Techniques of Financial Appraisal Commercial Banks

 

 

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.

 

 

 

FORM OF BALANCE SHEET AND P & L A/C

 

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:

 

Liabilities Side

 

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.

 

Assets Side

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


Re‑arrangement of 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.

 

TERM LIABILITIES

 

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.

 

CURRENT LIABILITIES

 

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.

 

MISCELLANEOUS CURRENT LIABILITIES

 

·         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

 

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’.

 

CURRENTASSETS

 

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.

 

OTHER NON‑CURRENT ASSESTS

 

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.

 

 

INTANGIBLE ASSETS

 

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.

 

Re‑arrangement of P&L a/c.

 

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:

 

Financial Stake of the Promoters/Owners and Solvency of the Concern

 

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.

 

 

APPENDIX 14.I

 

Balance Sheet as at 31st March 2003

 

 

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.