities during the course of

action.

The warmth showered upon me through every handshake, every smile and many time through

unsaid words is warmly acknowledged.

Rishabh Jain

02914803909


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CHAPTER- 1

INTRODUCTION


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1.1 PURPOSE OF RESEARCH

To Identify ways a financial statement impacts Minda Corporation

Demonstrate how different financial instruments impact financial statements.

Identify the characteristics of the statement of cash flows.

List ways a company's financial statements can impact the value of its stock.

To calculate a companys profitability ratios.

To calculate a company's liquidity ratios.

To discuss ways to manage the finances to achieve the strategic goals of the institution

To reach self-sufficiency/breakeven point.

To increase efficiency especially reducing the cost per client

Find the optimum level of each different operational expense including the cost of funds.

To manage the costs of human resources as part of overall human resource management.

How to manage liquidityi.e., how to keep solvent at the same time as disbursing the

maximum number of loans, setting a target level of liquidity.

What is the best financing structure, i.e., how much debt including from commercial sources

and how much capital do you need?

What should the asset structure be?

How to manage the fixed assets, i.e., the depreciation policy, how to finance them, are they

insured, are they safe?

How to undertake trend analysis and to compare actual performance against planned

performance.


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CHAPTER- 2

BACKGROUND

INFORMATION


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2.1 ABOUT THE COMPANY

History

Founded in 1958 by Sh SL Minda, the Minda Group today is one of the leading manufacturer of

automobile components with a turnover of Rs. 3,690 million and employs 3,000 people India-

wide.

The group is a major supplier to OEM's both in India and overseas. The group companies are

accredited with quality and environment certification and have collaborations and strategic

alliances with international manufacturers.


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The Group manufactures different lines of automobile parts:

Profile:

For over four decades, MINDA has been a major presence in India's automobile industry.

These forty-five years have been interspersed by a number of technological innovations that

have gone on to become industry standards. .

For assimilating the latest technologies, Minda has entered into strategic alliances and technical

collaborations with leading international companies. This has provided Minda with the cutting

edge in product design and technology to meet strict international quality standards.

The Groups' companies are accredited with QS 9000 and ISO-14001 certification from TUV,

GERMANY. We are one of India's leading manufacturers of Security systems, Wiring

harnesses, Couplers & Terminals and Instrument Clusters catering to all major two & four

wheeler vehicles manufacturer in India.

TOOL BOX LOCK

SEAT LOCK /

CABLE ASSY.

FUEL TANK

CAP LOCK

STEERING LOCK CUM

IGNITION SWITCH

IMMOBILISER

& ALARM

FLASHER

REGULATOR

RECTIFIER

INTELLIGENT CDI


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The products are well accepted worldwide both with O.E.M's and the after market.

Minda is a major supplier to General Motors India, Ford, Telco, Maruti (Suzuki), Mercedez

Benz, Daewoo, Fiat, Mahindras, Hero Motors, Kinetic Engg., Piaggio, Peugeot, Royal Enfield,

Escorts, LML (Piaggio), TVS-Suzuki, Bajaj (Kawasaki), Kinetic Honda, Honda Scooters, etc.

Organization & Management

To ensure product specialization and optimization of capacity the manufacturing is managed

between the Ashok Minda and NK Minda groups. This also encourages synergies in

manufacturing and product development.

Quality

Cost

DeliveryFocus AreaFocus Area

Development

Design Capability

Process Improvement

Productivity

Value Engineering

On time

First Time Right


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2.2 ABOUT THE TOPIC

Financial statements provide information about the financial activities and position of a firm.

Financial analysis is an aspect of the overall business finance function that involves examining

historical data to gain information about the current and future financial health of a company.

Financial analysis can be applied in a wide variety of situations to give business managers the

information they need to make critical decisions. Finance is the language of business. Goals are

set and performance is measured in financial terms. Plants are built, equipment ordered, and new

projects undertaken based on clear investment return criteria. Financial analysis is required in

every such case.

The finance function in business organizations involves evaluating economic trends, setting

financial policy, and creating long-range plans for business activities. It also involves

applying a system of internal controls for the handling of cash

the recognition of sales

the disbursement of expenses

the valuation of inventory

and the approval of capital expenditures.

In addition, the finance function reports on these internal control systems through the preparation

of financial statements, such as income statements, balance sheets, and cash flow statements.

Finally, finance involves analyzing the data contained in financial statements in order to provide

valuable information for management decisions.

Documents Used in Financial Analysis

Balance sheet

Profit & Loss statement

Cash flow statement


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The two main sources of data for financial analysis are a company's balance sheet and income

statement. The balance sheet outlines the financial and physical resources that a company has

available for business activities in the future. It is important to note, however, that the balance

sheet only lists these resources, and makes no judgment about how well they will be used by

management. For this reason, the balance sheet is more useful in analyzing a company's current

financial position than its expected performance.

The main elements of the balance sheet are assets and liabilities. Assets generally include both

current assets (cash or equivalents that will be converted to cash within one year, such as

accounts receivable, inventory, and prepaid expenses) and non-current assets (assets that are held

for more than one year and are used in running the business, including fixed assets like property,

plant, and equipment; long-term investments; and intangible assets like patents, copyrights, and

goodwill). Both the total amount of assets and the makeup of asset accounts are of interest to

financial analysts.

Using company accounts

The wealth of information can be obtained from company accounts. The information can provide

a valuable insight into our customers and their business: their trading performance,

creditworthiness, financial health and even their expansion plans for the future. Much of this is

simply stated in the notes or can be gleaned from the written reports from the chairman, chief

executive and finance director. Further insight can be gleaned from a straightforward analysis of

the figures from the Profit and Loss, Balance Sheet and Cash Flow reports.


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Cash-flow management

In its simplest form cash flow is the movement of money in and out of your business. Cash flow

is the life-blood of all growing businesses and is the primary indicator of business health. The

effect of cash flow is real, immediate and, if mismanaged, totally unforgiving. Cash needs to be

monitored, protected, controlled and put to work.

There are four principles regarding cash management:

First, cash is not given. It is not the passive, inevitable outcome of your business endeavours. It

does not arrive in your bank account willingly. Rather it has to be tracked, chased and captured.

You need to control the process and there is always scope for improvement.

Second, cash management is as much an integral part of your business cycle as, for example,

making and shipping widgets or preparing and providing detailed consultancy services

Third, you need information. For example, you need immediate access to information on:

your customers credit worthiness

your customers current track record on payments

outstanding receipts

your suppliers payment terms

short-term cash demands

short-term surpluses

investment options

current debt capacity

longer-term projections

Fourth, be masterful

Professional cash management in business is not, unfortunately, always the norm. You will find,

therefore, that the cash management process has a double benefit: it can help you to avoid the


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debilitating downside of cash crises and, in addition, grant you a commercial edge in all your

transactions.

Cash flow can be described as a cycle: business uses cash to acquire resources.

The resources are put to work and goods and services produced. These are then sold to

customers, funds are collected and deposited and so the cycle repeats. But what is crucially

important is to actively manage and control these cash inflows and outflows. It is the timing of

these money flows which can be vital to the success, or otherwise, of our business. It must be

emphasized that profits are not the same as the cash flow. It is possible to project a healthy profit

for the year and yet face a significant and costly monetary squeeze at various points during the

year, such that may worry whether company can survive.

Inflows

Inflows are the movement of money into the business. Inflows are most likely from the:

Receipt of monies from the sale of goods/services to customers

Receipt of monies on customer accounts outstanding

Proceeds from a bank loan

Interest received on investments

Investment by shareholders in the company

Outflows

Outflows are the movement of money out of the business. Outflows are most likely from:

Purchasing finished goods for re-sale

Purchasing raw materials and other components needed for the manufacturing of the final

product

Paying salaries and wages and other operating expenses


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Purchasing fixed assets

Paying principal and interest on loans

Paying taxes


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Cash Budget

Cash budget basically incorporates estimates of future inflows and outflows of cash over a

projected short period of time which may usually be a year, a half or a quarter year. Effective

cash management is facilitated if the cash budget is further broken down into month, week or

even on daily basis.

There are two components of cash budget

(i) Cash inflows and

(ii) Cash outflows.

The main sources for these flows are given hereunder:

Cash Inflows

(a) Cash sales

(b) Cash received from debtors

(c) Cash received from loans, deposits, etc.

(d) Cash receipt of other revenue income

(e) Cash received from sale of investments or assets.

Cash Outflows

(a) Cash purchases

(b) Cash payment to creditors

(c) Cash payment for other revenue expenditure

(d) Cash payment for assets creation

(e) Cash payment for withdrawals, taxes

(f) Repayment of loans, etc.


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A suggestive format for Cash Budget

Particulars Month

January February March

Estimated cash inflows

------------------

--------------

I. Total cash inflows

Estimates cash outflows

---------

---------

II. Total cash outflows

III. Opening cash balance

IV. Add/deduct surplus/deficit

during the month (I II )

V. Closing cash balance (III IV)

VI. Minimum level of cash balance

VII. Estimated excess or shortfall of

cash (V VI)

Cash-flow management is vital to the health of our business.

Hopefully, each time through the cycle, a little more money is put back into the business than

that flows out. But not necessarily, and if we dont carefully monitor our cash flow and take

corrective action when necessary, our business may find itself sinking into trouble. Cash


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outflows and inflows seldom seem to occur together. More often than not, cash inflows seem to

lag behind our cash outflows, leaving our business short. This money shortage is our cash-flow

gap. Managing cash flow allow us to narrow or completely close our cash-flow gap and we do

this by examining the different items that affect the cash flow of our business as listed above.

Answer the following questions:

How much cash does business have?

How much cash does business generate?

How much cash does my business need in order to operate?

When is it needed?

How do my income and expenses affect my capacity to expand my business?

If we can answer these questions, we can start to plot our cash-flow profile and importantly if we

can plan a response in accordance with these answers, we are then starting to manage our cash

flow.

Advantages of managing cash flow

The advantages are

We should know where our cash is tied up

We can spot potential bottlenecks and act to reduce their impact

We can plan ahead

We can reduce dependence on bankers and save interest charges

We can identify surpluses which can be invested to earn interest

We are in control of your business and can make informed decisions for future development

and expansion.


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Cash conversion period

The cash conversion period measures the amount of time it takes to convert product or service

into cash inflows. There are three key components:

1. The inventory conversion period The time taken to transform raw materials into a state

where they are ready to fulfill customers requirements. This is important for both manufacturing

and service industries. A manufacturer will have funds tied up in physical stocks while service

organizations will have funds tied up in work-in-progress that has not been invoiced to the

customer.

2. The receivables conversion period The time taken to convert sales into cash inflows.

3. The payable deferrable period The time between purchase/usage of inputs e.g. materials,

labour, etc. to payment.

The net period of (1+2)-3 gives the cash conversion period (or working capital cycle). The trick

is to minimize (1) and (2) and maximize (3), but it is essential to consider the overall needs of

the business.

The chart below is an illustration of the typical receivables conversion period for many businesses. The flow chart represents each event in the receivables conversion period.

Completing each event takes a certain amount of time. The total time taken is the receivables

conversion period. Shortening the receivables conversion period is an important step in

accelerating our cash inflows.


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Accelerating cash inflows

Accelerating cash inflows will improve our overall cash flow. The quicker we can collect cash,

the faster we can spend it in pursuit of further profit. Accelerating our cash inflows involves

streamlining all the elements of the cash conversion period:

The customers decision to buy

The ordering procedure

Credit decisions

Fulfillment, shipping and handling

Invoicing the customer

The collection period

Payment and deposit of funds


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Customer purchase decision and ordering

Without a customer, there will be no cash inflow to manage. Make sure that business is

advertising effectively and making it easy for the customer to place an order. Use of accessible,

up-to-date catalogues, displays, price lists, proposals or quotations to keep our customer

informed. Provide ways to bypass the postal service. Accept orders over the Internet, by

telephone, or via fax. Make the ordering process quick, precise and easy.

Credit policy

Companys credit policy is important. It should not be arrived at by default. It should be a Board

decision and should determine such items as companys credit criteria, the credit rating agency

to be used, the person responsible for obtaining that credit rating, the companys standard

payment terms, the procedure for authorizing any exemption and the requirements for regular

reporting. The policy should be written down and kept up to date with supplements as necessary

concerning any changes to the creditworthiness of specific customers, any warnings or notes of

current poor experience. The policy should be disseminated to all sales staff, the financial

controller and the Board.

Customer credit worthiness

Credit checks for new customers and reviews for existing customers are important. Checking

credit references, obtaining credit reports and chasing references will cost time and resources.

Start credit decision-making process when first meeting with new prospective customers or

clients. If necessary, consider allowing small orders to get underway quickly with a small start

limit for new accounts. This may be a reasonable level of risk and may ensure that new business

is not lost. With existing customers or clients, it is best to anticipate a request for an increase in

their credit limit whenever possible. This can be accomplished by monitoring customers current

credit limits and payment performance and comparing them with your expected levels of future

business.

Ask yourself:


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Do you methodically check the financial standing of all new customers before executing the

first order?

Do you periodically review the financial standing of existing customers?

Do you undertake a full recheck of the financial standing of existing customers whose

purchases have recently shown a substantial increase?

Do you use the telephone when checking trade references? Suppliers will often tell you over

the telephone what they would not put in writing

Do you recognize that salesmen are by nature optimists? Use other sources of information

before increasing/establishing credit for customers

Is there one person in your firm who is ultimately responsible for supervising credit and for

ensuring the prompt collection of monies due and who is accountable if the credit position gets

out of hand?

Are you clear in your own mind as to how you assess credit risks and how you impose normal

limits both in terms of total indebtedness for each customers account and also in terms of

payment period?

Do you make your credit terms very clear? In a sales negotiation it is professional, not anti-

selling, to be upfront about terms for payment. On an Account Application Form include a

paragraph for the buyer to sign, agreeing to comply with your stated payment terms and

conditions of sale. On a welcome letter restate the terms and conditions. On an Order

Acknowledgement again stress your payment terms and conditions of sale. On Invoices and

Statements show the payment terms boldly on the front. On invoices also show the due date e.g.

payment terms: X days from invoice date payment to reach us by (date).


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Cash-flow budget

The cash-flow budget projects your business cash inflows and outflows over a certain period of

time. A typical cash-flow budget predicts cash inflows and outflows on a month-to-month,

weekly or daily basis. The cash-flow budget can help predict your businesss cash-flow gaps

periods when cash outflows exceed cash inflows when combined with your cash reserves. This

will allow us to take steps to ensure that the gaps are closed, or at least narrowed, to avoid

expensive, uncontrolled overdrafts. These steps might include lowering our investment in

accounts receivable or inventory, increasing or advancing receipts, or looking to outside sources

of cash, such as a short-term loan, to fill the cash-flow gaps. If we want to apply for a loan, we

need to create a cash-flow budget that extends for several years into the future, as part of the

application process. But for our business needs, a six-month cash-flow budget is probably about

right. It predicts future events early enough for you to take some corrective action and yet may

minimize the amount of uncertainty involved in the budget preparation.

Preparing a cash-flow budget involves:

preparing a sales forecast

projecting our anticipated cash inflows

projecting our anticipated cash outflows

putting the projections together for our cash-flow bottom line

identifying surpluses and the opportunity to place short-term money on deposit to earn interest

identifying deficits and the need to accelerate cash flows or borrow short-term money

identifying longer-term surpluses to fund expansion and development

identifying longer-term needs for funds, either from banks or shareholders


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Cash inflows

Forecasting our sales is key to projecting our cash receipts. Any forecast will include some

uncertainty and will be subject to many variables: the economy, competitive influences, demand,

etc. It will also include other sources of revenue such as investment income, but sales are the

primary source. If our business only accepts cash sales, then our projected cash receipts will

equal the amount of sales predicted in the sales forecast. Projecting cash receipts is a little more

involved if the business extends credit to its customers. In this case, we must take into account

the collection period for our accounts receivable.

Accounts receivable

Accounts receivable can be looked upon as an investment. That is, the money tied up in accounts

receivable is not available for paying invoices, repaying loans, or expanding our business. If

credit is normally extended to our customers, the payment of accounts receivable is likely to be

the most important source of cash inflows. At worst, unpaid accounts receivable will leave our

business without the cash to pay its own bills. More commonly, late-paying or slow-paying

customers will create cash shortages, causing our business to be late in covering its own payment

obligations, spoiling its reputation and upsetting its suppliers. The payoff from an investment in

accounts receivable does not occur until your customers pay our invoices. The following

analysis tools can be used to help determine the effect our businesss accounts receivable is

having on our cash flow:

Average collection period measurement

Accounts receivable to sales ratio

Accounts receivable ageing schedule

Average collection period

The average collection period measures the length of time it takes to turn our average sales into

cash. A longer average collection period represents a higher investment in accounts receivable

and less cash available to cover cash outflows such as for purchases and expenses. Reducing our


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average collection period will reduce our investment in accounts receivable and improve our

cash flow. The average collection period in days is calculated by dividing our present accounts

receivable balance by average daily sales:

Average collection period = current accounts receivable balance / average daily sales where

average daily sales = annual sales /365

Cash outflows

Projecting cash outflows for our cash-flow budget involves projecting expenses and costs over a

period of time. An accounts payable ageing schedule helps to determine our cash outflows for

certain expenses in the near future 30 to 60 days. This will give us a good estimate of the cash

outflows necessary to pay our accounts payable on time. The cash outflows for every business

can be classified into one of four possible categories:

Costs of goods sold

Operating expenses

Major purchases

Debt payments

By classifying business expenses, it will help us to ensure that all our outflows are readily

identified.

Projecting operating expenses

Expenses tend to come under four headings:

o debt payments,

o cost of goods sold,

o asset purchases and

o operating expenses.


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Operating expenses include payroll and payroll taxes, utilities, rent, insurance and repairs and

maintenance. Operating expenses can be fixed or variable. Rent, for example, is fairly fixed,

being the same amount each month. However, payroll or utilities may vary in line with our sales

projections and have a seasonal aspect.

Projecting major purchases

Purchasing new assets for the company tend to occur when the business is expanding, or

improving its cash-flow position, or the result of machinery needing to be replaced. Cash

outflow in this area is generally large and irregular. Examples of fixed asset expenditure would

be on new company cars, computers, vans and machinery.

Projecting for debt payments

Projecting for debt payments is the easiest category to predict when preparing the cash-flow

budget. Mortgage payments and lease hire payments will follow the schedule agreed with the

lender. Only payment against an overdraft, for example, will be variable by nature.

Cash-flow surpluses and shortages

Surpluses

First, we can put the surplus to work by placing the surplus on short-term deposit, either

overnight or on term deposit with a bank or with a proprietary money fund, to earn interest until

we are ready to put the money to other uses

Second, we can use the money to fund capital investment for development and expansion in

line with our longer-term corporate plan

Third, if the funds truly are surplus to current and future requirements, then we can pay out

money to stakeholders


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Finally, we can advance payments to creditors and by so doing enhance our credit credentials

for the future. Similarly, we can pay down debt to improve our balance sheet gearing ratio and

make the payment profile for future principal and interest payments more manageable.

If we choose this route, then there are considerations of whether there is a premium to be paid

for early repayment and whether it restricts our future flexibility unduly.

Sources of finance

If there is a requirement for additional funds, either to meet short-term shortages or for

longer-term development, there are several sources of new funds that can be considered.

These are outlined, in brief, below.

First, we will have an overdraft facility with our relationship bank. We should negotiate with the

bank to agree acceptable limits to the facility and agree competitive interest rates. Well be

paying a premium over the base rate; haggle the premium.

Second, establish a short-term borrowing facility with the bank whereby, at short notice, you can

draw down a specific amount to be repaid in a specified number of days. The limits to the

facility, the repayment periods and the interest rates will be negotiated with the bank. The

interest on a short-term facility may be more favourable than for an overdraft.

Third, as a natural extension of the two sources above, establish a revolving credit facility with

the bank. The facility will enable us to make withdrawals at short notice. It will also enable us to

make unscheduled repayments whenever we have a cash surplus: the saving on interest owed

may outweigh the interest that could have been earned from a separate investment.

Fourth, for longer-term needs, we can raise fixed-term finance from the bank or other

institutions. The finance can be loan debt or bond issue and can be general company debt or

project specific. The interest rate can be fixed or variable. Although we want to maintain a good

relationship with our bank, there are now many competing sources of sound finance in the

market, especially since the de-mutualisation of many of the building societies. It is simply good

business to take the time to establish fresh links to some of these.


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Beyond that we can raise further equity, either from a private placing of shares or a public

offering. This is an important source of funds and can be essential if the debt-equity ratio is to be

maintained at acceptable levels. It requires consideration of the time, effort and cost required for

set-up. Finally, an excellent and sometimes overlooked, source of finance is factoring, which we

turn to in some detail below.

The Importance of Cash Management

Understanding the basic concepts of cash flow will help to plan for the unforeseen eventualities

that nearly every business faces.

Cash vs. Cash Flow

Cash is ready money in the bank or in the business. It is not inventory, it is not accounts

receivable (what we owe), and it is not property. These can potentially be converted to cash, but

can't be used to pay suppliers, rent, or employees.

Profit growth does not necessarily mean more cash on hand. Profit is the amount of money we

expect to make over a given period of time, while cash is what we must have on hand to keep

our business running. Over time, a company's profits are of little value if they are not

accompanied by positive net cash flow. We can't spend profit; we can only spend cash.

Cash flow refers to the movement of cash into and out of a business. Watching the cash inflows

and outflows is one of the most pressing management tasks for any business. The outflow of

cash includes those checks we write each month to pay salaries, suppliers, and creditors. The

inflow includes the cash we receive from customers, lenders, and investors.

Positive Cash Flow

If its cash inflow exceeds the outflow, a company has a positive cash flow. A positive cash flowis a good sign of financial health, but is by no means the only one.

Negative Cash Flow


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If its cash outflow exceeds the inflow, a company has a negative cash flow. Reasons for negative

cash flow include too much or obsolete inventory and poor collections on accounts receivable

(what your customers owe you). If the company can't borrow additional cash at this point, it may

be in serious trouble.

Components of cash flow

A "Cash Flow Statement" shows the sources and uses of cash and is typically divided into three

components:

Operating Cash Flow: - Operating cash flow, often referred to as working capital, is the cash

flow generated from internal operations. It comes from sales of the product or service of your

business, and because it is generated internally, it is under your control.

Investing Cash Flow: - Investing cash flow is generated internally from non-operating activities.

This includes investments in plant and equipment or other fixed assets, nonrecurring gains or

losses, or other sources and uses of cash outside of normal operations.

Financing Cash Flow :- Financing cash flow is the cash to and from external sources, such as

lenders, investors and shareholders. A new loan, the repayment of a loan, the issuance of stock,

and the payment of dividend are some of the activities that would be included in this section ofthe cash flow statement.

Cash Flow Statement

A cash flow statement shows where an institutions cash is coming from and how it is being used

over a period of time.

A cash flow statement classifies the cash flows into operating, investing and financing activities.

Operating activities: services provided (income-earning activities).

Investing activities: expenditures that have been made for resources intended to generate

future income and cash flows.

Financing activities: resources obtained from and resources returned to the owners, resources

obtained through borrowings (short-term or long-term) as well as donor funds.


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Can use either

The direct method, by which major classes of gross cash receipts and gross cash payments

are shown to arrive at net cash flow (recommended by IAS)

The indirect method, works back from net profit or loss, adding or deducting noncash

transactions, deferrals or accruals of past or future operating cash receipts or payments, and

items of income or expense associated with investing or financing cash flows to arrive at net

cash flow.

Taken together, the ratios in the framework provide a perspective on the financial health of the

lending/savings, and other operations of the institution. No one ratio tells it all. There are no

values for any specific ratio that is necessarily correct. It is the trend in these ratios which is

critically important. Ratios must be analyzed together, and ratios tell you more when consistently

tracked over a period of time. Frequent measurement can help identify problems which need to

be solved before they fundamentally threaten the MFI, thus enabling correction. Trend analysis

also helps moderate the influence of seasonality or exceptional factors. Different levels of users

will require a set of different indicators and analysis. They might be summarized as follows:

o Operations staff needs portfolio quality, efficiency ratios, outreach, and branch level

profitability.

o

Senior management needs institution-level portfolio quality, efficiency profitability,liquidity, and leverage.

o Regulators need capital adequacy and liquidity.

o Donors/investors need institution-level portfolio quality, leverage and profitability.

In addition to analyzing past trends, ratios, in conjunction with policy decisions, are helpful

when preparing financial projections.


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Cash vs. Working Capital

So far, we have discussed funds in terms of cash only. A broader and more useful way of

looking at the availability of funds involves the concept of working capital. How does your

company create income? If you manufacture a product, you use funds to purchase inventory,

produce goods with that inventory, convert those goods into accounts receivable by selling them,

and convert accounts receivable into cash when you take payment. If you are a merchandising

firm, the process is basically the same, although you probably purchase finished goods instead of

producing them. Each of the components in this process is a current asset, such as an asset that

you can convert into cash in a relatively short period (usually, but not always, one year) as a

result of your normal business operations. Inventory and accounts receivable, for example, are

not as liquid as cash, but your business expects to convert both to cash before too long. Current

liabilities, on the other hand, are obligations that you must meet during the same relatively short

time period that defines your current assets. Notes payable, accounts payable, and salaries are

examples of current liabilities. The accrual basis more accurately estimates income.

Funding a Business

Before making a choice of how we intend to fund the business, there are a few key factors that

need to be taken into consideration. Take a look at what they are as a starting guide and some of

the funding options available for start-ups and growing enterprises.

Factors to Consider

At what stage is our business right now? How risky is our business proposition?

Prioritize our funding needs: Do we require short-term or long term financing?

How much funds do we intend to raise?

How would the funds be utilized? What is the money used for Is it for operational needs or

for capital outlay (for assets like machinery, equipment)?

How long do we think the money can last? We need to work out some cash flow projections.


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Do we need the entire required amount at one go or can it be raised in stages over a period of

time?

What type of financing form would we be willing to consider borrowing, which means we

need to plan how and when we can pay it back or selling a certain percentage of the business

ownership to an interested and willing investor?

Funding Options

Choosing the right financing is critical to a business. Sources of funding can be broadly

categorized into two types:

Debt-financing Typically refers to borrowing or taking a loan from an external party (the

lender). Bank loan is a common example. This means that we borrow or owe the money and we

agree to pay it back over a period of time. Normally, debt-financing tends to be interest bearing

loans. Whether or not we succeed in your business, we will still need to repay the amount.

Bank borrowings alone may not be suitable or sufficient for all companies. A mixture of both

debt and equity are considered good.

Equity Financing This form of financing refers to selling a portion of your company to

interested investors in exchange for cash capital. The investors will then have a stake or

ownership of your company, and therefore becomes a shareholder. As investors, they are looking

for capital returns over a period of time and as an entrepreneur, you would need to be able to

succinctly convince investors of your growth and revenue potential.

Types of analysis:

In trend analysis, ratios are compared over time, typically years. Year-to-year

comparisons can highlight trends and point up the need for action. Trend analysis works

best with three to five years of ratios.

Another type of ratio analysis, cross-sectional analysis, compares the ratios of two or

more companies in similar lines of business. One of the most popular forms of cross-


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sectional analysis compares a company's ratios to industry averages. These averages are

developed by statistical services and trade associations and are updated annually.

Financial ratios can also give mixed signals about a company's financial health and can vary

significantly among companies, industries, and over time. Other factors should also be

considered such as a company's products, management, competitors and vision for the future.

By computing the financial ratios, we can also detect certain relationships between the different

types of information. It gives us a quick indication of the firm's performance in the areas of

liquidity, profitability, capital structure as well as the financial position and potential risk

involved.

The interpretation of company accounts-ratio analysis

Why ratios: Ratios are the means of presenting information, in the form of a ratio or percentage,

which enables a comparison to be made between one significant figure and another. Often the

same ratios of like firms are used to compare the performance of one firm with another. A "one

off" ratio is often useless - trends need to be established by company ratios over a number of

years.

The great volume of statistics made available in the annual accounts of companies must be

simplified in some way. Present and potential investors can therefore quickly assess whether the

company is a good investment or not.

Financial ratio analysis is helpful in assessing an organisation's internal strengths and

weaknesses. Potential suppliers will, for example, want to judge credit worthiness.

Ratios by themselves provide no information; they simply indicate by exceptions where

further study may improve company performance. Management can compare current

performance with previous periods and competing companies.


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Which areas are used for analysis

Four key areas are generally used for analysis:

Profitability

Liquidity

Leverage (capital structure)

Activity or management effectiveness (efficiency).

a) Profitability

In most organisations profits are limited by the cost of production and by the marketability of the

product. Therefore, "profit maximisation" entails the most efficient allocation of resources by

management and "profitability ratios" when compared to others in the industry will indicate how

well management has performed this task.

Key questions to be identified in profitability analysis include:

Does the company make a profit?

Is the profit reasonable in relation to the capital employed in the business?

Are the profits adequate to meet the returns required by the providers of capital, for the

maintenance of the business and to provide for growth?

How are sales and trading profit split among the major activities?

To what extent are changes due to price change?

To what extent does volume change?

Does inter-company transfer pricing policy distort the analysis?

Has the appropriate proportion of profit been taken in tax charged?

What deferred taxation policy is being followed?

Has the share of profit (or loss) attributable to minority interests in subsidiaries changed? If

so, is it clear why?

Are profits and losses on sales of fixed assets:


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-treated as adjustments of depreciation charges?

-disclosed separately "above the line" in the profit and loss account?

-treated as "below the line" items in the profit and loss account?

-transferred directly to reserves?

What has been included in Extraordinary Items?

Should any of these items be regarded as part of the ordinary business of the company?

Do any items tend to recur year after year?

Is it clear which items have been transferred directly to reserves without going through the

profit and loss account?

Is such treatment appropriate in each case?

b) Liquidity

"Liquidity measures" are based on the notion that a business cannot operate if it is unable to pay

its bills. A sufficient amount of cash and other short-term assets must be available when needed.

On the other hand, because most short term assets do not produce any return, a strong liquidity

position will be damaging to profits. Therefore, management must try to keep the firm's liquidity

as low as possible whilst ensuring that short term obligations will be met. This means that

industries with stable and predictable conditions will generally require smaller current ratios than

will more volatile industries.

Key questions to be identified in liquidity analysis include:

Has the business sufficient liquid resource to meet immediate demands from creditors?

Has the business sufficient resources to meet the requirements of creditors due for payment

in the next 12 months i.e. creditors payable within one year?

Has the business sufficient resource to meet the demands of its fixed asset replacement

programme and its commitments to providers of long-term capital falling due for repayment in

say, the next five years?

c) Leverage


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"Leverage ratios" show how a company's operations are financed. Too much equity in a firm

often means the management is not taking advantage of the leverage available with long-term

debt. On the other hand, outside financing will become more expensive as the debt-to-equity

ratio increases. Thus, the leverage of an organisation has to be considered with respect both to its

profitability and the volatility of the industry.

Key questions to be identified in leverage analysis include:

What sort of capital has the company issued?

Who owns the capital?

What is the cost of capital in terms of interest or dividend?

What proportions of the capital have a financed return (gearing or leverage)?

Is the mix of capital optimum for the company?

Is further capital available if required?

Is total capital employed analysed among different classes of business?

If so, can return on capital be calculated for each class?

Has issued Ordinary share capital increased during the period?

If so, why? E.g. Rights issue? Bonus (scrip) issue? Acquisition?

Are per share figures calculated using appropriately weighted numbers of shares?

Are prior years' figures comparable?

What individual items have caused significant movements on Reserves?

Do any of them really belong in the profit and loss account?

Is any long term debt convertible into ordinary shares?

On what terms?

Is any long term debt repayable within a short period?

If so, should it be treated as a current liability?

Are there significant borrowings in foreign currencies?

Are they matched by foreign assets?

How are exchange losses and gains thereon treated?

Is there any preference capital?


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Is short term borrowing included in capital employed? Should it be?

Is the treatment of pensions appropriate? Is information revealed?

Would capitalising leases significantly affect long term debt and gearing ratios?

d) Activity

"Activity ratios" are used to measure the productivity and efficiency of a firm. When compared

to the industry average, the fixed-asset turnover ratio, for example, will show how well the

company is using its productive capacity. Similarly, the inventory turnover ratio will indicate

whether the company used too much inventory in generating sales and whether the company

may be carrying obsolete inventory.

Key questions to be identified in activity analysis are:

Does management control the costs of the business well?

Which costs, if any, have changed significantly, thus reducing or improving apparent

profitability?

Does management control the investment in assets well?

Are fixed assets sufficient for the current level of activity? Are they replaced on a regular

basis and adequately maintained?

Are the stock levels adequate for the level of activity, or excessive?

Are debts collected promptly?

Are creditors paid within a reasonable period of time?

Are surplus cash resources invested to increase overall returns?

How variable are the profits before interest and tax?

How many times can the interest be paid from the available profit?

How many times can the existing dividend be paid from the available profit?


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FINANCIAL ANALYSIS

Financial analysis refers to an assessment of the viability, stability and profitability of a

business, sub-business or project. It is performed by professionals who prepare reports using

ratios that make use of information taken from financial statements and other reports. These

reports are usually presented to top management as one of their basis in making business

decisions. Based on these reports, management may:

Continue or discontinue its main operation or part of its business;

Make or purchase certain materials in the manufacture of its product;

Acquire or rent/lease certain machineries and equipments in the production of its goods;

Issue stocks or negotiate for a bank loan to increase its working capital.

Other decisions that allow management to make an informed selection on various

alternatives in the conduct of its business.

Goals

Financial analysts often assess the firm's:

1. Profitability- its ability to earn income and sustain growth in both short-term and long-term.

A company's degree of profitability is usually based on the income statement, which reports on

the company's results of operations;

2. Solvency- its ability to pay its obligation to debtors and other third parties in the long-term;

3. Liquidity- its ability to maintain positive cash flow, while satisfying immediate obligations;

Both 2 and 3 are based on the company's balance sheet, which indicates the financial condition

of a business as of a given point in time.

4. Stability- the firm's ability to remain in business in the long run, without having to sustain

significant losses in the conduct of its business. Assessing a company's stability requires the use

of both the income statement and the balance sheet, as well as other financial and non-financial

indicators.


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BRIEF INTRODUCTION

The term working capital refers to the amount of capital which is readily available to an

organization. The best way to look at current assets and current liabilities is by combining them

into something called Working Capital. That is, working capital is the difference between

resources in cash or readily convertible into cash (Current Assets) and organizational

commitments for which cash will soon be required (Current Liabilities). Working capital is

basically an expression of how much in liquid assets the company currently has to build its

business, fund its growth, and produce shareholder value. If a company has ample positive

working capital, then it is in good shape, with plenty of cash on hand to pay for everything it

might need to buy. If a company has negative working capital, then its current liabilities areactually greater than their current assets, so the company lacks the ability to spend with the same

aggressive nature as a working capital positive peer. All other things being equal, a company

with positive working capital will always outperform a company with negative working capital.

Working capital is the absolute lifeblood of a company. About 99% of the reason that the

company probably came public in the first place had to do with getting working capital for

whatever reasons -- building the business, funding acquisitions or developing new products.

Anything good that comes from a company springs out of working capital. If a company runs

out of working capital and still has bills to pay and products to develop, it has big problems.

Current Assets are resources which are in cash or will soon be converted into cash in "the

ordinary course of business"

Current Liabilities are commitments which will soon require cash settlement in "the ordinary

course of business".

Thus:

WORKING CAPITAL = CURRENT ASSETS - CURRENT LIABILITIES


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Working capital cycle and various components of working capital

Any business we start with cash is converted into various kinds of current assets during

production process and finally it is converted back to cash once the goods are sold and money

paid by customers. It is therefore obvious that in this entire process a cycle is involved wherein

we start with cash and end at cash. This cycle is called working capital cycle. This cycle is

shown below:

The above picture reflects the working capital cycle in most elementary fashion. In business,

however, generally, there are many more components of working capital. In order to understand

them more closely, a detailed list of various items of working capital cycle is being given below.

Current assets

Inventory - raw material

-work in progress

-consumables

-spares

-finished goods

Receivables (debtors)


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Loans and advances - Export incentives receivable

- Interest recoverable on bills discounting

- Advances given to suppliers

- Prepaid expenses

- Claims recoverable

- Security deposits given

- Loans given to staff and workers

- Advance tax paid

Cash & bank balances - Balances in current accounts

- Money kept in fixed deposit receipts

- Short term advances given to other corporates.

Current liabilities

- bank borrowings

- sundry creditors

- provision for gratuity an dividend

- ILC/FLC payable

- Interest accrued but not due

- Term loans installments falling due within one year

- Provision for income tax

- Sales tax payable

- Provision for expenses.


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A firm is required to maintain a balance between liquidity and profitability while conducting its

day to day operations. Liquidity is a precondition to ensure that firms are able to meet its short-

term obligations and its continued flow can be guaranteed from a profitable venture. The

importance of cash as an indicator of continuing financial health should not be surprising in view

of its crucial role within the business. This requires that business must be run both efficiently and

profitably. In the process, an asset-liability mismatch may occur which may increase firms

profitability in the short run but at a risk of its insolvency. On the other hand, too much focus on

liquidity will be at the expense of profitability Thus, as the manager of a business entity we are

into a dilemma of achieving desired tradeoff between liquidity and profitability in order to

maximize the value of a firm.

Every business needs investment to procure fixed assets, which remain in use for a longer

period. Money invested in these assets is called Long term Funds or Fixed Capital. Business

also needs funds for short-term purposes to finance current operations. Investment in short term

assets like cash, inventories, debtors etc., is called Short-term Funds or Working Capital. The

Working Capital can be categorized, as funds needed for carrying out day-to-day operations of

the business smoothly. The management of the working capital is equally important as the

management of long-term financial investment. Every running business needs working capital.

Even a business which is fully equipped with all types of fixed assets required is bound to

collapse without

(i) Adequate supply of raw materials for processing;

(ii) Cash to pay for wages, power and other costs;

(iii) Creating a stock of finished goods to feed the market demand regularly; and,

(iv) The ability to grant credit to its customers.

All these require working capital. Working capital is thus like the lifeblood of a business. The

business will not be able to carry on day-to-day activities without the availability of adequate

working capital. Working capital cycle involves conversions and rotation of various

constituents/ components of the working capital. Initially cash is converted into raw materials.

Subsequently, with the usage of fixed assets resulting in value additions, the raw materials get

converted into work in process and then into finished goods. When sold on credit, the finished

goods assume the form of debtors who give the business cash on due date. Thus cash assumes


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its original form again at the end of one such working capital cycle but in the course it passes

through various other forms of current assets too. This is how various components of current

assets keep on changing their forms due to value addition. As a result,

they rotate and business operations continue. Thus, the working capital cycle involves rotation of

various constituents of the working capital.

Current Assets

The first major component of the balance sheet is Current Assets, which are assets that a

company has at its disposal that can be easily converted into cash within one operating cycle. An

operating cycle is the time that it takes to sell a product and collect cash from the sale. It can last

anywhere from 60 to 180 days. Current assets are important because it is from current assets that

a company funds its ongoing, day-to-day operations. If there is a shortfall in current assets, then

the company is going to have to dig around to find some other form of short-term funding, which

normally results in interest payments or dilution of shareholder value through the issuance of

more shares of stock. There are five main kinds of current assets -- Cash & Equivalents, Short-

and Long-Term Investments, Accounts Receivable, Inventories and Prepaid Expenses.


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Cash & Equivalents are assets that are money in the bank, literally cold, hard cash or something

equivalent, like bearer bonds, money market funds. Cash and equivalents are completely liquid

assets, and thus should get special respect from shareholders. This is the money that a company

could immediately mail to you in the form of a fat dividend if it had nothing better to do with it.

This is the money that the company could use to buy back stock, and thus enhance the value of

the shares that you own.

Short-Term Investments are a step above cash and equivalents. These normally come into play

when a company has so much cash on hand that it can afford to tie some of it up in bonds with

durations of less than one year. This money cannot be immediately liquefied without some

effort, but it does earn a higher return than cash by itself. It is cash and investments that give

shares immediate value and could be distributed to shareholders with minimal effort.

Accounts Receivable, normally abbreviated as A/R, is the money that is currently owed to a

company by its customers. The reason why the customers owe money is that the product has

been delivered but has not been paid for yet. Companies routinely buy goods and services from

other companies using credit. Although typically A/R is almost always turned into cash within a

short amount of time, there are instances where a company will be forced to take a write-off for

bad accounts receivable if it has given credit to someone who cannot or will not pay. This is why

you will see something called allowance for bad debt in parentheses beside the accounts

receivable number.

The allowance for bad debt is the money set aside to cover the potential for bad customers, based

on the kind of receivables problems the company may or may not have had in the past. However,

even given this allowance, sometimes a company will be forced to take a write-down foraccounts receivable or convert a portion of it into a loan if a big customer gets in real trouble.

Looking at the growth in accounts receivable relative to the growth in revenues is important -- if

receivables are up more than revenues, you know that a lot of the sales for that particular quarter

have not been paid for yet.


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Inventories are the components and finished products that a company has currently stockpiled to

sell to customers. Not all companies have inventories, particularly if they are involved in

advertising, consulting, services or information industries. For those that do, however,

inventories are extremely important. Inventories should be viewed somewhat skeptically by

investors as an asset. First, because of various accounting systems like FIFO (first in, first out)

and LIFO (last in, first out) as well as real liquidation compared to accounting value, the value of

inventories is often overstated on the balance sheet. Second, inventories tie up capital. Money

that it is sitting in inventories cannot be used to sell it. Companies that have inventories growing

faster than revenues or that are unable to move their inventories fast enough are sometimes

disasters waiting to happen.

Finally, Prepaid Expenses are expenditures that the company has already paid to its suppliers.

This can be a lump sum given to an advertising agency or a credit for some bad merchandise

issued by a supplier. Although this is not liquid in the sense that the company does not have it in

the bank, having bills already paid is a definite plus. It means that these bills will not have to be

paid in the future, and more of the revenues for that particular quarter will flow to the bottom

line and become liquid assets.

Fixed Assets

Fixed assets are long-term assets.

-Tangible fixed assets are physical assets like plant.

-Intangible fixed assets are the firms rights and claims, such as patents, copyrights, goodwill

etc.

-Gross block represent all tangible assets at acquisition costs.

-Net block is gross block net of depreciation.


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The balance sheet also includes two categories of liabilities, current liabilities (debts that will

come due within one year, such as accounts payable, short-term loans, and taxes) and long-term

debts (debts that are due more than one year from the date of the statement). Liabilities are

important to financial analysts because businesses have same obligation to pay their bills

regularly as individuals, while business income tends to be less certain. Long-term liabilities are

less important to analysts, since they lack the urgency of short-term debts, though their presence

does indicate that a company is strong enough to be allowed to borrow money.

Current Liabilities

Current Liabilities are what a company currently owes to its suppliers and creditors. These are

short-term debts that normally require that the company convert some of its current assets into

cash in order to pay them off. These are all bills that are due in less than a year. As well as

simply being a bill that needs to be paid, liabilities are also a source of assets. Any money that a

company pulls out of its line of credit or gains the use of because it pushes out its accounts

payable is an asset that can be used to grow the business. There are five main categories of

current liabilities: Accounts Payable, Accrued Expenses, Income Tax Payable, Short-Term Notes

Payable and Portion of Long-Term Debt Payable.

Accounts Payable is the money that the company currently owes to its suppliers, its partners and

its employees. Basically, these are the basic costs of doing business that a company, for

whatever reason, has not paid off yet. One company's accounts payable is another company's

accounts receivable, which is why both terms are similarly structured. A company has the power

to push out some of its accounts payable, which often produces a short-term increase in earnings

and current assets.

Accrued Expenses are bills that the company has racked up that it has not yet paid. These are

normally marketing and distribution expenses that are billed on a set schedule and have not yet

come due. A specific type of accrued expense is Income Tax Payable. This is the income tax a

company accrues over the year that it does not have to pay yet according to various federal, state

and local tax schedules. Although subject to withholding, there are some taxes that simply are

not accrued by the government over the course of the quarter or the year and instead are paid in

lump sums whenever the bill is due.


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Short-Term Notes Payable is the amount that a company has drawn off from its line of credit

from a bank or other financial institution that needs to be repaid within the next 12 months. The

company also might have a portion of its Long-Term Debt come due with the year, which is why

this gets counted as a current liability even though it is called long-term debt.

Long-Term Notes Payable or Long-Term Liabilities are loans that are not due for more than a

year. These are normally loans from banks or other financial institutions that are secured by

various assets on the balance sheet, such as inventories. Most companies will tell you in a

footnote to this item when this debt is due and what interest rate the company is paying.

The balance sheet also commonly includes stock-holders' equity accounts, which detail the

permanent capital of the business. The total equity usually consists of two parts: the money that

has been invested by shareholders, and the money that has been retained from profits and

reinvested in the business. In general, the more equity that is held by a business, the better the

ability of the business to borrow additional funds.

Stockholders or Shareholder's Equity is composed of Capital Stock and Retained Earnings.

Frankly, this is more than a little bit confusing and does not always add all that much value to

the analysis. Capital stock is the par value of the stock issued that is recorded purely for

accounting purposes and has no real relevance to the actual value of the company's stock. Capital

in Excess of Stock is another weird accounting convention that is pretty difficult to explain.

Essentially, it is any additional cash that a company gets from issuing stock in excess of par

value under certain financial conventions.

Retained earnings is another accounting convention that basically takes the money that a

company has earned, less any earnings that are paid out to shareholders in the form of dividends

and stock buybacks, and records this on the company's books. Retained earnings simplymeasures the amount of capital a company has generated and is best used to determine what

sorts of returns on capital a company has produced. If you add together capital stock and retained

earnings, you get shareholder's equity -- the amount of equity that shareholders currently have in

the company.


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Debt & Equity

The remainder of the balance sheet is taken up by a hodge-podge of items that are not current,

meaning that they are either assets that cannot be easily turned into cash or liabilities that will

not come due for more than a year. Specifically, there are five main categories -- Total Assets,

Long-Term Notes Payable, Stockholder's/Shareholder's Equity, Capital Stock and Retained

Earnings.

Total Assets are assets that are not liquid, but that are kept on a company's books for accounting

purposes. The main component is plants, property and equipment and encompasses any land,

buildings, vehicles and equipment that a company has bought in order to operate its business.

Much of this is actually subject to an accounting convention called depreciation for tax purposes,

meaning that the stated value of the total assets and the actual value or price paid might be very

different.

In contrast to the balance sheet, the income statement provides information about a company's

performance over a certain period of time. Although it does not reveal much about the

company's current financial condition, it does provide indications of its future viability. The

main elements of the income statement are revenues earned, expenses incurred, and net profit or

loss. Revenues consist mainly of sales, though financial analysts may also note the inclusion of

royalties, interest, and extraordinary items. Likewise, operating expenses usually consist

primarily of the cost of goods sold, but can also include some unusual items.

Revenue

Refers to money earned by an organization for goods sold and services rendered during an

accounting period, including

Interest earned on loans to clients

Fees earned on loans to clients

Interest earned on deposits with a bank, etc

Expenses


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Represent costs incurred for goods and services used in the process of earning revenue. Direct

expenses for an MFI include

Financial costs,

Administrative expenses, and

Loan loss provisions.

Matching Costs and Revenues

Revenue should be matched with whatever expenses or assets produce that revenue. This notion

leads inevitably to the accrual method of accounting. If we obtain the annual registration for a

truck in January and use that truck to deliver products to our customers for 12 months, we have

paid for an item in January that helps us produce revenue all year long. If we record the entire

amount of the expense in January, we overstate our costs and understate our profitability for that

month. We also understate our costs and overstate our profitability for the remaining 11 months.

Largely for this reason, the accrual method evolved. Using the accrual method, we would accrue

1/12th of the expense of the truck registration during each month of the year. Doing so enables

us to measure expenses against our revenues more accurately throughout the year. Similarly,

suppose that we sell a product to a customer on a credit basis. We might receive periodic

payments for the product over several months, or we might receive payment in a lump sum

sometime after the sale. Again, if we wait to record that income until we have received full

payment, we will misestimate our profit until the customer finishes paying us.

Some very small businessesprimarily sole proprietorshipsuse an alternative to accrual,

called the cash method of accounting. They find it more convenient to record expenses and

revenues when the transaction took place. In very small businesses, the additional accuracy of

the accrual method might not be worth the effort. An accrual basis is more complicated than acash basis and requires more effort to maintain, but it is often a more accurate method for

reporting purposes. The main distinction between the two methods is that if we distribute the

recording of revenues and expenses over the full time period when we earned and made use of

them, we are using the accrual method. If we record their totals during the time period that we

received or made payment, we are using the cash method.


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The cash basis understates income when costs are not associated with revenue that they help

generate. Suppose that a person starts a new firm, Marble Designs, in January. At the end of the

first month of operations, she has made 10,000 Rs. in sales and paid various operating expenses:

her salary, the office lease, phone costs, office supplies, and a computer. She was able to save

20% of the cost of office supplies by making a bulk purchase that she estimates will last the

entire year. Recording all of these as expenses during the current period results in net income for

the month of 1,554 Rs.

Using the accrual method, Marble Designs records 1/12th of the cost of the office supplies

during January. This is a reasonable decision because they are expected to last a full year. It also

records 1/36th of the cost of the computer as depreciation. The assumption is that the computers

useful life is three years and that its eventual salvage or residual value will be zero. The net

income for January is now 5,283Rs.which is 3.4 times the net income recorded under the cash

basis.

The net income of 5,283Rs. is a much more realistic estimate for January than 1,554Rs. Both the

office supplies and the computer will contribute to the creation of revenue for much longer than

one month. In contrast, the benefits of the salary, lease, and phone expenses pertain to that

month only, so it is appropriate to record the entire expense for January. But this analysis says

nothing about how much cash Marble Designs has in the bank. Suppose that the company must

pay off a major loan in the near future. The income

statement does not necessarily show whether Marble Designs will likely be able to make

that payment.

Nature and Importance of working capital

Working capital management (WCM) is of particular importance to the small business. With

limited access to the long-term capital markets, these firms tend to rely more heavily on owner

financing, trade credit and short-term bank loans to finance their needed investment in cash,

accounts receivable and inventory. The success factors or impediments that contribute to success

or failure are categorized as internal and external factors. The factors categorized as external


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include financing (such as the availability of attractive financing), economic conditions,

competition, government regulations, technology and environmental factors. While the internal

factors are managerial skills, workforce, accounting systems and financial management

practices.

The working capital meets the short-term financial requirements of a business enterprise. It is a

trading capital, not retained in the business in a particular form for longer than a year. The

money invested in it changes form and substance during the normal course of business

operations. The need for maintaining an adequate working capital can hardly be questioned. Just

as circulation of blood is very necessary in the human body to maintain life, the flow of funds is

very necessary to maintain business. If it becomes weak, the business can hardly prosper and

survive. The success of a firm depends ultimately, on its ability to generate cash receipts in

excess of disbursements. The cash flow problems of many small businesses are exacerbated by

poor financial management and in particular the lack of planning cash requirements.


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Approaches to Working Capital Management

The objective of working capital management is to maintain the optimum balance of each of the

working capital components. This includes making sure that funds are held as cash in bank

deposits for as long as and in the largest amounts possible, thereby maximizing the interest

earned. However, such cash may more appropriately be "invested" in other assets or in reducing

other liabilities.

Working capital management takes place on two levels:

o Ratio analysis can be used to monitor overall trends in working capital and to identify areas

requiring closer management.

o The individual components of working capital can be effectively managed by using various

techniques and strategies.

When considering these techniques and strategies, departments need to recognize that each

department has a unique mix of working capital components. The emphasis that needs to be

placed on each component varies according to department. For example, some departments have

significant inventory levels; others have little if any inventory.

Furthermore, working capital management is not an end in itself. It is an integral part of the

department's overall management. The needs of efficient working capital management must be

considered in relation to other aspects of the department's financial and non-financial

performance. While managing the working capital, two characteristics of current assets should

be kept in mind viz.

(i) Short life span, and

(ii) Swift transformation into other form of current asset.

Each constituent of current asset has comparatively very short life span. Investment remains in a

particular form of current asset for a short period. The life span of current assets depends upon

the time required in the activities of procurement; production, sales and collection and degree of

synchronization among them. A very short life span of current assets results into swift

transformation into other form of current assets for a running business.


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Working Capital Analysis

The major components of gross working capital include stocks (raw materials, work-in-progress

and finished goods), debtors, cash and bank balances. The composition of working capital

depends on a multiple of factors, such as operating level, level of operational efficiency,

inventory policies, book debt policies, technology used and nature of the industry. While inter-

industry variation is expected to be high, the degree of variation is expected to be low for firms

within the industry.

Working capital needs of a business influenced by numerous factors.

The important ones are discussed in brief as given below:

i.Nature of Enterprise

The nature and the working capital requirements of an enterprise are interlinked. While a

manufacturing industry has a long cycle of operation of the working capital, the same would be

short in an enterprise involved in providing services. The amount required also varies as per the

nature; an enterprise involved in production would require more working capital than a service

sector enterprise.

ii. Manufacturing/Production Policy

Each enterprise in the manufacturing sector has its own production policy, some follow the

policy of uniform production even if the demand varies from time to time, and others may follow

the principle of 'demand-based production' in which production is based on the demand during

that particular phase of time. Accordingly, the working capital requirements vary for both of

them.

iii. Operations

The requirement of working capital fluctuates for seasonal business. The working capital needs

of such businesses may increase considerably during the busy season and decrease during the


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slack season. Ice creams and cold drinks have a great demand during summers, while in winters

the sales are negligible.

iv. Market Condition

If there is high competition in the chosen product category, then one shall need to offer sops like

credit, immediate delivery of goods etc. for which the working capital requirement will be high.

Otherwise, if there is no competition or less competition in the market then the working capital

requirements will be low.

v.Availability of Raw Material

If raw material is readily available then one need not maintain a large stock of the same, thereby

reducing the working capital investment in raw material stock. On the other hand, if raw material

is not readily available then a large inventory/stock needs to be maintained, thereby calling for

substantial investment in the same.

vi. Growth and Expansion

Growth and expansion in the volume of business results in enhancement of the working capital

requirement. As business grows and expands, it needs a larger amount of working capital.

Normally, the need for increased working capital funds precedes growth in business activities.

vii.Price Level Changes

Generally, rising price level requires a higher investment in the working capital. With increasing

prices, the same level of current assets needs enhanced investment.

viii. Manufacturing Cycle

The manufacturing cycle starts with the purchase of raw material and is completed with the

production of finished goods. If the manufacturing cycle involves a longer period, the need for

working capital would be more. At times, business needs to estimate the requirement of working

capital in advance for proper control and management. The factors discussed above influence the

quantum of working capital in the business.


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The assessment of working capital requirement is made keeping these factors in view. Each

constituent of working capital retains its form for a certain period and that holding period is

determined by the factors discussed above. So for correct assessment of the working capital

requirement, the duration at various stages of the working capital cycle is estimated. Thereafter,

proper value is assigned to the respective current assets, depending on its level of completion.

The basis for assigning value to each component is given below:

Components of working capital Basis of valuation

i Stock of raw material

ii Stock of work in process

iii Stock of finished goods

iv Debtors

v Cash

Purchase cost of raw materials

At cost or market value whichever is lower

Cost of sales

Cost of sales or sales value

Working expenses

Each constituent of the working capital is valued on the basis of valuation enumerated above for

the holding period estimated. The total of all such valuation becomes the total estimated working

capital requirement. We know that working capital has a very close relationship with day-to-day

operations of a business. Negligence in proper assessment of the working capital, therefore, can

affect the day-to-day operations severely. It may lead to cash crisis and ultimately to liquidation.

An inaccurate assessment of the working capital may cause either under-assessment or over-

assessment of the working capital and both of them are dangerous.

Consequences of under assessment of working capital

o Growth may be stunted. It may become difficult for the enterprise to undertake profitable

projects due to non-availability of working capital.

o Implementation of operating plans may become difficult and consequently the profit goals

may not be achieved.


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o Cash crisis may emerge due to paucity of working funds.

o Optimum capacity utilization of fixed assets may not be achieved due to non-availability of

the working capital.

o The business may fail to honour its commitment in time, thereby adversely affecting its

credibility. This situation may lead to business closure.

o The business may be compelled to buy raw materials on credit and sell finished goods on

cash. In the process it may end up with increasing cost of purchases and reducing selling

prices by offering discounts. Both these situations would affect profitability adversely.

o Non-availability of stocks due to non-availability of funds may result in production stoppage.

o While underassessment of working capital has disastrous implications on business, over

assessment of working capital also has its own dangers.

Consequences of over assessment of working capital

o Excess of working ca