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Financial analysis

Ratio Analysis:An integral aspect of financial appraisal is financial analysis, which takes into account the
financial features of a project, especially source of finance. Financial analysis helps to determine
smooth operation of the project over its entire life cycle.
The two major aspects of financial analysis are liquidity analysis and capital structure. For
this purpose ratios are employed which reveal existing strengths and weakness of the project.
1) Liquidity ratios- Liquidity ratio or solvency ratios measure a projects ability to meet
its current or short-term obligations when they become due. Liquidity is the pre-requisite
for the very survival of a firm. A proper balance between the liquidity and profitability is
required for efficient financial management. It reflects the short-term financial strength or
solvency of the firm. Two ratios are calculated to measure liquidity, the current ratio and
quick ratio.
a) Current ratioThe current ratio is defined as the ratio of total current assets to total current
liabilities. It is computed by,
Current assets
Current ratio
Current liabilities

Particulars

2004

2005

2006

2007

2008

Current assets

91.47

101.72

112.76

128.7

145.25

Current liabilities

144.32

127.66

121.59

96.05

80.09

Current ratio

0.634

0.767

0.927

1.339

1.8134

InterpretationIt is an indicator of the extent to which short term creditors are covered by assets
that are expected to be converted to cash in a period corresponding to the maturity of claims. The
ideal current ratio is 2:1. The firm current ratio indicate that the firm is in a position to meet its
short term obligation because the ratio is in increasing trend , by observing the above table we
can say that though the firm does not maintain ideal current ratio, it is still in a position to meet
its current obligations. After clearing all the dues the firm is still in a position to maintain
liquidity.

b) Acid test or quick ratioIt is a measure of liquidity calculated dividing current assets minus inventory
and prepaid expenses by current liabilities. Since inventories among current assets are not quite

liquid (means not quickly converted into cash), the quick ratio excludes it. The quick ratio
includes only assets, which can be readily converted into cash and constitutes a better test of
liquidity. It is often called as quick quick ratio because it is a measurement of a firms ability to
convert its assets quickly into cash in order to meet its current liabilities.

Particulars

2004

2005

2006

2007

2008

Quick assets

60.47

67.65

75.28

87.47

99.9

Current liabilities

144.32

127.66

121.59

96.05

80.09

Current ratio

0.534

0.53

0.62

0.911

1.247

InterpretationAcid test ratio is a rigorous measure of firms ability to service short term liabilities. The
usefulness of the ratio lies in the fact that it is widely accepted as the best available test of
liquidity position of a firm. Generally an acid test ratio of 1:1 is considered satisfactory as a firm

can easily meet all its current claims. In the case of the above firm the quick ratio is in increasing
trend by year on. So it shows that firm is capable of paying its quick short term obligations

2. Capital structure ratio


The long-term lenders/creditors would judge the soundness of a firm on the basis of the long
term financial strength measured in terms of its ability to pay the interest regularly as well as
repay the installment of the principal on due dates or in one lump sum at the time of maturity.
The long term solvency of firm can be examined by using leverage or capital structure ratios.
The leverage or capital structure ratios may be defined as financial ratios which throw light on
the long term solvency of a firm as reflected in its ability to assure the long term lenders with
regard to (i) periodic payment of interest during the period of the loan and (ii) repayment of the
principal on maturity or in predetermined installments at due dates.
a) Debt equity ratio- This ratio measures the long term or total debt to shareholders
equity. This ratio reflects claims of creditors and shareholders against the assets of
the firm. Debt Equity Ratio is given by:
Long term debt
Debt Equity Ratio =
Shareholders equity

Particulars

2004

2005

2006

2007

2008

Debt

82.00

61.50

41.00

20.05

0.00

Equity(Promoter contribution)

56.38

54.07

56.88

68.94

84.49

Debt equity ratio

1.454

1.14

0.721

0.291

0.00

InterpretationThe debt equity ratio is an important tool of financial analysis to appraise the financial structure
of the firm. The ratio reflects the relative contribution of creditors and owners of the business in
its financing. A high ratio shows a large share of financing by the creditors of the firm; a low
ratio implies the a smaller claim of the creditors. Debt Equity ratio indicates the margin of
safety to the creditors. The debt-equity ratio is in decreasing and in 2008 it become nil, which
implies that the owners are putting up relatively more money of their own.

3. Profitability ratios related to salesThese ratios are based on the premise that a firm should earn sufficient profit on each rupee of
sales. If adequate profits are not earned on sales, there will be difficulty in meeting the operating
expenses and no returns will be available to the owners.
A. Net profit margin-

It is also known as net margin. This measures the relationship between the net profits and
sales of a firm. Depending on the concept of net profit employed. , this ratio can be computed
as followsEarnings after tax
100

Net Profit ratio =


Net sales

Particulars

2004

2005

2006

2007

2008

Earnings after tax

10.68

17.82

27.05

35.56

43.75

Net sales

265.49

292.04

321.24

353.36

388.7

Net profit margin

4.023%

6.102%

8.420%

10.06%

11.25%

Interpretation
The net profit margin is indicative of managements ability to operate the business with sufficient
success not only to recover from revenues of the period, the cost of services, the operating
expenses and the cost of borrowed funds, but also to leave a margin of reasonable compensation
to the owners for providing their capital at risk. A high profit margin would ensure the adequate
return to the owners as well as enable the firm to withstand adverse economic conditions. A low
net profit margin has the opposite implications. With respect to the above firm the net profit
margin is increasing trend so it will show that the company is in good condition and the demand
for the product is increasing.

4 . Profitability ratios related to InvestmentsReturn on InvestmentsReturn on investments measures the overall effectiveness of management in generating
profits with its available assets. There are three different concepts of investments in financial

literature: assets, capital employed and shareholders equity. Based on each of them, there are
three broad categories of ROIs. They are
I. Return on assets,
II. Return on total capital employed.

Return on assetsThe profitability ratio is measured in terms of relationship between net profits and assets. The
ROA may also be called profit-to-asset ratio. It can be computed as followsNet profit after tax
100

Return on Assets =
Average total assets
Particulars

2004

2005

2006

2007

2008

Earnings after tax

10.68

17.82

27.05

35.56

43.75

Average total assets

208.39

199.54

195.9

200.54

208.34

ROA

5.125%

8.93%

13.81%

17.73%

20.99%

InterpretationReturn on assets employed is favorable. That means the firm is in a position to employ its assets
in an efficient manner.

Return on Capital EmployedIt is similar to ROI except in one respect. Here the profits are related to the total capital
employed. The term capital employed refers to long term funds supplied by the lenders and
owners of the firm. It is given by the formulaEBIT
100

Return on Capital employed =


Average total capital employed
Particulars

2004

2005

2006

2007

2008

34.82

42.24

52.66

62.04

70.99

total capital employed

203.39

199.54

195.90

200.54

208.34

ROCE

17.2%

21.16%

28.92%

30.9%

34.07%

EBIT

Interpretation:The capital employed basis provides a test of profitability related to the source of long term
funds. The higher the ratio, the more efficient is the use of capital employed. From the above
table we can say that the ROCE is quite high. Compared to previous years ratio. It is good for the
company.

Repayment Period and debt service coverage


A) Projections of performance and profitability

particulars

2004

2005

2006

2007

2008

A) Sales

300.00

330.00

363.00

399.30

439.23

Less: Excise

34.51

37.96

41.76

45.94

50.53

Net sales

265.49

292.04

321.24

353.36

388.70

1.Raw material consumed

185.84

204.42

224.87

247.35

272.09

2.Power & Fuel

6.00

6.60

7.26

7.99

8.78

3.Direct labor & wages

12.24

13.46

14.81

16.29

17.92

4.consumable stores

0.60

0.66

0.73

0.80

0.88

5.Repair & Maintenance

1.20

1.32

1.65

2.48

3.47

6.Othermanufacturingexpences

0.72

0.79

1.11

1.55

2.17

7.Depreciation

24.97

19.10

14.66

11.30

8.75

8.Preliminary expenses w/off

2.40

2.40

2.40

2.40

2.40

Total Cost of Production

233.47

248.76

267.49

290.16

316.46

Add: Opening stock

0.00

4.50

4.78

5.14

5.58

Less: Closing Stock

4.50

4.78

5.14

5.58

6.09

D)Cost of goods sold

229.47

248.78

267.13

289.72

315.96

E) Gross Profit (B-D)

36.02

43.56

54.11

63.64

72.74

1) Term Loan

12.80

10.03

7.26

4.50

1.73

2) Working Captial

6.75

6.75

6.75

6.75

6.75

Total

19.55

16.78

14.01

11.25

8.48

1.20

1.32

1.45

1.60

1.76

B) cost of Production

F) Interest on

G) Selling, administration Exp

H)Profit

Before

Taxation(E- 15.27

25.45

38.65

50.80

62.51

(F+G))
I) Provision for Taxation

4.58

7.64

11.59

15.24

18.75

J) Profit after tax (H-I)

10.69

17.82

27.05

35.56

43.75

K) Depreciation

24.97

19.10

14.66

11.30

8.75

L) Net Cash accruals( J+K)

35.66

36.92

41.72

46.86

52.5

2004

2005

2006

2007

2008

1.Net profit before interest and tax

34.82

42.24

52.66

62.04

70.99

2. Depreciation

24.97

19.10

14.66

11.30

8.75

3.Promoters capital

51.38

4.own contribution towards

5.00

5.term loan

102.50

6.working capital loan

50.00

7.Sundry creditior

7.74

0.77

0.85

0.94

1.03

8.Amortisationofpreliminaryexpences

2.40

2.40

2.40

2.40

2.40

Total:

278.8

64.52

70.58

76.68

83.17

B) Projected Cash Flow Statement


SL.NO

Particulars

A)

Sources of funds

B)

Application of funds
1. Buldings

25.00

2. Land

22.00

3.Macinary

83.38

4.Electrification

6.50

5.Electricity Deposit

5.00

6.Preliminary Expenditure
6. Increase in receivables

44.25

4.42

4.87

5.35

5.89

7.incerase in stock of material

30.97

3.10

3.41

3.75

4.12

9.increase in stock of finished goods

4.50

0.28

0.36

0.44

0.51

10.Drawing/ Dividend

3.00

10.00

15.00

15.00

20.00

11.interest on loans

19.55

16.78

14.01

11.25

8.48

12.income tax

0.00

4.58

7.64

11.59

15.24

13.Repayment of term loans

20.5

20.5

20.5

20.5

20.5

Total

276.65

59.67

65.79

67.88

74.74

Surplus/deficit

2.15

4.85

4.79

8.80

8.43

Opening Balance

0.00

2,15

7.00

11.80

20.6

Add: surplus/ deficit

2.15

4.85

4.79

8.80

8.43

Closing Balance

2.15

7.00

11.80

20.6

29.03

Projectd Balance Sheet


SL.NO

Particulars

Captial & Liability


Promoter captial

2004

2005

2006

2007

2008

0.00

64.07

71.88

83.94

104.49

Less

Own contribution

56.38

0.00

0.00

0.00

0.00

Drawings

3,00

10.00

15.00

15.00

20.00

Equity

53.38

54.07

56.88

68,94

84.49

Retained Earning

10.69

17.82

27.05

35.56

43.75

64.07

71.88

83.94

104.49

128.25

Term loan(Debt)

82.00

61.50

41.00

20.50

0.00

Sundry creditors

7.74

8.52

9.37

10.31

11.34

Working Captial loan

50.00

50.00

50.00

50.00

50.00

Provision for tax

4.58

7.64

11.59

15.24

18.75

Grand Total

203.39

199.54

195.90

200.54

208.34

Fixed assets

89.91

70.81

56.14

44.84

36.09

land

22.00

22.00

22.00

22.00

22.00

Electricity deposit

5.00

5.00

5.00

5.00

5.00

Cash & Bank Balances

2.15

7.00

11.80

20.6

29.03

Receivables

44.25

48.67

53.54

58.89

64.78

Stock of material

30.97

34.07

37.48

41.23

45.35

Stock of finished goods

4.50

4.78

5.14

5.58

6.09

Preliminary expences not w/off

9.60

7.20

4.80

2.40

0.00

Grand Total

208.39

199.54

195.9

200.54

208.34

Assets:

Debt Service Coverage Ratio:(DSCR)

It is considered a more comprehensive and apt measure to compute debt service capacity of firm.
It provides the value in terms of the number of times the total debt service obligations consisting
of interest and repayment of principal in installments are covered by the operating funds
available after the payment of tax : earnings after taxes, EAT+interest+Depreciation+Other non
cash expenditure like amortization.
EAT+interest+Depreciation+Other Non cash expenditure
DSCR

=
Installments

Particulars

2004

2005

2006

2007

2008

Net Cash Accruals

35.66

36.92

41.72

46.86

52.50

Instalment

20.5

20.5

20.5

20.5

20.5

1.74

1.80

2.03

2.29

2.56

DSCR

year

Net profit for the year

Interest on term loan

Repayment of term loan

2004

35.66

19.55

20.5

2005

36.92

16.78

20.5

2006

41.72

14.01

20.5

2007

46.86

11.25

20.5

2008

52.50

8.48

20.5

Interpretation:-

The higher the ratio, the better it is, A ratio of less than one may be taken as a sign of long term
solvency problem as it indicates that the firm does not generate enough cash internally to service
debt. in general, lending financial institution consider 2:1 as satisfactory ratio.
In this project DSCR is in increasing trend it shows that firm is able to meet its debt obligation.

Capital investment evaluation methods


Successful completion of a project mainly depends on the selection criteria adopted while
choosing the project in the initial phases itself and the choice of a project must be based on a
sound financial assessment and not based on impressions. Among the several criteria
available for financial assessment of projects, Discounted Cash Flow (DCF) techniques are being
widely used in both public and private sectors. Usually the basic criterion used in project
appraisal is Internal Rate of Returns (IRR), which is the most popular DCF technique used in the
country. However, in most of the projects of the projects , the actual returns are vastly different
from the expected returns based on IRR, necessitating looking for alternative project appraisal
criteria. Therefore, an attempt is made to analyse other alternative project appraisal methods
available for catering to the requirements of vivid circumstances. Emphasis is given for DCF
techniques as they were proved to be the best techniques for project appraisal all over the world.
1) Pay Back Period (PBP) Method:
Pay back period is the minimum period required to cover the initial cost and a project with
minimum PBP is acceptable in this model. This is a very useful tool to decide rapidly if it is
worth to do a small investment by a local manager and also helps to reduce the risk of bad
choices. But the basic economic principles involved in PBP method are not as reliable as the
other methods like NPV etc. The most important drawback of PWP method is, it is insensitive to
changes in timing with in the payback period and ignores the cash flows beyond the PBP. This
method also lacks a natural bench mark against which comparisons can be made among various
projects. Discounted PBP method gives a more accurate period to cover the initial cost but
doesnt overcome the above drawbacks. However this is a very good method to use in
combination with other methods.

Year

Cash Flows (in lakhs)

Cumulative cash flows

2004

35.66

35.66

2005

36.92

72.58

2006

41.72

114.3

2007

46.86

161.16

2008

52.50

213.66

Total cash outflow


Pay Back Period =
Annual cash inflow
The recovery of the investment is in the 3rd year and 0.64 month.
InterpretationThe Pay back period is a measure of liquidity of investments rather than their profitability.
Since the period within which the total cost of the period is less than the completion period, the
project can be accepted. It means that the firm will be able to pay the dues out of their inflows.
Therefore the project is said to be feasible.

2. Average Rate of ReturnThe average rate of return (ARR) method of evaluating proposed capital expenditure is also
known as the accounting rate of return method. It is also known as Return on Investment, as it
uses the information revealed by financial statements, to measure the profitability of an
investment. The accounting rate of return can be found out by dividing the average after-tax
profit by the average investment. It is given by the formula-

Average annual profit after tax


Average rate of return =

* 100
Average investment
213.66/ 5

Average rate of return =

* 100
152.5/ 2

42.732
Average rate of return =

* 100
76.25

Average rate of return =

56.04%.

InterpretationHere the ARR is more consistent as the ARR is quite higher ( more than average) and the project
can be accepted.

3. Net Present valueIt is calculated by discounting the future cash flows of the project to the present value with the
required rate of return to finance the cost of capital. A project is acceptable if the capital value of
the project is less than or equal to the net present value of cash flows over the operating life cycle
of the project. This method is highly useful when selection has to be made among many projects,
which are mutually exclusive, and there are no budgetary constraints. Selection of projects with
the largest positive NPV will yield highest returns. But this method is useful only to determine
whether a project is acceptable or not but doesnt indicate which project is best under budgetary
constraints. It is difficult to rank different compatible projects with NPV as there is no account
for scale of investment while calculating NPV.

Year

Cash Flows(lakhs)

PV factor @10%

Total present value

35.66

0.909

32.414

36.92

0.826

30.495

41.72

0.751

31.290

46.86

0.683

32.005

52.50

0.621

32.603

Total PV

Less- Initial outlay


Net Present Value
Interpretation-

158.807
152.5

6.307

The acceptance rule using NPV method is to accept the investment proposal if its net present
value is positive (NPV > 0) and to reject it if the NPV is negative (NPV<0). Positive NPVs
contribute to the net wealth of the shareholders which should result in the increased price of a
firms share. The positive net present value will result only if the project generates cash inflows
at a rate higher than the opportunity cost of capital . Since the Net Present Value of the above
project is positive, the proposal can be accepted.

4 . Profitability IndexIt is also known as Benefit Cost Ratio. It is similar to NPV approach. The profitability
index approach measures the present value of returns per rupee invested, While the NPV is based
on the difference between the present value of the future cash inflows and the present value of
cash outlays. It may be defined as the ratio which is obtained dividing the present value of cash
inflows by the present value of cash outlays. It is given by the formula:
Present value of cash inflows
Profitabillity Index =
Present value of cash outflows
158.807
Profitabillity Index =
152.5
Profitability Index =

1.041

InterpretationUsing the profitability index, a project will qualify for acceptance if its PI exceeds one (PI>1).
When PI is greater than or equal to or less than 1, the net present value is greater than or equal to
or less than zero respectively. Since the Profitability Index of the above project shows the PI
greater than 1 and hence the project should be accepted.

5. Internal Rate of ReturnIt is the rate of return at which the Net Present Value (NPV) of a project becomes zero. A project
is acceptable if the IRR exceeds the cost of capital. It is possible to rank various compatible
projects with IRR method and a project with highest IRR can be selected. However, this method
is not useful when selection has to be made among mutually exclusive projects. This method
assumes that the net cash flows from a project are first negative and then positive for the rest of
the project life and vice versa. But this condition is not always fulfilled resulting in multiple
IRRs for the same project. Due to ambiguous results, project selection becomes difficult. Further,
selection of a project based on highest IRR alone, without taking project specific risk factors into
consideration, may be often misleading.

Year

Cash flows

Weights

Weighted average
CFs

35.66

178.3

36.92

147.68

41.72

125.16

46.86

93.72

52.50

52.5

15

597.36

Total
597.36
Weighted Average Cost

=
15
=

39.824
Initial Investment

Pay Back Period

=
Weighted average cost

152.5
Pay Back Period

=
39.824

Pay back period

3.8 years

A)
Year

CashFlows(lakhs)

PV factor @10%

present value

35.66

0.909

32.414

36.92

0.826

30.495

41.72

0.751

31.290

46.86

0.683

32.005

5Year
1
Total PV

52.50flows
Cash
35.66

0.621
PV factor @ 12% 32.603
Present value
0.893
31.84
158.807

2
Less- Initial outlay

36.92

0.797

3
Net Present Value

41.72
-

0.712

46.86

0.636

29.80

52.50

0.567

29.76

29.43
152.5
29.70
6.307

Total PV

150.53

Less- Initial outlay

152.53

Net Present Value

-1.97

A
Internal rate of return =

L+

{H-L}

A- B
6.307
Internal rate of return =

(12-10)

10 +
6.307-1.97
6.307

B)

Internal rate of return =

{2}

10+
4.337

Internal rate of return =

10 + 2.908

Internal rate of return =

12.91%

InterpretationSince the expected rate of return is 10% so the project is said to be accepted.

Measures taken by SBI when the repayment is not possible


1) Firstly they send a notice to the clients stating therein to pay their dues.
2) When there no improvements in the repayments even after the notice being sent then the
bank will forward the legal notice stating the clients to make payments
3) Third is the compromise dealing wherein both the parties sit together and decide what
measures has to be taken which means whether the clients make the payments, or
whether to file a suit or decide to sell the Properties etc..

Analysis:This analysis part is related to the financial viability of the project SL Flow Controls:

Through ratio analysis I analyzed that the liquidity position of the firm is good and it
is maintaining the standard ratio..

Debt Equity ratio is in decreasing trend, it shows that the firm is reducing its liability
portion by paying the loan year on year so the financial risk less.

Profitability ratios related to sales and capital employed are in increasing trend, it
shows that the sales are increasing and the firm using its resources efficiently.

Debt Service Coverage Ratio is also in increasing trend, it shows that the firms ability
to make the loan repayments on time over the debt life of the project.

The payback period is within the debt life of the project.

The net present value of the project is positive, The positive net present value will
result only if the project generates cash inflows at a rate higher than the opportunity
cost of capital . Since the Net Present Value of the above project is positive, the
proposal can be accepted.

The internal rate of the return is higher than what accepted so the project is accepted.