One of the foremost considerations for granting of credit facilities for
any project is the financial position of a concern. Banks employ various techniques
for financial appraisal. However, there is neither any uniformity in appraisal
nor any standard norms are fixed for such appraisal. The position may be
different from bank to bank and from project to project within the same bank
depending upon the nature and the size of the project. There are, however, some
important common features of financial appraisal, which will be discussed in
this chapter.
Financial appraisal revolves round two important financial statements,
which are required to be submitted to the bank with the loan application. These
financial statements are:
·
Balance Sheet.
·
Profit & Loss a/c (short form of
Manufacturing, Trading and Profit & Loss a/c).
Balance sheet reveals the financial position of a concern at a particular point of time (usually the closing date of the operating year) while profit and loss a/e is the summary of operations during the operating year.
Balance sheet is generally prepared on the basis of 'business entity'
concept under which the concern is taken as a separate entity than its promoter
and will have its separate assets and liabilities. The capital contributed by
the, Promoter is a liability for the concern though it is an asset of the
promoter. The balance sheet gives particulars of assets and liabilities of a
concern as on the date of closing and must also reveal the manner in which
these are distributed. Total assets of any concern will be matched by its total
liabilities at all the times.
Profit and loss a/c is the statement of working results of the concern for its operations during the year and is an important indicator of the way the business is being conducted by the concern and its financial results.
Financial appraisal is an important tool in the hands of bankers and
forms the very basis of the credit decision to be taken by them. The
credibility of the financial statements submitted to the banks is thus very
important. It is preferable that audited balance sheet and profit and loss a/c
are submitted as these are generally considered more reliable.
Another important point to be noted here is that financial statements of
a single year may not be considered sufficient to form any opinion about the
financial position of a concern as the banks are interested to establish the
trend in which the business is being conducted from year to year. The financial
statements of at least last three years are analysed simultaneously to draw
comparisons on year to year basis of the important financial indicators of a
concern. The financial analysis is thus followed with 'trend analysis' which
assumes more significance in as much as the concern with comparative weak
financial base but improving trend may get favourable response from banks.
Except for limited companies, no specific form in which the Balance
Sheet and P & L ale of a concern is to be presented has been prescribed.
Limited companies have to draw their balance sheet in the format prescribed in
Schedule VI under section 211 of Companies Act, 1956. The companies are also
required to submit a copy of their
annual financial statements to the Registrar of companies as per the provisions
of Companies Act. Non corporate borrowers with aggregate working capital fund
based limits of Rs.10 lacs and above are required to submit their statement of
accounts prepared and audited on the formats prescribed by Reserve Bank.
Proformae of these formats have been given in the preceding chapter. Other
concerns may present their financial statements in any form and it is not
necessary to discuss the various forms of presentation as at the time of
analysis, the various items in the balance sheet are rearranged by the bankers
to find out various financial indicators.
The first step for rearrangement starts with grouping of individual items of assets and liabilities into major groups as under:
A. Capital and Reserves: Representing
contribution of the promoters/owners of the concern towards business. It is
also known as the 'net worth' of the concern.
B. Term Liabilities: Representing those liabilities which are payable after
one year.
C. Current Liabilities: Representing those liabilities which are generally
payable within one year.
A. Fixed Assets: Representing
assets of fixed nature such as land, building, plant and machinery etc.
permanently required by the concern to carry out its business.
B. Intangible Assets: Representing
assets such as goodwill, patents, preliminary expenses etc.
C. Current Assets: Representing
those assets which are likely to be converted to cash within an operating
period.
D. Other Non‑current Assets: Which
represent miscellaneous assets not realisable during the current operating
period such as non‑consumable stores and spares.
Non current assets also include investments/loans/advances etc. to other
group concerns or for activities not directly related to the business of the
unit.
The balance sheet after rearrangement will thus be represented as under:
Balance Sheet
The rearrangement of various items in a balance sheet follows a set
principle and Reserve Bank of India has also issued guidelines on
classification of current assets and current liabilities. The most acceptable
form of this classification is discussed in the following paragraphs.
CAPITAL & RESERVES (NET WORTH)
Net worth is a measure of financial stake of the promoters/owners in the
business and is also referred to as 'owned funds'. This is an important
indicator of intrinsic financial strength of' the concern and is generally
compared to the total outside liabilities of the concern which is discussed in
details in subsequent paragraphs. The following items oil the liability side of
the balance sheet are added up to find out the net worth:
·
Ordinary share capital.
·
Preference share capital (redeemable after 12
years).
·
General reserve.
·
Share premium
·
Development rebate reserve.
·
Investment allowance reserve.
·
Other reserves (excluding provisions).
·
Surplus in profit and loss account.
However, if there is any deficit (carry forward loss) in profit and loss a/c on tile assets side of the balance sheet, the same should be deducted to find out the net worth of the concern. The value of any intangible assets is also deducted to arrive at the tangible net worth.
The revaluation reserve, if any, is generally not counted for the
purpose of determining the net worth.
Capital investment in subsidiary/other group companies may also be
sometimes deducted from the net worth/net owned funds to arrive at the correct
status of the stake of owners in the business.
In case of partnership & proprietary concerns any debit balance in
the current accounts of the partners/proprietor shall also be deducted from
partners' capital while computing the net worth.
The liabilities which are not payable within one year are grouped as
‘term liabilities’ and will generally include the following items in the
balance sheet:
·
Debentures (not maturing within one year).
·
The part of debentures which is compulsorily
convertible to share capital should be shown as a part of equity capital
forming net worth of the concern. The balance amount only need he shown under
this head and included in the term liabilities.
·
Redeemable preference shares (not maturing within
one year, but of maturity not exceeding 12 years).
·
Term loans (exclusive of instalments payable
within one year and overdue instalments. if any).
·
Deferred payment credits (exclusive of
instalments payable within one year).
·
Term deposits repayable after one year.
·
Deposits from dealers/selling agents
irrespective of their tenure if such deposits are accepted to be repayable
only, when the dealership/agency is terminated.
·
Other such liabilities, which are repayable
after one year such as sales tax loan etc.
All liabilities which are of short‑term nature and are generally
payable within a period of' one year are taken as current liabilities. Current
liabilities also include estimated or accrued amounts which are anticipated to
cover expenditure within the year for known obligations such as provisions for
bonus payments, taxation etc. The following items are required to be added up
to calculate the total current liabilities of a concern:
·
Short‑term borrowing (including bills
purchased and discounted) from banks and others.
Liability towards bills which are got purchased/discounted from banks is
generally not reflected ill the balance sheet. Tile liability towards such
items is separately reported by way of note as 'off balance sheet' item.
The outstanding under this item is to he added up to 'short‑term
borrowing' from banks and others and classified as current liability. The
contra‑entry for these bills will be reflected as an addition to
receivables and classified as current assets.
·
Unsecured loans.
·
Public deposits maturing within one year.
In certain cases e.g. manufacturers of automobiles such as two wheelers,
etc. who accept deposits for booking orders for new vehicle, are required, in
terms of regulations framed by the Government, to earmark a part of such amount for investment in certain approved
securities, etc. The benefit of netting may be allowed to the extent of such
investment and only the balance amount need be classified as a current liability.
Set off of advance payment/progress payments against work in progress in
respect of construction companies turnkey project is also permissible.
·
Sundry creditors (trade) for raw materials and
consumable stores and spares.
·
Interest and other charges accrued but not due
for payment.
·
Advances/progress payments from customers.
·
Instalments of term loans, deferred payment
credits, debentures, long‑term deposits payable within one year.
Overdue instalments of term loans and instalments due over the next 12
months should be shown separately. This information will be necessary at the
time of assessment of working capital.
·
Redeemable preference shares maturing within
one year.
It is interesting to note that preference share capital is classified under not worth, term liabilities and also under current liabilities. Irredeemable preference share capital and redeemable preference shares of maturity beyond 12 years are to be included in the net worth of the concern, while redeemable preference share of maturity beyond one year and upto 12 years are taken as term liabilities and redeemable preference shares maturing within one year are classified as current liabilities.
·
Lease rentals payable during the year in
respect of leased assets, if any.
·
Provident Fund dues.
·
Provision for taxation.
It may be possible that specific provisions for taxation are not made and taxes are payable from General Reserve or balance of profit carried to the balance sheet as per the accounting policy of the concern. In such an eventuality estimated amount of taxes payable by the concern should he deducted from general reserve, balance of profit and added to current liabilities.
In some cases tax as per the provision has already been paid and is shown as 'advance payment of tax on the asset side of the balance sheet. Provision could not be adjusted as the assessment by tax ‑ authorities has not been completed. In such circumstances ‘Provision for taxation’ may be netted off with ‘advance payment of tax' and only the balance amount may be included as a part of current liability/asset as the case may be.
·
Sales tax, excise duty etc.
It has been provided that disputed liability under sales‑tax, excise duty which has not been actually collected by the concern should not be included in the current liabilities. This has been done to ensure that where there is a dispute in respect of' sales tax or excise liability and where the disputed amount has not actually been collected and available with the unit, the unit should not suffer due to reduction in working capital finance by the banks. This aspect will be further elaborated while discussing assessment of working capital limits in the next chapter.
·
Other provisions.
·
Dividends
Liability on account of dividends is also subject to same treatment as
explained in case of provision for taxation.
·
Liabilities for expenses.
·
Gratuity payable within one year.
·
Other provisions.
·
Any other payments due within one year.
Fixed assets are generally shown in the balance sheet on the gross value
termed as 'gross block' which would generally include land and building, plant
and machinery, construction in progress, furniture and fixtures, vehicles, etc.
The depreciation on fixed assets is provided annually and credited to a
separate depreciation reserve fund. The 'net block' of fixed assets which is
actually taken into the balance sheet would he obtained by deducting
depreciation reserve fund from the 'Gross block'. 'Capital work in progress' if
shown separately in the balance sheet is also to be classified under ‘Fixed
Assets’.
The item is of current assets include cash and bank balances and such
assets which are realisable into cash within an operating period of one year.
It is a very important classification of assets and has direct bearing on
current ratio and assessment of working capital requirements discussed in the
later part of this chapter and in the next chapter. The items to be included in
current assets are described below:
·
Cash and bank balance.
·
Investments.
Investments in shares and advances to other firm/companies, not
connected with the business of the concern may not be allowed to be included in current assets. Investment for long‑term
purposes e.g. sinking fund, gratuity fund etc. is also not considered as a current asset. The following
investments under this head will be considered:
(a) Government and other trustees securities.
(b) Fixed deposits with banks.
Investments made in shares, debentures etc. of a current nature, units
of Unit Trust of India and other mutual funds, and in associate
companies/subsidiaries, as well as investments made and/or loans extended as
inter‑ corporate deposits shall not be considered as current assets.
Fixed deposits with banks as margin for non‑fund based credit
facilities shall also not be taken as current assets.
This stipulation had been brought in by the Reserve Bank on the ground
that margin against non fund based facilities forms a security cover for the
bank and should not therefore, form a part of current assets to be financed by
the bank. Nevertheless margin in the shape of fixed deposits with the bank is
in the nature of current asset only and may he classified as such to reflect a
trite status of the financial position. However, while assessing the working
capital, the amount of fixed deposits held as margin may riot be included in
the build up of current assets. This treatment will meet both the above
requirements.
·
Receivables arising out of sales including
exports other than deferred receivables including bills purchased and
discounted by banks.
It will be interesting to note that bills purchased/discounted from banks may not appear in the balance sheet of the concern at all as per the accounting system. However, for tile purpose of analysis of financial statements, the liability on account of bills purchased/discounted by the banks is added to current liability and the amount of bills receivable is added to the current assets. This information is generally given as separate note with the balance sheet. If not so, complete information in this regard will be required by the banks. Refer to clarification under short‑term borrowings.
Receivables outstanding for more than 6 months may not be accepted as current assets.
Note: Export receivables are to be shown separately
than other receivables for domestic sales as this information will be necessary
to determine the margin requirements for working capital.
Domestic receivables arising out of usance bills negotiated under inland letters of credit should also
be shown separately.
·
Instalments of deferred receivables due within
one year.
·
Inventory/stock of goods consisting of
q
Raw materials and components used in the
process of manufacture including those in the transit.
q
Stocks in process including semi‑finished
goods.
q
Finished goods including goods in transit.
q Other consumable spares.
Banks may sometimes require a detailed statement of inventories of all the items as described above with the age of individual items. Dead inventory consisting of slow moving, obsolete items may be excluded for being added up as current assets.
· Advance payment for taxes.
·
The amount under this head may be netted off
against 'Provisions for Taxation' as already explained.
·
Prepaid expenses.
·
Advances for purchase of raw materials,
components and consumable stores.
·
Deposits kept with public bodies etc. for
normal business operations such as earnest deposits kept by construction
companies etc. maturing within the normal operating cycle.
·
Monies receivable from contracted sale of fixed
assets during the next one year.
This category includes such tangible miscellaneous assets which are not current
in nature and are also not classified as fixed assets. It may be taken as
residual category of tangible assets with a concern and will consist of:
·
Investments/book debts/advances/deposits to
subsidiary companies/ affiliates and others inter corporate deposits/investment
in units of Unit Trust of India & other Mutual Funds.
·
Investment for long term purposes e.g. sinking
fund, gratuity fund etc.
·
Advances to suppliers of capital goods/spares
and contractors for capital expenditure.
·
Deferred receivables excluding those which are
maturing within one year and have been included in current assets.
·
Dead inventory including non‑consumable
stores and spares. Other miscellaneous assets including dues from directors.
Security deposits/ tender deposits.
·
Fixed deposits with banks as margin for non‑fund
based credit facilities.
(Please also refer to the explanation given while elaborating
investments under current assets.)
·
Receivables outstanding for more than 6 months.
A large outstanding under this head will not only be an adverse factor
but also impair the overall financial position of the unit. If there had been
some particular reasons for such outstandings on the balance sheet date and
such receivables have already been realised, the positions needs to be discussed
and these amounts may be classified as current assets. Cogent specific reasons
for adopting the above classification will be necessary.
The items under this head would generally consist of.
·
Goodwill.
·
Patents.
·
Preliminary and formation expenses not written
off.
·
Bad and doubtful debts not provided for.
It must be noted that the list of items of balance sheet as discussed above is not exhaustive but indicative only and with the general explanation provided here in above it would be possible to classify all the items under different broad categories. It is also possible that a few items, which may not be shown in the balance sheet, are required to be taken into account while evaluating current assets and current liabilities.
Classification of assets and liabilities as discussed above is based on guidelines issued by Reserve Bank of India from time to time. Reserve Sank of India has now given complete freedom to banks to frame their own policy, in this regard. The above classification, however, continues to be most acceptable even now.
The manufacturing/trading and profit and loss account of the concern is
also required to be rearranged for the purpose of financial analysis. The most
acceptable general form for assessment of operating statement is given below:
1. Gross
sales (Net of returns) 2. Less
excise duty 3. Net
sales 4. Cost
of sales (i) Raw materials (including stores and other items used in the process of manufacture) (a) Imported (b) Indigenous (ii) Other spares (iii) Power
& Fuel
(iv) Direct
Labour (v) Repairs & maintenance (vi) Other
manufacturing expenses (vii)Depreciation (viii)
Sub total of items (i) to (vii) i.e. (ix)
Add opening stocks in process Sub-total (x)
Deduct closing stock in process Sub-total (xi)
Add opening stocks of finished goods Sub-total (xii)
Deduct closing stock of finished goods Sub-total (Total
cost of sales) 5. Gross
profit 6.
Interest 7. Selling,
General and Administrative expenses Sub-total 8. Operating
Profit 9. Other
Income & Expenses Add
Income Deduct
expenses Sub-total(-)
or (+) X –Y = 10. Profit
before tax O. P. (+) or (‑) Z = 11.Provision for taxation 12.Net Profit |
A B A-B=C D E F G H I J K D+E+F+G+H+I+J+K=L M L+M=N O N-O=P Q P+Q=R S R-S=T G.P.=C-T U V U+V=W O.P.=G.P.-W X Y Z. PBT AA NP=PBT-AA |
Even at the sake of repetition it may be mentioned that the rearrangement of the Balance Sheet and P&L a/c is to be done for a number of operating years and also on the basis of estimates for the current year followed by projections for the next year. This enables the banks to study the trend and draw conclusion regarding operations of the concern on year to year basis. The important indicators of financial strength of a concern that are considered for arriving at the credit decisions are now discussed. The analysis may relate to four different aspects of a concern as under:
We have already calculated the net worth of the concern which is a measure of the financial stake of the owners/promoters in the business. The better measurement of real financial stake is determined by finding out the tangible net worth, as under:
Tangible Net Worth (TNW)=Net Worth ‑ Intangible Assets
An increase in TNW on year to year basis may reveal increased stake of
the promoters/owners which may be as a result of new addition to the capital or
by retaining profits in the business itself. This is a positive factor which
needs to be highlighted. The decrease in TNW from the earlier years will call
for suitable explanatory notes as it would mean loss and/or withdrawals from
capital or reserves
Solvency means the ability of the concern to meet its outside
liabilities and is a measure of its dependence on the borrowed funds vis‑a‑vis
owned fund represented by tangible net worth. The other method to find out the
net worth of the concern would be :
Tangible Net Worth = Total Tangible Assets ‑ Total Outside
Liabilities
Positive net worth i. e. when assets exceed total outside liabilities,
would mean that the concern is solvent. The other important financial
indicators under this category are
Debt Equity ratio.
Total Indebtedness
ratio.
·
Debt Equity ratio : It is a measurement of long‑term
solvency of concern and is calculated by comparing term liabilities with the
net worth of the concern as under :
Debt
Equity Ratio = Total Term
Liabilities
Tangible
Net Worth
Debt equity ratio of 2: 1 is generally acceptable. In highly capital
intensive units it may even go upto 3:1. For small projects under priority
sector, the promoter may not bring any equity/capital from his own source and
the debt equity ratio may be infinity.
The ratio gives an indication of the dependence of the concern on
borrowed funds. A lower ratio means high financial stake of the concern in the
business whereas a higher ratio would mean that the firm is working with a thin
equity. A low debt equity ratio will, therefore, be preferable.
However, the level of acceptance of debt equity ratio by the bank also
depends upon the nature of project and sometimes comparisons may have to be
drawn with projects of similar nature to arrive at a conclusion. The change in
debt equity ratio over a number of years is also to be watched carefully and it
should gradually reduce. Any increase in debt equity ratio over successive
years would mean erosion in the net worth either due to losses or withdrawals from
capital or reserve. The other reason for such reduction maybe due to heavy
borrowings without corresponding additions to capital. Debt equity ratio may
also be affected by diversification/modernisation etc. programme involving
capital expenditure being undertaken by the unit where matching funds by the
unit from its own sources in relation to borrowed funds for implementation of
such programmes are not arranged. The change in debt ratio also throws light on
the policy of management for distribution/retention of profits. Units; with
good profitability not showing improvement in debt equity ratio over a period
of time would reveal that most of the profits are being distributed to
shareholders. However, any intervening capital expenditure for modernisation/diversification
programme necessitating additional borrowings may alter the situation in this
regard. All these aspects need to be probed and suitable explanatory notes
would be necessary if there is any adverse movement in debt equity ratio as
compare to earlier years.
Total
indebtedness ratio: This ratio is in fact an
extension of debt equity ratio and is also sometimes referred to as 'leverage
ratio'. It is calculated by
comparing the tangible net worth with total outside liabilities of the concern as
under:
Total Indebtedness
Ratio = Total Outside Liabilities
Tangible Net worth
The calculation of this ratio thus takes into consideration the term
liabilities as well as the current liabilities of the concern and may be
considered as a better indicator of solvency of the concern. However, the financing pattern of any unit as
prevalent in our country does not very much depend on it and the ratio is thus
relatively less important. There is no ideal ratio prescribed under this
category and ratios generally ranging from 4:1 to 6:1 are acceptable. Higher
ratio would indicate excessive dependence on outside funds and may be
considered as a negative factor.
The study of movement in this ratio over successive years also gains
importance as any increase in the ratio over the successive period means
deterioration in the financial stake of the promoter in the project and may be
another negative factor. The reasons for such an adverse change are, therefore,
to be found and suitable explanation is necessary.
Liquidity: Liquidity here relates to solvency of the firm in the short‑term.
Fixed assets are required by any going concern for long‑term use and are
not available to meet its obligation for short‑term or immediate
liabilities. These liabilities are to be met from current assets. The value and
reliability of current assets into cash is thus an important indicator of the
capacity of the concern to meet its current liabilities to ensure smooth day to
day functioning of the unit. Study of this aspect is undertaken to find out the
liquidity position or short‑term solvency of the unit. The most important
aspect of financial appraisal by banks is to study the liquidity position of
the concern which is very relevant for assessment of working capital
requirements of the unit. The following two ratios are important in this
regard.
·
Current ratio.
·
Quick or Acid test ratio.
Current Ratio: We have
already explained in details the rearranging and regrouping of various items in
the balance sheet. The balance sheet in a simple form can now be presented as
given on next page.
Balance Sheet
(Rs.
in lacs)
Liabilities |
Assets |
Equity
& Reserves 100 Term
Liabilities 200 Current
Liabilities 150 450 |
Fixed
Assets 150 Current
Assets 300 ___ 450 |
Current ratio is a
comparison of current assets in relation to current liabilities and is
calculated as under:
Current Ratio = Current Assets
Current Liabilities
The current ratio as
per the balance sheet given above would be
Current Ratio = 300 =
2:1
150
The current ratio of 2:1 conveys that current liabilities are covered as
much as two times by current assets revealing a good liquid position of the
concern. As a sound financing policy adopted by the banks, it is necessary that
a part of the current assets are financed by long‑term liabilities. The
portion of long‑term liabilities available for financing of current
assets is known as margin for working capital
or liquid surplus or net working capital. These terms are fully explained and
extensively used in the next chapter on assessment of working capital
requirements.
Let us now consider
another example.
Balance Sheet
(Rs.
in lacs)
Liabilities |
Assets |
Net
Worth 100 Term
Liabilities 150 Current
Liabilities 300 550 |
Fixed
Assets 300 Current
Assets 250 ___ 550 |
The current ratio in the above example will be 250=0.83:1 and the
concern has a
300
negative working capital. It is very clear from the above example that Current liabilities are not fully covered by the current assets and the position of the concern is not liquid. It will not be able to meet its current dues from its short term assets.
A minimum current ratio of 1: 1 indicates that current liabilities are just
matched by current assets. As per recent Reserve Bank of India's guidelines a
minimum current ratio of 1.33:1 is to be ensured for large borrowers. This
aspect will again be taken up in the succeeding chapters.
By closely monitoring the current liabilities and cash and bank balances
it is possible to improve the current ratio to some extent. Optimum utilisation
of cash in hand and keeping it at the minimum level would ensure a better
reflection in this regard as illustrated by the following example:
Let us presume that the balance sheet of a concern as on a particular
date is as under
Liabilities |
Assets |
Capital 50,000 Reserves 1,00,000 Term
Loans 3,00,000 S.
Creditors 2,00,000 Other Current liabilities 1,50,000 |
Fixed
assets 3,80,000 Misc.non
current assets 20,000 Cash
& bank balance 2,00,000 Other
current assets 2,00,000 |
8,00,000 |
8,00,000 |
Current, ratio from
the above example will be calculated as under:
Total current
liabilities =
(S.Creditors +Other Current Liabilities)
(Taking total term
loan =
Rs2,00,000 + Rs.1,50,000
as term liability for
the =
Rs.3,50,000
sake of
simplification)
Total current assets
= (Cash & bank balance Other current assets)
= Rs.2,00,000 + Rs.2,00,000
= Rs.4,00.000
Current ratio = 4,00,000 = 1.14:1
3,50,000
Let us now further presume that the firm pays off its Sundry Creditors of Rs.2,00,000 from the cash and bank balance of Rs.2,00,000. The new balance sheet after this adjustment will be as under:
Liabilities |
Assets |
Capital 50,000 Reserves 1,00,000 Term
Loans 3,00,000
Current liabilities 1,50,000 |
Fixed
assets 3,80,000 Misc.non
current Assets 20,000 Current
assets 2,00,000 |
6,00,000 |
6,00,000 |
The current ratio based
upon the above balance sheet will be
2,00,000
1,50,000 = 1.33: 1
By this adjustment the current ratio has improved to 1.33 as compared to
1:14 in the earlier option. It is thus very important that all efforts to
realise current assets into cash shall be made on urgent basis and the cash and
bank balances are kept to the minimum level to present a fairly good picture.
It is interesting to note that keeping large cash balances is not necessarily
an indication of a very liquid nature of a concern.
Every effort is also to be made to reduce sundry creditors for purchase and other expenses to the minimum level. The cumulative effect of keeping minimum cash and bank balance and utilising it to reduce sundry creditors will help to improve the current ratio and present a better position of the concern.
Current liabilities other than bank borrowings are reduced from total
current assets to find out working capital gap on the basis of which
requirement of working capital is assessed by banks. Current liabilities
should, therefore, be paid to the maximum extent even if by increase in bank
borrowings (within limits). Current ratio will not be affected this exercise
but the maximum permissible bank finance will
increase.
The other important aspect to be examined in this regard is to study the
trend in the movement of current ratio over a period of time. An increasing
ratio is an indicator of improving position of a concern while a decrease in
the current ratio may raise doubts about the overall functioning of the
concern. A deteriorating current ratio will either mean successive losses being
suffered by the concern or diversion of short term funds for long term uses.
Both these factors will have a negative influence on the decision making and
would require suitable explanation being given for adverse change in the
current ratio.
·
Quick or Acid test ratio: While calculating current ratio, we have presumed that all
current assets can be realised to meet the current liabilities of a concern. But in practice all current assets are
not so realisable. For example, inventory of finished
goods etc. and stock in process may take a long time before these can be
converted to cash and may thus not be available to meet the current dues of the
firm. This may sometimes lead to erroneous conclusion regarding the real
liquidity of the concern. Assets of such nature are thus excluded to find out
the real liquidity position of the concern on a very short term basis. The
relationship of such assets to current liabilities is termed as 'Quick or Acid
test ratio' and is determined as under:
Quick Ratio = Current assets‑ (Inventory +Prepaid expenses)
Current liabilities
While calculating this ratio sometimes total current liabilities are not
taken into consideration and bank borrowing is which are generally available
against the stocks of inventory are excluded from the current liabilities and
the quick ratio is determined as under :
Quick Ratio = Current assets ‑ (Inventory + Prepaid
expenses)
Current liabilities‑ Bank borrowings against
stocks of inventory
This ratio shows the real liquidity position. No fixed norms have been
prescribed for this ratio but a ratio of 1:1 should be considered as adequate.
Profitability
Aspects. Every business is undertaken for a profit and in ultimate analysis it is
the profit earned by a project which eventually determines its success. The
profit in absolute terms, however, does not reveal the competitiveness of a
project in relation to its size and investment made. The profitability aspect is, therefore, examined from
various angles to make comparisons with other similar projects. Three important relationships which are examined
are as follows:
The gross profit
ratio.
The operating profit
ratio.
The return on
investment ratio.
All these ratios are expressed in percentage terms.
The Gross
profit ratio: The gross profit ratio is a
relationship of gross profit earned to total sales and is calculated as under :
Gross Profit Ratio = Gross
Profit x 100
Sales
There cannot be any norms for minimum or maximum percentage of gross
profit earned by any project. Two types of comparisons can, however, be made to
determine relative competitiveness of the project in relation to other similar
projects and to watch its progress through successive years.
The comparison of gross profit ratio with other similar projects may reveal competitive edge and better
management which needs to be highlighted. If the gross profit ratio is low, the
reasons therefor are to be probed to improve the working results for future.
The more important aspect is, however, the change in the ratio on year
to year basis. An increasing gross profit ratio would mean stabilisation of
production, effective management of inventory besides marketing efficiency and
better production management. The
lower gross profit ratio on the other hand may mean a strain on the margins due
to increase in the cost of raw materials and other production costs without a corresponding increase in sales realisation.
This may also require an in depth study of all other aspects resulting
increased cost of production to establish the real cause of such a decrease so
that necessary adjustment in policy, if necessary, can be made to show better
results in future.
The operating
profit ratio: The operating profit ratio
is almost similar in content to gross profit ratio except that operating profit
instead of gross profit is compared to net sales to find out this ratio.
We are already aware of the relationship between the gross profit and operating profit as under:
Operating Profit =
Gross Profit ‑ Selling, general and
administrative expenses.
The absolute ratio is not important even in this case and comparison on year
to year basis is to be made to draw some important conclusions on the working
of the unit. An increase in operating profit ratio would mean stabilisation of
the products of concern and effective control on selling and administrative
expenses. However, the change in
operating profit ratio is largely dependent on the, change in gross profit
ratios though it is not necessary that both the ratios move, in the same
direction and all types of combinations are possible.
Let us now briefly
discuss various combinations that could be obtained between these two ratios:
·
Positive change in Gross Profit ratio and
positive change in Operating Profit.
This situation reveals all round improvement in working results of the
unit and is a plus factor. It proves stabilisation of production and marketing
arrangements by the unit and effective control over the overheads.
·
Positive change in Gross Profit ratio and
negative change in Operating Profit.
Positive change in gross profit ratio points towards better control over
cost of production which is, however, lost by increased selling and
administrative costs resulting in negative change in operating profits. The
position in this regard is now to be rectified by exercising better control
over the overheads eroding the profitability.
·
Negative change in Gross Profit ratio and
negative change in Operating Profit.
This situation reveals an overall deterioration in the working of the
unit. The change in gross profit ratio is due to increased cost of production
while the change in operating profit may be either directly as a consequence of
increase in cost of production or may also be contributed by increased
overheads A very detailed investigation in the circumstances resulting in such
a situation is necessary to rectify it in future.
·
Negative change in Gross Profit ratio and
positive change in Operating Profit.
The increase in the cost of production has been more than offset by
savings in other overheads which indicates towards a stable marketing effort
coupled with effective control over expenditure. The increase in production
cost needs to be investigated and suitable remedial measures are required to be
taken to improve the position.
It may be possible sometimes particularly for small firms that figures of
operating profits are not exactly known due to accounts not being maintained in
a proper manner. Net profit may replace the operating profit in such situations
for the purpose of this analysis.
The profitability analysis may be carried by the management to its own
advantage as well. The conclusions drawn from it may be utilised for future
policy formation and also to exercise effective internal control over
expenditure on various factors of production. The positive factors need to be
highlighted while submitting application to the bank for sanctioning/renewal of
credit facilities. Suitable explanations and future strategies are to be spelt
out for the deficiencies.
The Return on
Investment ratio (R0I). Investment for this purpose
means the capital fund and also other term liabilities which are deployed for long term use to run
the business. The return means net profit before tax plus interest paid on term
liabilities. Interest on term liabilities is to be added as it is a direct
charge on term liability which is counted as investment The ROI is calculated
as under:
Net Profit before tax + Int. on term liabilities x 100
Return on investment
ratio Net worth + Term liabilities
The ratio indicates the earning power of any project in relation to the investment made and risks undertaken. It will also benefit to compare it with other projects to, find out the relative strength of any project in terms of profitability. This ratio is also found out for a number of successive years to establish the trend. Any deterioration would mean lower earning capacity of the project due to erosion in margins as a result of many factors which may include increase in cost of production, overheads and difficult competitive market. A careful study of these factors may help to plan suitable strategies for improvement in future.
As a modification of the above ratio sometimes an attempt is made to
find out return on the net worth which is a better indicator of the earning
capacity of project in relation to the owned funds employed for the project.
Return on net
worth = Net profit after tax x
100
Tangible net worth
This indicates the real amount available to owners as a return/on their
investment after all the claims on income including taxes have been Satisfied.
Activity Aspects. An establishment of any
size would include many activities such as production and sales. For production
there may be many activities such as purchase of raw material, actual
production process, holding of inventories etc. The sales may also be effected
on credit etc. Even the trading concerns would involve purchasing activity,
holding the inventories and their sales. Various activity ratios are indicators
of the efficiency of an enterprise to manage the available resources on a short
term basis. Three important ratios under this category are as under:
Inventory turnover ratio.
Creditors ratio.
Debtors ratio.
The inventory
turnover ratio: This ratio is an indicator of
the movement of inventory over an operating period and is calculated as under:
Inventory turnover
ratio = Cost of sale
Average inventory
Average inventory is found by taking average of opening stocks and
closing stocks. This ratio is a measure of the fastness in the turnover of the inventory.
The higher ratio indicates that the enterprise is able to achieve higher
turnover with low level of inventory thereby reducing the chances of inventory
hold ups or carrying over of obsolete inventory. The lower ratio indicates slow
turnover with possible chances of carrying over of unsaleable inventory. It is
also interesting to study the change in this ratio over a number of years. The
increase in the ratio reveals a healthy trend where the firm may not be facing
any selling problems. This would further mean low investment in inventories
resulting in higher profits. The declining trend in the ratio would point
towards sluggishness in the demand of goods manufactured/traded by the
enterprise with large carry over stocks demanding more investment with slow
movement. This may also mean carry over of dead inventory. It is a negative
feature and this trend is to be arrested as early as possible.
The creditors
ratio:
This ratio is determined to find out
the average period of credit available to the concern for its purchases and its
policy to pay its creditors. The ratio is calculated as under:
Creditors ratio
= Bills payable + Sundry Creditors x 365
Total
credit purchases
This will give result in
days and indicates average period taken by the concern to pay its creditors.
Sometimes, separate figures for credit purchases may not be available and
figures of total purchases may be taken in the denominator. A longer repayment
period would mean that the firm is not making prompt payment.
This ratio may be compared with similar ratio for other projects to
evaluate the reputation of the unit in the market and its ability to get credit
form the market. The increasing
trend in this ratio would reveal that the concern is defaulting in making
prompt payment to creditors and is an indicator of some financial difficulties
being faced by it.
·
The debtors ratio: This ratio is similar in
content to creditors ratio and indicates the capacity of the unit to realise
its sale proceeds. The ratio is calculated as under :
Debtors
ratio = Bills Receivable +Sundry debtors x 365
Total
credit sales
This ratio will give the result in number of days that are taken on the
average to realise the sale proceeds. Where figures of credit sales are not
separately available, the figures of total sales may be taken in the denominator. Longer period in
realisation of sales proceeds points towards the incapacity if the unit to
realise its dues in time. The trend in the ratio on year to year basis is also
required to be studied. The increasing ratio would indicate that the concern is
having difficulty in sales due to sluggishness in demand or has ended up with
some bad debts which cannot be realised promptly. Sometimes, the ratio may
deteriorate due to the lack of efforts by the management to realise its dues
promptly. This situation, therefore, needs very close examination and
corrective measures are to be initiated immediately.
Another interesting dimension is to compare the debtor’s ratio with the creditor
ratio. A small creditor ratio with a high debtor’s ratio means that the firm is
prompt in making its payment but has to extend credit for its sales for a
longer period. This may be due to adverse market conditions for the product in
which the firm is dealing and in any case means large investment for financing
its sales. Whereas a low debtors ratio and higher creditors ratio means that
the firm is able to get its supplies on credit but is not required to extend
credit for its sales. From this situation it may be concluded that the product
has a ready market and the firm is enjoying a good reputation enabling it to
get goods on credit on its own terms.
In the preceding paragraphs an attempt has been made to familiarise the
readers with the techniques of financial analysis generally adopted by the banks. The actual procedure may
differ from bank to bank but the principles
involved almost remain the same. The appraisal for working capital as directed by Reserve Bank of India
remains the same for large borrowers. Flexibility has since been given by
Reserve Bank in this regard and banks are free to make their own policies. The
methods to be adopted for assessment of working capital have been entirely left
to the discretion of banks. 'Me exercise of analysis of financial statement
reveals many important points from where some valuable conclusions can be drawn
by the management of the unit. Such an analysis will thus not only help the
prospective borrowers in perusing their applications with the banks but also
assist in formulation of strategies to effectively overcome the deficiencies
noted during the course of such analysis. Appendix 14.1 gives the copy of the
balance sheet of a company with its analysis to illustrate the application of
the discussion carried out in this chapter.
RBI GUIDELINES OF RESERVE BANK FOR CLASSIFICATION OF VARIOUS, ITEMS OF BALANCE SHEET
As would be evident from the discussion in the preceding paragraphs, rearrangement
of various items of balance sheet to determine the various ratios is very
important. Reserve Bank of India had also issued various guidelines in this
regard from time to time. The assessment of working capital (as discussed in
the next chapter) is directly dependent on the level of current assets and
current liabilities of any concern. These guidelines have since been withdrawn.
However, no material difference is expected in the short run and re‑arrangement
as suggested by Reserve Bank is given on the next page.
I Current Liabilities (i)
Short-term borrowings (including bills
purchased and discounted) from (a) Banks (b) Others (ii) Unsecured loans (iii) Public deposits maturing
within one year (iv) Sundry creditors (trade) for raw materials and
consumable stores and spares (v) Interest
and other charges accrued but not due for payment (vi)Advance / progress payments from Customers (vii)Deposits from dealers, selling agents etc. (viii)Instalments of term loans, deferred payment
credits, debenture redeemable, preference shares and long term deposits
payable within one year overdue instalments to be shown separately. (ix) Statutory liabilities (a) Provident fund due (b) Provision for taxation (c) Sales-tax, excise etc. (d) Obligation towards workers considered
as statutory (e) Others (to be specified) (x)
Miscellaneous current liabilities (a) Dividends (b) Liabilities for expenses (c) Gratuity payable within one year (d) Other provisions (e) Any other payments due within 12 months. |
II Current Assets (i) Cash
and bank balances (ii)
Investments (a)
Governments and
other Trustee Securities (other than for long term purposes e.g. sinking
fund, Gratuity fund, etc. (b)
Fixed deposits with
banks for margin against non fund based facilities are not to be treated as
current assets. (iii)
Receivables arising
out of sales other than deferred receivables (including bills purchased and
discounted by bankers) (iv)
Instalments of
deferred receivables due within one year (v)
Raw material and
components used in the process of manufacture including those in transit (vi)
Stocks in process
including semi finished goods (vii)
Finished goods
including goods in transit (viii)
Other consumable
spares (ix)
Advances payment
for tax (x)
Pre-paid expenses (xi)
Monies receivable from
contracted sale of fixed assets during the next 12 months. |
Notes: (i) The concept of current liabilities would
include estimated or accrued amounts which are anticipated to cover expenditure within
the year for known obligations, viz the amount of which can be determined only approximately as
for example, provisions, accrued bonus payments, taxes etc.
(ii) In cases where specific provisions have not been made for these liabilities and will be eventually paid out of general reserves, estimated amount should be shown as current liabilities.
(iii) Investment in shares and advances to other firms/companies, not connected with the business of the borrowing firm should be excluded from current assets.
(iv) Dead
inventory i.e. slow moving or obsolete items should not to classified as
current assets.
(v) Amounts representing inter connected company transactions should be treated as current only after examining the nature of transactions and merits of the case. For example, advance paid for supplies for a period more than the normal trade practice, inspite of any other considerations such as regular and assured supply should not be considered as current.
(vi) Advance/progress payments from customers are to be classified as current liabilities. Where deposits are required in terms of regulations formed by the Government, to be invested in a specified manner. (e.g. advances for booking of vehicles), the benefit of netting may be allowed to the extent of such investment in approved securities and only the balance amount need be classified as current liability. Where on account of different accounting procedure progress payment are shown on the liabilities side without deduction from work‑in‑progress, the bank may set‑off the progress payments against work- in‑progress. Advance payment received area so adjusted progressively from the value of work completed, as agreed in the contract. Outstanding advance payment are to be reckoned as current liabilities or otherwise, depending upon whether they are adjustable within a year or later.
(vii) Deposits from dealers, selling agents etc. may be treated as term liabilities irrespective of their tenure if such deposits are accepted to be repayable only when the dealership/agency is terminated after due verification by banks. The deposits which do not satisfy the above conditions should continue to be classified as current liabilities. Security deposits/tender deposits may be classified as non-current assets irrespective of whether they mature within the normal operating cycle of one year or not.
(viii) Netting of tax‑provision and advance tax paid may be effected for all the years uniformly and, as such, for the current year also the advance tax paid can be set‑off against the on, if any made for that year.
(ix) Disputed excise liabilities shown as contingent liability or by way of note tome balance sheet need not be treated as a current liability for calculating, the permissible bank finance unless it has been collected provided for in the accounts of the concern.
Provision for disputed excise‑duty should classified as current liabilities, unless the amount is payable in instalments spread over a period exceeding one year as per the orders of competent authority like the Excise Department or in terms of the directions of a competent court. In such cases if the instalments payable after one year are classified as long term liability, no objection may be taken to such classification.
Where the provision made for disputed excise duty is invested separately, Say in fixed deposits with banks such, provision may be set off against the relative investment
Disputed liabilities in respect of income‑tax, customs and electricity charges need not be‑ treated as current liability for the purpose of computation of maximum permissible bank finance except, to the extent provision for in the books of the concern.
(x) Export receivables maybe included in the total current assets for arriving at the maximum Permissible Bank Finance but the minimum stipulated Net Working Capital (i.e.25% of the total current assets under 2nd Method of Lending) may be reckoned after excluding the quantum of export receivables from the total current assets.
(xi) Projected levels of spares on the basis of past experience but not exceeding 12 months consumption for imported items and 9 months consumption for, indigenous items may be treated as current assets for the purpose of assessment of working capital requirements.
|
Schedule |
Rupees
in lacs |
Sources
of funds Shareholders' funds Loan fund Secured loans Unsecured loans Total Application
of funds Fixed assets Gross block at cost Less: Depreciation Net
block Capital
work in progress Current
assets, loans & advance Inventories
Sundry debtors Cash and bank balances Loans & advances Less: Current Liabilities and
Provisions Net
Current Assets Preliminary
expenses not written off Profit
& loss account |
‘A’ ‘B’ ‘C’ ‘D’ ‘E’ ‘F’ |
743.32 2,875.76 30.26 3,649.34 2,108.65 472.09 1,636.56 337.36 1,973.92
1,973.92 1,359.62 665.35 32.86 36.21 2,093.14 466.01 1,627.03 13.02 35.37 |
Total |
|
3,649.34 |
Profit and Loss Account for the year ending 31-3-2003
|
Schedule |
Rupees in lacs |
Income Sales Other
income Expenditure
Materials consumed
Operating and other expenses
Interest
Depreciation Total |
‘G’ ‘H’ ‘I’ |
4,832.57 23.45 4,856.02 3,047.82 1,211.32 443.27 188.98 4,891.39 |
Loss
for the year, carried to balance sheet |
|
35.37 |
SCHEDULE ‘A’
|
Rs.
in lacs |
Shareholders
Funds Share
Capital Authorised 1,00,00,000
equity shares of Rs.10 each Issued
& Subscribed 60,00,000 equity
shares of Rs.10
each fully paid up
Investment allowance reserve |
1000.00 600.00 143.32 |
Total |
743.32 |
SCHEDULE ‘B’
|
Rs. in lacs |
Loan
Funds Secured
Loans/ 15% non‑convertible debentures of Rs.100 each fully paid up Foreign
currency loan from IDBI secured by mortgage of plant & machinery Term
loans from IDBI and others secured by mortgage of fixed assets Working
Capital finance from bank secured by hypothecation of stocks of inventory and
book debts |
200.00 130.00 1,295.35 1,250.41 |
Total |
2,875.76 |
SCHEDULE 'C'
|
Rs. in lacs |
Unsecured
Loans Loan from directors Loan from others |
15.26 15.00 |
Total |
30.26 |
SCHEDULE ‘D’
Fixed Assets |
|
|
|
|
Rs. in lacs |
|
|
|
Gross |
Block |
Net Block |
|
Cost as at 1.4.2002 |
Additions |
Cost as at 31.3.2003 |
Depreciation up to 31.3.2003 |
As at 31.3.2003 |
Land free hold Building Plant machinery &
equipment Furniture fixtures & other office
equipment Vehicles |
18.67 185.23 1,375.87 213.67 63.29 |
___ 62.35 1,87.39 ___ 2.18 |
18.67 247.58 1,563.26 213.67 65.47 |
___ 33.27 365.67 44.83 28.32 |
18.67 214.31 1,197.59 168.84 37.15 |
Total |
1,856.73 |
251.92 |
2,108.65 |
472.09 |
1,636.56 |
Capital work in progress |
|
|
|
|
337.36 |
Total |
|
|
|
|
1,973.92 |
SCHEDULE ‘E’
|
|
Rs. in lacs |
Current
Assets, Loans and Advances Inventories Stock‑in‑trade,
at cost or net realisable
value whichever is lower Raw
materials and components Stocks‑in‑process Finished
goods Consumable stores at cost Sundry debtors (unsecured and considered
good)
Under six months
More than six months Cash and bank balances Loans & advances
(unsecured and considered good)
Deposits with associate company
Interest accrued on above
Advance to staff |
652.77 215.08 483.92 623.17 42.18 30.25 1.98 3.98 |
1,351.77 7.85 1,359.62 665.35 31.86 36.21 |
Total |
|
2,093.04 |
SCHEDULE ‘F’
|
Rs. in lacs |
Current
Liabilities Sundry
creditors
Interest accrued but not due on loans
Other provisions |
394.85 30.43 40.73 |
Total |
466.01 |
SCHEDULE ‘G’
|
Rs. in lacs |
Other
Income Interest
received Miscellaneous
income |
20.41 3.04 |
Total |
23.45 |
SCHEDULE ‘H’
|
|
Rs. in lacs |
Materials Consumed Opening stocks Raw
material Stock‑in‑process Finished
stocks Consumable
stores Add: Purchases during the year Less: Closing stocks Raw
material Stock‑in‑process Finished
stocks Consumable
stores |
458.23 188.92 385.73 9.93 652.77 215.08 485.92 7.85 |
10442.81 3,364.63 4,407.44 1,359.62 |
Total |
|
3,047.82 |
SCHEDULE ‘I’
|
Rs. in lacs |
Operating
and other expenses Power
and fuel Repairs
and maintenance Wages Salaries Staff
welfare expenses Advertising
and selling expenses Insurance Rent Rates
and taxes Travel Training
and recruitment expenses General
expenses Audit
fees Directors
fees Preliminary
expenses written off |
111.21 58.11 428.51 268.32 38.73 152.31 1.85 12.00 37.00 27.93 43.38 27.53 1.30 1.25 1.89 |
Total |
1,211.32 |
Additional Notes:
The value of bills
purchased and discounted from banks and outstanding as on 31.3.2003 amounts to
Rs.73.35 lacs.
The first step is to
rearrange various items of the balance sheet to bring it to a simplified form
as under:
|
|
Rs. in lacs |
Current
Liabilities 1. Short‑term
borrowings from banks including bills purchased and discounted 2. Unsecured
loans2 3. Sundry
creditors 4. Interest
and other charges accrued but not due 5. Instalments
of term loans3 due within one year (includes overdue instalments of
Rs.36 lacs) 6. Other
current liabilities and provisions Total current liabilities (Items 1 to 6) Term
Liabilities 8. Debentures 9. Term
loans exclusive of instalments payable within next 12 months
4 10. Other term liabilities (Loan from directors) 11.
Total term liabilities (items 8 to 11 12.
Total outside liabilities (items 7+11) Net
worth 13. Ordinary
share capital 14. Investment
allowance Reserve 15. Deficit
in profit & loss a/c 16. Net
worth (Total of items 13 to 15) 17.
Total liabilities (Item 12 plus item 16) Current
Assets 18. Cash
and bank balances 19. Receivables including bill discounted by the bankers (including export receivable of Rs.325.26 lacs) 20. Inventories ·
Raw materials ·
Stock‑in‑process ·
Finished goods ·
Other consumable stores and spares 21. Other
current assets7 22. Total
current assets (items
18 to 21) Fixed
Assets 23. Gross
block including capital work‑in‑progress 24. Depreciation
to date 25. Net
block (item
23 minus item 24) Other
Non‑current Assets 26. Investment/book
debts advances which are not current assets (i)
Investment/deposits to associate company and interest accrued thereon (ii)
Others (Sundry
debtors older than 6 months) 27. Intangible
assets Preliminary expenses not written off 28. Total
assets
(Total of item 22, 25, 26 & 27) 29. Tangible
net worth
(item16 ‑ item 27) |
1,250.41 73.351 623.175 73.356 652.77 215.08 483.92 7.85 _ 2,108.65 337.36 30.25 1.98 42.18 2,091.98 1,973.92 74.41 13.02 707.95 (-)13.02 |
1,323.76 15.00 394.85 30.43 104.50 40.73 1,909.27 200.00 1,320.85 15.26 1536.11 3,445.38 600.00 143.32 (-)35.37 707.95 4,153.33 31.86 696.52 1359.62 3.98 2091.98 2,446.01 472.09 1,973.92 74.41 13.02 4,153.33 694.93 |
The simplified form
of the balance sheet after this rearrangement can now be drawn as under :
Balance Sheet as at 31‑3‑2003
Liabilities |
Rs. in lacs |
Assets |
Rs. in lacs |
Tangible Net Worth Term liabilities Current liabilities |
694.93 1,536.11 1,909.27 |
Fixed assets Non‑current assets Current assets |
1,973.92 74041 2,091.98 |
Total |
4,140.31 |
Total |
4,140.31 |
We shall now attempt
to simplify the profit and loss account
of the company as under:
|
Rs. in lacs |
1. Net sales 2. Cost of Sales (i) Raw materials (including
stores and other items used in the process of
manufacture) (ii) Power and fuel (iii) Wages (iv) Repairs and maintenance (v) Depreciation (vi) Sub‑total items (i)
to (v) (vii) Opening stock in process (viii) Sub‑total items (vi) & (vii) (ix) Deduct closing stock in
process Sub‑total
(cost of production) (x) Add: opening stock of
finished goods Sub‑total (xi) Deduct: closing stocks of
finished goods Sub‑total
(cost of sales) 3. Gross Profit (G.P.) (item 1‑item 2) 4. Interest 5. Selling, general and administrative
expenses 6. Operating profit (item 3 minus total of
items 4 & 5) 7. Other income 8. Net Loss |
4,832.57 3,172.17 111.21 428.51 58.11 188.98 3,958.98 188.92 4,147.90 215.08 3,932.82 385.73 4,318.55 485.92 3,834.63 997.94 443.27 613.49 -58.82 23.45 35.37 |
We can now proceed on
to calculate various ratios as have been discussed already.
Debt Equity ratio = Term liabilities
Tangible Net worth
= 1,536.11
694.93
= 2.21 : 1 (app.)
Total indebtedness ratio = Total
outside liabilities
Tangible Net worth
= 3,445.38
694.93
= 4.95 : 1 (app.)
Current ratio = Current
Assets
Current liabilities
= 2,091.98
1,909.27
=
1.09 : 1 (app.)
Quick ratio = Current Assets ‑ Inventories
Current liabilities ‑ Bank
borrowings against inventories
=2,091098 – 1,359062
1,909.27 – 1050.411
=732.36
858.56
=0.85 : 1 (app.)
Gross profit ratio = Gross
profit X 100 Sales
Sales
= 997.94 x 100
4,832.57
Operating profit ratio is negative as the company has incurred operating loss. It would also he noted that the company is ha incurred operating loss. It would also be noted that the company is having a very good gross profit but is saddled with heavy overhead costs resulting in operating loss.
Return on Investment ratio.
The company has no
profits during the year and there is in fact negative return on the investment.
Inventory turn‑over ratio
= Cost of sale
Average inventory
= 3,834.63
s(1,042.81 + 1,359.62)/2
= 3,834.63
1,201.21
= 3.19
Creditors ratio = Bills
payable + Sundry Creditors x 365
Total credit purchases
= 394.85
3364,631
= 43
days
Debtors ratio = Bills
receivable + Sundry debtors x 365
Total credit sales
= 738.702 x 365
4832.573
= 56 days.
We have only analysed the balance sheet for one year. As already stated,
the balance sheet for last three years along with estimated figures for the current
year and projected figures for the next year are analysed together to evaluate
the functioning of the unit over a period of time. This analysis is also
important from the point of view of assessment of working capital which is
discussed in the next chapter. This analysis will also be used by us in the
next chapter.
[M1]Unsecured loan from directors is not taken as current liability as it is presumed that director' loan is subordinated to the term loans granted by financial institutions.
[M2]It represents is the amount of instalments due within the next 12 months.
[M3]The term loan outstanding has been reduced to the extent of instalment payable during the next 12 months. (Includes foreign currency loan & term loans as per schedule B).
[M4]Deposit with associate company along with interest accrued thereon is not taken as current assets.
[M5]The figure of bills purchased and discounted from banks though not reflected in balance sheet has been taken here as reported in other notes.
[M6]Sundry debtors older than six months are not taken as current assets.
[M7]The figure of bills purchased and discounted from banks is to be added here as counter entry for short‑ term borrowings from banks.
[M8]The total borrowing against hypothecation of inventory and book debts are Rs. 1251.41 lacs out of which Rs. 200 lacs is presumed to be against book debts.
[M9]As figures for credit purchase are not separately given, the figure of total purchase has been taken into consideration for the calculation of this ratio.
[M10]This figure includes total debtors plus the figure of bills discounted from banks.
[M11]As figures for credit sales are not available separately, the figure of total sales has been taken into consideration for the purpose of calculation of this ratio.