ANALYSIS OF FINANCIAL STATEMENTS

PURPOSES:
• To assess short term liquidity position of a firm.

• Comprehensive assessment of the strength &

weaknesses of the firm in various areas.
• Judgement of excellence of the firm and
creditworthiness.
• To assess the firm’s ability to meet its short and long
term liabilities on due date.
• Overall financial health of the firm.
TOOLS OF ANALYSIS
Financial Ratios
Comparative analysis

Financial Ratios:

It is a study of ratios between various items or groups of

items in financial statements.

BROAD CATEGORY OF RATIOS:

Liquidity Ratio
Leverage
Turn over Ratio
Profitability Ratio
LIQUIDITY RATIOS:

This refers to the ability of a firm to meet its

obligations in the short run, usually one year.

IMPORTANT RATIOS:

1. CURRENT RATIO : It is defined as

__CURRENT ASSETS__
CURRENT LIABILITIES

Measures the ability of the firm to meet its current

liabilities i.e. current assets get converted into cash in
the operating cycle of the firm and provide the funds
to pay current liabilities.
2. Acid Test Ratio (Quick Ratio)

___Quick Assets___
Current Liabilities

Quick assets = Current Assets – Inventories

It is fairly stringent measure of liquidity.

10. Interval Measure

A dynamic measure of liquidity, the interval measure is defined

as :

____________Quick Assets__________
Average daily expenses on operations

This measure shows how long the liquid assets of the firm will
suffice to meet its operating expenses.
LEVERAGE RATIOS:

 Refers to us of debt finance.

 It helps in assessing the risk arising from the use of
debt capital
 Structural Ratio : Proportion of debt/Equity
 Coverage Ratio : Relationship between debt
servicing commitments
and the sources for
meeting these burdens.
A-(1) Debt -Equity Ratio :
shows the relative contributions of creditors and
owners. It is defined as : Debt / Equity
where debt = All liabilities (short & long term)
& Equity = Net worth
Lower the debt/equity ratio, the higher the degree of
protection enjoyed by the creditors.
A-(2) Interest Coverage Ratio :
It is defined as
Earnings before Interest & taxes
Interest
A high interest coverage ratio means that the firm can
easily meet its interest burden even if earnings before
interest and taxes suffer a considerable decline.
A lower interest coverage ratio means financial
embarrassment when earnings decline.
A-(3) DEBT SERVICE COVERAGE RATIO (D.S.C.R)

It shows the firm’s financial capability to service interest and

repayment instalment of term borrowings. It is defined as :
Profit after tax + Depreciation + Interest on term loans
Interest on term loans + Repayment of term loans

It is advisable to calculate the average d.s.c.r. for the period

during the currency of the term loan(s).

A D.S.C.R. of 1.5 to 2.0 is considered as satisfactory.

TURN OVER RATIOS:
Referred to activity ratios or assets management ratios.

Measures how efficiently the assets are employed by a

firm.
1. INVENTORY TURNOVER

 Measures how fast the inventory is moving

through the firm and generating sales. It is
defined as :

Cost of goods sold

Average Inventory

It reflects the efficiency of inventory

management. The higher the ratio, the more
efficient the management of inventories and vice
versa.
1. Working Capital Turnover Ratio :

 Measures efficiency of working capital

management

 Improve profitability by turning over working

capital faster.

It is defined as :

________Sales Turnover_______
Total working capital employed
Obviously, the higher the ratio, the greater the efficiency of
working capital management.
1. Average Collection Period:
 Represents the number of days’ worth of credit sales that is
locked in debtors (accounts receivables). It is defined as:
Average accounts receivables
Average daily credit sales
The average collection period may be compared with the firm’s
credit terms to judge the efficiency of credit management.
An average collection period which is shorter than the credit
period allowed by the firm needs to be interpreted carefully. It
may mean efficiency of credit management or excessive
conservatism.
PROFITABILITY RATIOS
 Reflects the final result of business operations.
Twotypes of ratios :
(1) profit margin ratios
(2) Rate of return ratios
(1) – (i) GROSS PROFIT MARGIN RATIO:
It is defined as
Gross Profit
Net Sales
(G.P. = Net Sales – Cost of goods sold)
This ratio shows the margin left after meeting manufacturing
costs. It measures the efficiency of production as well as
pricing.
(1) – (ii) NET PROFIT MARGIN RATIO:
Net Profit
Net Sales
This ratio shows the earnings left for shareholders as a
percentage of net sales. It measures the overall
efficiency of production, administration, selling,
financing, pricing and tax management.

(2) Rate of return Ratios:

(2) – (i) Return on assets :

It is defined as :

Net Income (profit)

Average total assets

It measures the efficiency of employment of capital.

(2) – (ii) Earning power

A measure of operating profitability, it

is defined as :

Earning before interest and taxes

Average total assets
 BALANCE SHEET AS ON 31.03.1998 OF ABC & CO. LTD.
LIABILITIES 1998 1997 ASSETS 1998 1997
Share Capital 15.00 15.50 Fixed Assets(Net) 33.00 32.20
Equity 15.00 15.00 Gross Block 59.00 46.20
Preference -- -- Acc. Depr’n 26.00 14.00
Reserves & Surplus 11.20 10.60 Investments 1.00 1.00
Secured Loans 14.30 13.10 Current Assets, loans & 23.40 15.60
advances
Term Loans 7.00 5.80 Cash & Bank 1.00 0.60
Cash Credits 7.30 7.30 Debtors 11.40 6.80
Unsecured Loans 6.90 2.50 Inventories 10.50 7.20
Bank Credit 2.50 2.50 Pre-paid exp. 0.50 1.00
Inter-Corporate 4.40 -- Misc. Expenditures & 0.50 0.50
losses
Current Liabilities & 10.50 8.10
Provisions
57.90 49.30 57.90 49.30
 PROFIT & LOSS ACCOUNT FOR THE YEAR 1997-98
OF M/S ABC & CO. LTD.
1997-98 1996-97
Net Sales 70.10 62.30
Cost of goods sold 55.20 47.50
Stocks 42.10 37.00
Wages & Salaries 6.80 5.50
Other Mfg. Expenses 6.30 5.00
Gross Profit 14.90 14.80
Operating Expenses 5.60 4.90
Depreciation 3.00 2.60
General Administration 1.20 1.10
Selling 1.40 1.20
Operating Profit 9.30 9.90
contd…
 PROFIT & LOSS ACCOUNT FOR THE YEAR 1997-98
OF M/S ABC & CO. LTD. (Contd.)
Non-operating surplus/deficit (0.40) 0.60
Earning before interest and tax 8.90 10.50
Interest 2.10 2.20
Profit before tax 6.80 8.30
Tax 3.50 4.10
Profit after tax 3.30 4.20
Dividends 2.70 2.70
Retained Earnings 0.60 1.50
Per share data (in Rupees)
Earnings per share 2.20 2.80
Dividend per share 1.80 1.80
Market price per share 21.00 20.00
 COMPARISION OF RATIOS OF M/S ABC & CO. LTD.
with Industry Average
RATIO FORMULA ABC INDUSTRY
LTD. AVERAGE
LIQUIDITY

CURRENT RATIO CURRENT ASSETS 1.34 1.26

CURRENT LIABILITIES

ACID TEST RATIO QUICK ASSETS 0.74 0.69

CURRENT LIABILITIES

INTERVAL MEASURE QUICK ASSETS 81 days 75 days

Average daily oper. Expenses

contd…
 COMPARISION OF RATIOS OF M/S ABC & CO. LTD.
with Industry Average
RATIO FORMULA ABC INDUSTRY
LTD. AVERAGE
LEVERAGE

DEBT EQUITY DEBT 1.21 1.25

RATIO EQUITY

INTEREST EBIT 4.23 4.14

COVERAGE INTEREST

D.S.C.R PAT + Dep. + Interest on Term loans 3.31 5.96

Int. on term loans + Repayment of T/L

contd…
 COMPARISION OF RATIOS OF M/S ABC & CO. LTD.
with Industry Average
RATIO FORMULA ABC INDUSTRY
LTD. AVERAGE
TURN OVER RATIO

INVENTORY TURNOVER Cost of goods sold 6.24 6.43

Average Inventory

WORKING CAPITAL T/O Sales Turnover 2.83 3.48

W/L employed

AVERAGE COLLECTION Average a/c receivables 47 days 45.2 days

RATIO Average daily credit sales

contd…
 COMPARISION OF RATIOS OF M/S ABC & CO. LTD.
with Industry Average
RATIO FORMULA ABC INDUSTRY
LTD. AVERAGE
PROFITABILITY RATIO
21.00% 18.00%
GROSS PROFIT MARGIN Gross Profit
RATIO
Net Sales

NET PROFIT MARGIN Net Profit 4.70% 4.00%

RATIO
Net Sales

RETURN ON ASSETS Net Income (Profit) 6.20% 5.90%

Average total assets

EARNING POWER EBIT 16.60% 15.50%

Average total sales
 OVERVIEW OF FINANCIAL MANAGEMENT

FINANCIAL
MANAGEMENT

MAXIMIZATION
OF SHARE VALUE

FINANCIAL
DECISIONS

CAPITAL DIVIDEND
BUDGETING DECISIONS
DECISIONS CURRENT
ASSETS FINANCING
MANAGEMENT DECISIONS

RETURN TRADE OFF RISK

ACTIVITIES OF BUSINESS

FINANCE
PRODUCTION
MARKETING

A firm secures capital and employs it business/

manufacturing activities (FINANCE) which generate
returns on invested capital (PRODUCTION) by selling
products/services. (MARKETING)

BUSINESS ACTIVITIES

ACQUISITION OF REAL ASSETS

TANGIBLE INTANGIBLE
 BALANCE SHEET

It indicates the financial condition or the state of affairs of a

business at a particular moment of time.

In the language of accounting, balance sheet communicates

information about assets, liabilities and owner’s equity for a
business firm as on a specific date.

“It provides a snapshot of the financial position of the

firm at the close of the firm’s accounting period.”

ASSETS
•Represents economic resources
•Valuable possessions owned by the firm
•should be capable of being measured in monetary terms
TANGIBLE ASSETS
•PLANT & MACHINERY

•OFFICE

•FACTORY PREMISES
•BUILDING

•FURNITURE/FIXTURES

INTANGIBLE ASSETS
•TECHNICAL KNOW HOW

•TECHNOLOGICAL COLLABORATION
•PATENTS AND COPYRIGHTS

•GOODWILL
•CAPITAL EXPENDITURE
OR
INVESTMENT
IS
APPLICATION FUNDS
•RETURN ON INVESTMENT BY EMPLOYING
FUNDS FOR BUSINESS / MANUFACTURING
ACTIVITY
•DISTRIBUTION OF RETURNS TO INVESTOR
THESE PROCESSES OF RAISING FUNDS,
INVESTING THEM IN ASSETS AND DISTRIBUTING
RETURNS IS KNOWN AS FINANCING,
INVESTMENT & DIVIDEND DECISIONS
 FORMS OF BALANCE SHEET

C. HORIZONTAL FORM

LIABILITIES ASSETS
* Share Capital * Fixed Assets
* Reserves & Surplus * Investments
* Secured Loans * Current Assets,
* Unsecured Loans loans & advances
* Current Liabilities * Miscellaneous
& Provisions expenditure

contd…
 B. VERTICAL FORM

1. Sources of Funds
(a) Shareholders’ funds – Share Capital

(b) Reserves & Surplus

(c) Secured Loans

(d) Unsecured Loans

contd…
2. Application of Funds
(a) Fixed Assets

(b) Investments

(c) Current Assets & Advances

Less : Current liabilities & provisions
(Net Current Assets)

(d) Miscellaneous Expenditure

 Balance Sheet & Finance Topics
3. Share Capital Capital Structure
* Equity & Cost of Capital
* Preference
Reserves / Surplus
Secured Loans
* Debentures
* Loans/ Advances
2. Unsecured Loans Working Capital
Current Liabilities financing policy
* Trade Creditors
* Provisions
16. Fixed Assets Capital Budgeting
18. Investments Security Analysis
5. Current Assets
* Cash & Bank Cash Management
* Receivables Credit Management
* Inventories Inventory Management
 BALANCE SHEET OF ABC LTD.
AS ON 31.3.1997
(Rs. in million)
LIABILITIES 1997 1996 ASSETS 1997 1996
Share Capital 15.00 15.00 Fixed Assets 33.00 32.20
Reserves & Surplus 11.20 10.60 Investments 1.00 1.00

Secured Loans 14.30 13.10 Current Assets, 23.40 15.60

Loan & advances
Unsecured Loans 6.90 2.50 Miscellaneous 0.50 0.50
Expenditures
Current Liabilities & 10.50 8.10
Provisions
57.90 49.30 57.90 49.30

contd…
 Profit and Loss Account
It is a financial result of a firm from operations.

It highlights the following :

Net Sales
Cost of goods sold
Gross Profit
Operating expenses
 Non operating surplus / deficit
Profit before interest & tax (PBIT)
Interest
Profit before tax (PBT)
Tax
Profit after tax (PAT)
 Profit and Loss Account & Finance Topics
• Net Sales Revenue Risk
• Cost of goods sold
- Stocks
- Wages & Salaries
- Other manufacturing expenses
• Gross Profit Gross profit margin
• Operating expenses
- Selling & Admn. Exp.
• Depreciation Depreciation policy
• Operating profit
• EBIT Business Risk
• Interest Financial Risk
• PBT
• Tax Tax planning
• PAT Return on Equity
• Dividends Dividend Policy
• Retained Earnings
 PROFIT & LOSS ACCOUNT OF
M/S ABC LTD. (AS ON 31.3.1997)
(Rs. in million)
Income
Sales 70.10
Other Income (Loss) 0.40
69.70
Expenditure
Material etc. 57.80
Interest 2.10
Depreciation 3.00
PBT 6.80
Provision for tax 3.50
PAT 3.30
Appropriations
Dividend 2.70
Reserve 0.60
Surplus carried to balance sheet ----
 Fixed & Variable Costs

Fixed Costs remain constant during a certain period and

arencurred irrespective of production level.

Examples : Salaries, Rent, Depreciation, Interest on Term loan

etc.

Variable Costs increase or decrease according to a rise or fall in

the production level proportionately.

Examples : Raw Materials, Piece rate contract labour, Carriage

inwards, Power & Fuel etc.

Semi-variable costs may increase or decrease in sympathy but not

in proportion with production levels.

Examples : Incentive, bonus.

BREAK EVEN ANALYSIS

Break even level is the level of operation at which the unit neither
makes a profit nor loses money.
REVENUES
PROFIT TOTAL COSTS
BREAK EVEN POINT

VARIABLE COSTS
FIXED COSTS

LOSS

UNITS
contd…
Sales – total variable cost = contribution.

Contribution – total fixed cost = profit earned.

Break even value = Fixed costs

Contribution ratio

B.E. Quantity = Fixed costs

Contribution per unit

Contribution ratio = Sales – Variable cost

Sales
 BREAK EVEN ANALYSIS
EXERCISE
• Installed Capacity : 900 MT
• Capacity Utilization : 70%
• Sales Turnover : 144.40
• Cost of Production : (Rs. in lacs)
i) Raw Materials - 59.01
ii) Packing Materials - 26.87
iii) Power - 0.95
iv) Fuel - 1.51
v) Salary & Wages - 7.95
vi) Repairs & Maintenance - 1.21
vii) Rent & Taxes - 0.75
viii)Stores & spares - 1.18
ix) Admn. Expenses - 3.03
x) Selling Expenses - 25.09
xi) Interest on long term borrowing - 2.65
xii) Working Capital - 2.42
xiii)Depreciation - 2.22
TOTAL - 135.74
contd…
 e) Profit Before Tax : 0.66

Assumptions – Variable costs & Fixed cost in respect of following

components of cost are 80% & 20% and 60% & 40%
respectively.

i) Power, Fuel, Salary & Wages, Repairs & Maintenance,

Selling Expenses.
ii) Stores & spares.

CALCULATE :

• Contribution per Unit

• Break Even Quantity
• Break Even Sales
• Break Even Point
• Cash Break Even
 BREAK-EVEN EXERCISE – S0LUTION
A.VARIABLE COSTS : B. SEMI-VARIABLE COSTS :

GROUP - I :
i) Raw Materials - 59.01 i) Power - 0.98
• Packing Material - 26.87 ii) Fuel - 1.51
• Group I - 30.09* iii) Salary & Wages - 7.95
• Group II - 0.71@ iv) Repairs - 1.21
116.68 v) Selling expenses - 25.99
37.61
C. FIXED COSTS :
• Rents & Taxes - 0.75 Variable portion - 30.09*
• Admn. Expenses - 3.03 Fixed portion - 7.52*
• Intt. On LT Borr. - 2.65
• Intt. on W.C. - 2.42 GROUP – II :
• Depreciation - 2.22 i) Stores & spares - 1.18
• Group I - 7.52* Variable Portion - 0.71@
• Group II - 0.47# Fixed Portion - 0.47 #
19.06
contd..
A. Total Sales : 14440000
B. Sales in tons : 630
C. Selling Price per ton : 22921
D. Variable Cost per ton : 18520

• Contribution per ton 4401

• Break Even Sales (Nos.) –
Fixed Cost / Cont. per ton 433.21
9. Break Even Sales (in Rs.) –
Break Even Sales (Nos.) x SP per unit 9929453
• Break Even Point (in %) 68.76%
• Cash Break Even –
Fixed Cost – Depreciation x Sales 8773169.8168
Total contribution
 CASH BUDGET
All payments made constitute outflows of funds and the receipts
are inflows of cash
Inflows and outflows of funds (cash) determine the availability of
cash i.e. liquidity.
Objective of cash budget is to ensure the availability of cash to
meet anticipated payments, but also the unexpected ones.
The mechanism of cash budget consists of controlling the inflows
and outflows of cash.
Cash and receivables form quick assets of a unit. It is only asset
with which a unit can make payments and the receipts of a unit are
also usually in the form of cash
In order to effectively control the inflows and outflows of cash
there should be cash forecasts. (both long term and short term basis).
A UNIT’S SHORT TERM CASH FORECAST IS THE CASH
BUDGET AND LONG TERM FORECAST IS THE FUNDS
FLOW ESTIMATE

A cash budget is a written statement of a unit’s :

(vii)Expected sources amounts and time of cash inflows :
(viii)Expected sources amounts and time of cash outflows :
(ix) The expected cash balances at various dates.

PREPARATION OF A CASH BUDGET PRE-REQUISITES:

xiii)Sales forecasts Inflows of
xiv)Credit Plans cash
xv) Production Plan Outflows of
xvi)Inventory budget cash
xvii)Expenses budget : Wages, power, taxes etc.
xviii)Capital budget : Details of long term Inflow/Outflow
 TYPICAL PROFORMA OF CASH BUDGET
Receipts (Rs.)

Month I II III IV V VI

Sales

Additional Capital
from sale of Fixed assets

Misc. Receipts.
Total Receipts :
Disbursements (Rs.)
Purchases
Payments
Advances
Labour
Other factory expenses
Admn. & Selling exp.
Taxes
Payment for purchase
of fixed assets

Total Disbursements :
TOTAL RECEIPTS
TOTAL PAYMENTS
SURPLUS/DEFICIT
(-/+)
OPENING BALANCE
IN C.C. ACCOUNT
CLOSING BALANCE
(-/+)
TO SUM UP, THE CASH BUDGET –

• INDICATES PROBABLE CASH POSITIONS AS A RESULT

OF PLANNED OPERATIONS

• INDICATES CASH EXCESSES OR SHORTAGES AND

THUS NEED FOR ADDITIONAL FUNDS OR
BORROWINGS

• MAKES PROVISION FOR THE CO-ORDINATION OF

CASH IN RELATION TO

(a) TOTAL WORKING CAPITAL

(b) SALES
(c) INVESTMENTS
(d) DEBT
 CASH BUDGET CAN BE A SOUND BASIS FOR THE
CONTROL OF INFLOWS AND OUTFLOWS OF CASH.

 ANY MAJOR DEVIATION CAN BE TRACED AND

CORRECTIVE ACTION BE INITIATED.

SUCH AS

 INCREASED EFFORTS TO COLLECT RECEIVABLES

 REDUCTION OF EXPENSES

 DEFERMENT OF CAPITAL EXPENDITURE

 DEFERMENT OF SELECTED PAYMENTS

 REDUCTION OF PURCHASES
 CASE STUDY
CASH BUDGET
ANAND INDUSTRIES
The proprietor of Anand Industries is having current account with
your bank. His concern is engaged in the manufacture of furniture
and is having good sales. He has purchased machinery worth Rs.1
lac on 31st March 1977 on deferred payment basis. Instalments are
payable from April 1978 at the rate of Rs.25,000 per quarter. For
working capital requirements he has collected deposits amounting
Rs.1 lac from his relatives and friends on which he has agreed to
pay 16% interest in the month of June every year. Despite utilising
these funds in the business and having good sales, the proprietor is
worried about the repayment of instalments of Rs.25,000 in April
1978. He wants an overdraft. He has furnished projections
regarding purchases, sales etc. (Vide Annexure).
contd…
ASSIGNMENT

3. You are required to prepare a cash budget for a period

from April to December 1978 on the basis of the
information furnished and to indicate the overdraft
limit which you would like to fix and for what period.
Critically examine the figures and give your comments.
 ANNEXURE
(Amount in Rs.)
1978 SALES PURCHASES WAGES OTHER EXPENSES
January 80,000 40,000 15,000 4,000
February 1,00,000 60,000 20,000 5,000
March 1,20,000 80,000 24,000 6,000
April 1,40,000 70,000 25,000 4,000
May 1,00,000 60,000 24,000 5,000
June 60,000 40,000 15,000 4,500
July 70,000 30,000 16,000 5,500
August 80,000 30,000 18,000 5,000
September 60,000 40,000 16,000 4,000
October 1,00,000 50,000 22,000 6,000
November 1,20,000 60,000 24,000 7,000
December 1,30,000 70,000 25,000 8,500
11,60,000 6,30,000 2,44,000 64,500
contd…
Additional Information
• 40% sales are on cash basis and 2 months credit is allowed
for the credit sales.
• Creditors are paid after one month.
• Income tax advance payments are to be made at Rs.3,000
in March, June, September and December.
• Sales Tax (5% on the basis of monthly sales) is t o be paid
every month.
• Wages are kept in arrears for 15 days. Besides wages, an
ex-gratia payment of Rs.5,000 is to be made in the month
of May.
• Monthly rent is Rs.2,000/-.
• Other expenses are kept one month in arrears.
• Closing cash balance as on 31st March 1978 is expected to
be Rs.10,000/-.
 CASH BUDGET OF ANAND INDUSTRIES
MONTH APRIL MAY JUNE JULY AUGUST
Receipts
Sales 1,40,000 1,00,000 60,000 70,000 80,000
Collections Cash 56,000 40,000 24,000 28,000 32,000
Credit Collections 60,000 72,000 84,000 60,000 36,000
Total Receipts 1,16,000 1,12,000 1,04,000 88,000 68,000
Disbursements
Purchases 70,000 60,000 40,000 30,000 30,000
Payments 80,000 70,000 60,000 40,000 30,000
Advances – Income Tax 30,000
Sales Tax 7,000 5,000 3,000 3,500 4,000
Inst. of Term Loan 25,000 25,000
Int. on Deposits 16,000
Labour 24,000 25,000 24,000 15,000 16,000
Ex-Gratia payment 5,000
Rent 2,000 2,000 2,000 2,000 2,000
Other expenses 6,000 4,000 5,000 4,500 5,500
Total payments 1,44,000 1,11,000 1,13,000 90,000 57,500
Surplus / Deficit (-) 28,000 (+) 1,000 (-) 9,000 (-) 2,000 (+) 10,500
 CASH BUDGET OF ANAND INDUSTRIES (Contd.)
MONTH SEPTEMBER OCTOBER NOVEMBER DECEMBER
Receipts
Sales 60,000 1,00,000 1,20,000 1,30,000
Collections Cash 24,000 40,000 48,000 52,000
Credit Collections 42,000 48,000 36,000 60,000
Total Receipts 66,000 88,000 84,000 1,12,000
Disbursements
Purchases 40,000 50,000 60,000 70,000
Payments 30,000 40,000 50,000 60,000
Advances – Income Tax 3,000 3,000
Sales Tax 3,000 5,000 6,000 6,500
Inst. of Term Loan 25,000
Int. on Deposits
Labour 18,000 16,000 22,000 24,000
Ex-Gratia payment
Rent 2,000 2,000 2,000 2,000
Other expenses 5,000 4,000 6,000 7,000
Total payments 61,000 92,000 86,000 1,02,500
Surplus / Deficit (+) 5,000 (-) 4,000 (-) 2,000 (+) 9,500
BUSINESS PLAN
 A document which provides flesh and blood to
business idea.
AREA OF FOCUS
 Steps or decisions needed to take prior to business
becoming operational
 Expected performance of business.
KEY QUESTIONS
12.Product, Features, Capacity, Uses.
13.Market prospects, selling price and cost of selling
14.Production process and technical arrangement
15.Plant/Machinery, Suppliers & Cost.
contd…
1. Location – Locational Advantages (analysis)
2. Infrastructural Facilities
3. Raw Materials and other requirements
4. Manpower
5. Working Capital
6. Project Cost
7. Means of Finance
8. Capacity Utilization and Income Estimates
9. Expenditure
10.Profit and Tax
11.Risk Analysis
12.Others–Govt.policy/approvals time schedule
What is Planning?
It is a process of arranging various activities to be
undertaken well in advance in systematic and
sequential order so as ensure that the project is
implemented in shortest possible time.

Stages of planning for a small business :

1. Identification of an opportunity and assessing its
market potential
2. Resources Mobilisation
3. Govt. procedures & formalities
4. Establishment
5. Management
Process of planning involves basically the co-
ordination of various resources at the
appropriate time to enable an entrepreneurs
to

1. Proceed systematically & sequentially

without missing important activities/
aspects.

2. Evaluate the resources required.

3. Self-evaluation of a project.
 FACILITIES FOR PRODUCTION
MARKET AND FINANCE
PRODUCTION

LAND & BUILDING

MACHINERY
POWER & WATER ARRANGEMENT
OTHER FIXED ASSETS
INFRASTRUCTURAL FACILITES

COMMUNICATION
TRANSPORT
EFFLUENT TREATMENT
DRAINAGE ETC.

RAW MATERIALS
LABOUR & STAFF
MARKET

GOVT. AGENCIES
EXPORT PROMOTION COUNCILS

FINANCE

NATIONAL LEVEL FINANCIAL INSTITUTES

STATE LEVEL FINANCIAL CORPORATIONS
NATIONALISED, PRIVATE & CO-OP. BANKS
PRIVATE LEASE COMPANIES
PUBLIC-SHARES/DEBENTURES
DEPOSITS
ANCILLARY SUPPORT

GUARANTEES

INSURANCE

RESEARCH–DEVELOPMENT
LABORATORIES

INDUSTRIAL ASSOCIATIONS,
CHAMBERS, CII ETC.
 SUPPORT ORGANISATIONS
NATIONAL LEVEL STATE LEVEL NATIONAL LEVEL STATE LEVEL ANCILLARY
ORGANISATION ORGANISATION FINANCIAL FINANCIAL AGENCIES
ORGANISATION ORGANISATION

1. ALL INDIA SSI 1. DIRECTOR OF 1. IND. DEV. 1. GUJ. STATE 1. EXPORT

BOARD(AISSB) COTTAGE BANK OF FIN. CORPN. CREDIT &
INDUSTRIES INDIA (IDBI) (GSFC) GUARANTEE
CORPN.
(ECGC)
2. SMALL IND. 2. DISTRICT 2. SMALL IND. 2. GUJ. STATE 2. NATIONAL
DEV. ORGAN. INDUSTRIES DEV. BANK OF IND. CORPN. RESEARCH &
(SIDO) CENTRES(DIC) INDIA (SIDBI) (GIIC) DEV. CORPN.
(NRDC)
3. SMALL IND. 3. IND. EXTN. 3. IND. FIN. 3. GUJ. IND. DEV. 3. INDUSTRIES
SER. INST. BUREAU CORP. OF CORPN.(GIDC)
(SISI) (INDEXTb) INDIA (IFCI) ASSOCIATIONS

4. SMALL IND. 4. IND. EXTN. 4. I.C.I.C.I. 4. COMMERCIAL

DEV. CORPN. COTTAGE BANKS
(SIDC) (INDEXT C)
5. NATIONAL
S.I. CORPN.
(NSIC)
 ENTERPRISE

FIXED ASSETS CURRENT ASSETS

FIXED ASSETS:

LAND, BUILDING, PLANT & MACHINERY

FURNITURE & FIXTURES
TECHNICAL KNOW-HOW
TECHNICAL COLLABORATION
SOURCES OF FINANCE

TERM LOAN FROM FINANCIAL CORPORATION &

COMMERCIAL BANKS

HIRE PURCHASE FROM NSIC

LEASE FROM LEASING COMPANIES

EXTERNAL COMMERCIAL BORROWINGS

DEPOSITS FROM N.R.Is.

EQUITY COLLABORATION WITH FOREIGN

COMPANIES

GUARANTEE AGAINST BORROWINGS

(DEFERRED PAYMENT GUARANTEE) {DPG}
CURRENT ASSETS

Raw materials

In-process materials

Finished Goods

Bills receivables

Others

SOURCES OF FINANCING CURRENT ASSETS

(WORKING CAPITAL)
CURRENT LIABILITIES

SHORT TERM LOAN FROM COMMERCIAL

BANKS IN THE FORM OF CASH CREDIT
LIMIT.

LIQUID SURPLUS

DIFFERENCE BETWEEN LONG TERM

LIABILITIES AND FIXED ASSETS IN THE
FORM OF MARGIN.

SINGLE WINDOW SCHEME (SFCs)

PROVIDING WORKING CAPITAL TERM
LOAN (WCTL).
ADVANCES RECEIVED FROM CUSTOMERS

SHORT TERM DEPOSITS

CORPORATE LOAN

CREDIT AVAILABLE FROM FOREIGN SUPPLIERS

ANCILLARY FACILITIES FROM BANKS

LETTER OF CREDIT (INLAND / FOREIGN)

BILLS DISCOUNTING

DEMAND BILLS

USANCE BILLS
D.D. PURCHASE OF CHEQUES

ISSUE OF GUARANTEES

OVERDRAFT AGAINST SECURITIES

SHORT TERM LOANS

SUMMARY OF SUPPORT SYSTEMS

1. ENT.DEV.PRG. (EDP) 1. NATIONAL / STATE
LEVEL INSTITUTES
2. SCHEME FOR FINANCE 2. FINANCIAL
CORPORATION
3. PROCUREMENT OF 3. BANKS
MACHINERY
contd…
4. INFRASTRUCTURE 4. GOVT. CORPORATIONS

5. TECHNICAL 5. CSIR, GPCB, DIC,

ASSISTANCE INDEXTB,
LABORATORIES

6. MARKETING SCHEMES 6. GOVT. AGENCIES

7. RESEARCH & 7. N.R.D.C. & OTHER

DEVELOPMENT RESEARCH LABS

8. INCENTIVE SCHEME / 8. DIC, GOVT. ETC.

CASH SUBSIDY ETC.
 CASE STUDY ON PROJECT PROFIT PROJECTION
OF OPERATING ECONOMICS

Prepared by B.R. Narielwala, Asst. General Manager,

State Bank of India, Ahmedabad LHO.
---------------------------------------------------------------------------------
XYZ Forge is a proposed small scale unit for the
manufacture of various kinds of forgings.
Estimated Sales
Three kinds of forgings are to be manufactured viz. Rough
forgings, head treated forgings and machined forgings.
The total estimated sales of these forgings is expected to
rise from a level of 1000 tons/yr in the first year to 2000
tons/yr in the third year.
contd…
2. The type-wise breakups of sales (in tons) is expected to
be as:

I YEAR II YEAR III YEAR

Rough Forgings 300 400 500
Heat Treated Forgings 500 800 1000
Machined Forgings 200 300 500
1000 1500 2000
3. The sales price per ton of the different types of forgings
would be Rs.25,000/- per ton for rough forgings.
Rs.30,000.00 per ton for Heat treated forgings and
Rs.35,000/- per ton for machined forgings. On the sales at
this price a discount/ commission of 5% is to be paid to
dealers.
Physical Requirements
• Plant for the expected sales level is expected to require
investment in various assets as indicated below :
• Land of total area about one acre costing Rs.3,00,000.00
B. Building for Factory and Office :
The factory building of area 100’ x 40’ is to be constructed
and the cost of construction is estimated to be Rs.150/- per
sq.ft. Office building of area 40’ x 20’ would have to be
constructed @ Rs.400/- per sq.ft. Additional structures to
be constructed are expected to cost another Rs.2,50,000.00
C. Plant and Machinery required consist of

• Machinery for processing costing Rs.25.50 lacs

inclusive of one furnace costing Rs.2.50 lacs and Heat
Treatment furnace costing Rs.10 lacs.

• Workshop equipment costing Rs.10 lacs.

• Inspection and Testing equipment etc. Rs.5 lacs.

D. In addition to the above an investment of Rs.1 lac is

expected to be required for miscellaneous assets like
furniture, fittings, office equipments etc.
Operational Requirements :

Process : The stages in manufacture of the different

types of forgings is outlined below :

e) Rough forgings – Heating in pre-furnace, forging in forge

shop, heat treatment in the heat treatment furnace.

g) Heat treated forgings – Heating in pre-furnace, forging in

forge shop, heat treatment in the heat treatment furnace.

i) Machined forgings – Heating in pre furnaces, forging in

the forge shop, machining in the machine shop.
Raw Materials
Raw materials used are Carbon Steel and mild steel.
Mild steel used in rough and machined forging costs
Rs.16,000/- per ton and carbon steel used in Heat
treated forgings cost Rs.20,000/- per ton. To allow for
waste rejections etc. 1.10 tons of raw materials per ton
of finished products.

Consumables
a) Furnace Oil – This is used in the furnaces. In the pre-
furnace 1000 litres of furnace oil are required for every
5 tons of product processed. In the Heat treatment
furnace 1000 litres of furnace oil are required for every
10 ton of product processed. Furnace oil is bought at a
rate of Rs.10.00 per litre.
• Coal – Coal is required for the boiler
which provides steam for the hammers
in the forge shop. The annual
consumption of coal is expected to be
1250 tons per annum and is bought at
Rs.2000/- per ton.

c) In addition machinery spares and

lubricating oil etc. would be consumed
the annual cost of which are expected to
be Rs.1,00,000.00
Labour
• Most of the work is done through the employment of
contract labour.
• Contract labour in the forge shop is to be paid Rs.2000/-
per ton of forged product.
• In addition contract labour is also hired for the heat
treatment shop and are paid Rs.1500/- per ton of heat
treated product for this part of work (heat treatment).
• Apart from contract labour a fixed complement of
workers are required for the workshop. Wages to this
complement would amount Rs.2.50 lacs per annum.
Other Expenses

Other administrative expenses are estimated to be as follows:

Rs.
i) Office salaries 5,00,000
ii) Postage, stationery, printing 50,000
iii) Conveyance, Freight etc. 1,50,000
iv) Miscellaneous expenses 40,000
7,40,000
2. In addition repairs and maintenance costs are estimated to
be 2% of value of plant and machinery.

3. Depreciation will have to be charged at 5% on Building,

20% on furnace, 10% on other plant and machinery except
furnaces) and 10% on other miscellaneous assets.
Stocks and Bills

It is considered necessary to carry average stock

of raw materials, furnace oil and coal for 2
months, finished goods for 2 weeks. Bills are
expected to be cleared on the average after a
period of 2 weeks.

Banks Finance

Banks finance expenses would be available

towards both fixed assets and working capital
with interest at 18% p.a.
1. The margins to be met from own source are as
below :-
%
a) Land and Building 33 1/3

b)Plant and machinery 25

c) Miscellaneous assets 20

d) Raw material furnace oil & coal 25

e) Finished goods 30

f) Bills 10

g) Expenses 100
Repayment of Term Loan:
In 5 yearly instalments of Rs. 8 Lacs each with
a moratorium of 2 years.

Based on the information given above.

• Compute the total project cost and the quantum

of Bank Finance that would be available towards
meeting this.

• Prepare the statements of Profitability, working

capital requirements and Break even analysis.
 CASE STUDY – XYZ FORGINGS

Cost of the Project

Rs. Rs.
I Land & Building
Land (Depreciation @ nil%) 3,00,000
Building (Dep @ 5%)

Factory (4000*150) 6,00,000

Office Working space(800*400) 3,20,000

Others 2,50,000
Total 11,70,000

Therefore Land & Buildings 14,70,000

 Rs. Rs.
II Plant & Machinery :

Pre Furnace (Dep @ 20%) 2,50,000

Heat Treatment Furnace (Dep @ 20%) 10,00,000

Other Processing Machines (Dep 10%) 13,00,000

Workshop equipment (Dep 10%) 10,00,000

Inspection / Testing Machines (Dep 10%) 5,00,000

Total 40,50,000

III Misc. Assets (D 10%) 1,00,000

Therefore Cost of Project (I + II + III) 56,20,000

 Raw materials required (At the rate of 1.10 ton of raw
material per ton of finished products)
QUANTITY I YEAR II YEAR III YEAR
Mild Steel (MS) 330 440 550
(Rough Frgi)
Carbon Steel (CS) 550 880 1100
(HT Forgi)
Mild Steel (MS) 220 330 550
(Machined Frgi)
Value (Rs. in lacs)
Mild Steel @ 16000/ton 88 123 176
Carbon Steel @ 20000/ton 110 176 220
TOTAL 198 299 396
 QUANTITY I YEAR II YEAR III YEAR
LABOUR :
1. Forg. Shop @ 2000 + 20 30 40
(Qty. in tons) (1000) (1500) (2000)
2. HT Shop @ 1500+ 7.5 12 15
(Qty. in tons) (500) (800) (1000)
3. Fixed Labour 2.5 2.5 2.5
TOTAL LABOUR 30 44.5 57.5
OTHER EXPENSES
1. Office Expenses 5 5 5
2. P&T & Printing 0.5 0.5 0.5
3. Conveyance & Freight 1.5 1.5 1.5
4. Misc. 0.4 0.4 0.4
TOTAL 7.4 7.4 7.4
I Consumables : (Rs. in lacs) I II III
1. Furnace oil @ 1000 lit/5t
for pre-furnace and 1000
lit/ 10 t. for H.T. furnace
Price of one litre Rs.10/- 22 33 44
(Qty. processed in tons) (1100) (1650) (2200)
HT Furnace 5.5 8.8 11
(Qty. processed in tons) (550) (880) (1100)
TOTAL 27.5 41.8 55
II Coal :-
1250 + p.a. (a) + Rs.2000/- + Rs.25 lacs

III Other Consumables : Rs. 1 lac

Therefore total Consumables 53.5 67.8 81

(Rs. in lacs)
 YEAR I II III
Repairs & Maintenance 0.81 0.81 0.81
Depreciation Rate
Land NIL 0 0 0
Building 5% 0.58 0.58 0.58
Furnace 20% 2.5 2.5 2.5
Other Plant & Machinery 10% 2.8 2.8 2.8
Misc. 10% 0.1 0.1 0.1
TOTAL 5.98 5.98 5.98
Sales (Rs. in lacs) I II III
Rough Forgings M.S 75 100 125
(Qty. in tons) (300) (400) (500)
HT Forgings (CS) 150 240 300
(Qty. in tons) (500) (800) (1000)
Machined Forgings (MS) 70 105 175
(200) (300) (500)
TOTAL 295 445 600
Process Involved:
Rough Forgings – Heating in Pre-Furnace
Heat Treatment forgings – Heating in arc furnace
Machined Forgings – Heating in pre furnace machine
 XYZ FORGINGS
PROFIT & LOSS A/C
YEAR I II III
Sales 295.00 445.00 600.00
Less : Commission @ 5% 14.75 22.75 30.00
Net Sales 280.25 422.75 570.00

Raw Materials 198.00 299.00 396.00

Furnace Oil 27.50 41.80 55.00
Coal 25.00 25.00 25.00
Other consumables 1.00 1.00 1.00
Labour 30.00 44.50 57.50
Repairs & Maintenance 0.81 0.81 0.81
Depreciation 5.98 5.98 5.98

COST OF PRODUCTION 288.29 418.09 541.29

Selling & General Expenses 7.40 7.40 7.40
Interest on Term Loan 7.38 7.38 5.94
Interest on Working Capital 9.00 12.96 16.14
Cost of sales 312.07 445.83 570.77

NET PROFIT (-31.82) (-23.08) (-0.77)

Add : Depreciation 5.98 5.98 5.98

Cash Accruals ---- ---- 5.21
Term Loan Repayment ---- ---- 8.00

DSCR ---- ---- ?

CASH EXPENSES PER YEAR

YEAR I II III
Labour 30.00 44.50 57.56
Repairs & Maintenance 0.81 0.81 0.81
Selling & Administration 7.40 7.40 7.40
Interest on Term Loan 7.38 7.38 5.94
TOTAL 45.59 60.09 71.71
Per month 3.79 5.00 5.97

contd…
Cost of sales (For W.C. purpose)

YEAR I II III
Cost of Production 288.29 418.09 541.29
Selling & Administration 7.40 7.40 7.40
Interest on Term Loan 7.38 7.38 5.94
303.07 432.87 554.63
Less : Depreciation 5.98 5.98 5.98
Cost of sales 297.09 426.89 548.45
For 2 Weeks 11.42 16.41 21.08
 WORKING CAPITAL ASSESSMENT FOR 1ST YEAR (Amount in
Rs. Lacs)
Item Period Amount Margin Permissible
limit
RM 2M 33.00 8.25 (25%) 24.75
Furnace Oil 2M 4.60 1.15 (25%) 3.45
Coal 2M 4.20 1.05 (25%) 3.15
Finished Goods* 2W 11.42 3.42 (30%) 8.00
Receivables 2W 11.42 1.14 (10%) 10.28
Expenses 1M 3.79 3.79 (100%) ---

TOTAL 68.43 18.80 49.63

Working capital finance say Rs.50.00 lacs

Interest @ 18% Rs. 9.00 lacs
Margin to be brought in Rs.18.80 lacs
•Valued at cost of sales excluding interest on working capital &
depreciation.
 WORKING CAPITAL ASSESSMENT
(YEAR II)

Item Margin Period Amount

II Year
RM 25% 2M 49.83
Furnace Oil 25% 2M 6.97
Coal 25% 2M 4.17
Finished Goods* 30% 2W 16.64
Receivables* 10% 2W 16.64
Expenses 100% 1M 5.00
TOTAL 98.79

contd…
 WORKING CAPITAL ASSESSMENT
(YEAR II) (contd.)
Item Margin Permissible
II Year limits II
RM 12.46 37.37
Furnace Oil 1.74 5.23
Coal 1.04 3.13
Finished Goods* 4.92 10.45
Receivables* 1.64 14.63
Expenses 5.00 ----
TOTAL 26.80 71.99

* valued at cost of sales

Working capital finance for II year Rs.72.00 lacs.
 WORKING CAPITAL ASSESSMENT
(YEAR III)
Item Margin Period Amount
III Year
RM 25% 2M 66.00
Furnace Oil 25% 2M 9.17
Coal 25% 2M 4.17
Finished Goods* 30% 2W 21.07
Receivables* 10% 2W 21.07
Expenses 100% 1M 5.91
TOTAL 127.39

contd…
 WORKING CAPITAL ASSESSMENT
(YEAR III) (contd.)
Item Margin Permissible
III Year limits III
RM 16.50 49.50
Furnace Oil 2.29 6.94
Coal 1.04 3.13
Finished Goods* 6.32 12.77
Receivables* 2.10 19.73
Expenses 5.91 ----
TOTAL 34.16 93.23

* valued at cost of sales

Working capital finance for III year Rs.93.23 lacs.
Margin to be brought in Rs.26.80 and Rs.34.16 lacs
respectively.
Year II III
Interest @ 18% on WC 12.96 16.14
Term Loan

Cost Margin Finance

(%) Amount
Land & Bldg. 14.70 33.33 4.90 9.80
Plant & Machinery 40.50 25.00 10.10 30.40
Misc. Assets 1.00 20.00 0.20 0.80
Total 56.20 15.20 41.00

contd…
Year T.L. Interest W.C. Interest Total
(18%) (18%) Interest
I 7.38 8.64 16.02
II 7.38 12.60 19.98
III 5.94 16.20 22.14

Term loan repayment Moratorium 2 years, Rs.8

lacs per year thereafter 5 years.
Year I II III
Net Sales 295.00 445.00 600.00
VARIABLE COST
Raw Materials 198.00 299.00 396.00
Furnace Oil 27.50 41.80 55.00
Coal 25.00 25.00 25.00
Other Consumables 1.00 1.00 1.00
Labour 30.00 44.50 57.50
Interest on WC 9.00 12.96 16.78
Commission 14.75 22.25 30.00
Total 305.25 446.51 581.28
contd…
Year I II III
FIXED COST
Repairs & Maintenance 0.81 0.81 0.81
Selling & Administration 7.40 7.40 7.40
Interest on Term Loan 7.38 7.38 5.94
Depreciation 5.98 5.98 5.98
Total 22.47 22.47 20.13
Contribution -10.25 -1.51 18.72