Final Report

A REPORT

ON

ANALYSIS OF WORKING CAPITAL MANAGEMENT AND FINANCIAL PERFORMANCE

BY

K.SAI BHARGAV

14BSPHH011223

TECHNOCHEM ENGINEERS PVT. LTD.

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A REPORT

ON

ANALYSIS OF WORKING CAPITAL MANAGEMENT AND FINANCIAL PERFORMANCE

TECHNOCHEM ENGINEERS PVT. LTD.

BY

K. SAI BHARGAV

14BSPHH011223

A report submitted in partial fulfilment of the requirements of MBA Program of IBS Hyderabad

Distribution List

Company Guide Faculty Guide

Sudhakar Dasari Prof. Nikhat

Director IBS Hyderabad

Technochem Engineers Pvt. Ltd.

Date of submission: 08/05/2015

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AUTHORISATION

This is to certify that this project is the original work of K.Sai Bhargav and is being submitted as a partial fulfilment of MBA program of IBS Hyderabad.

No project, on the same line, has been submitted prior to this to any other college or institution. This project deals with the working capital management, Ratio analysis and finding the relationship between the liquidity and profitability by using SAS software.

The project has been done under the guidance and supervision of

1. Mr. Sudhakar Dasari (Director, Company Guide)2. Mrs. Nikhat (Faculty Guide)3. Mr. Santosh (Manager)4. Mr. Sarma (Accountant)

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ACKNOWLEDGEMENT

On successful completion of the Project, I would like to take pleasure to thank Mr. Santosh for lending his precious support throughout the term without whom it would have been difficult to come up with the work I have done.

I would also like to express my sincere thanks to Mr. Bharath Supra for expert guidance on critical areas and helping me. It is with their constant support and guidance I have been able to complete my internship project.

I would also like to thank Director Mr. Sudhakar Dasari for the support and motivation time to time.

I would also like to thank Mrs. Nikhat Afshan for constant guidance and support.

I would like to thank my friend Shrikanth for helping me time to time and providing enough support to complete my project.

I would like to express my deepest gratitude towards all who have helped me in any way during the tenure of my internship.

Thanking You K.Sai Bhargav

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TABLE OF CONTENTS

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Sr. No. Topic Page No.

Authorization 3

Acknowledgement 4

Executive Summary 7

1 INTRODUCTION 8

1.1 Objective of the study 8

1.2 Limitations 8

1.3 Methodology 8

1.4 Introduction to TEPL 9

1.5 Industry Profile 10

1.6 SWOT Analysis 12

2 WORKING CAPITAL MANAGEMENT 13

2.1 On the basis of B/S concept 13

2.2 On the basis of time 14

3 RATIO ANALYSIS 17

3.1 Introduction to Ratio Analysis 17

4 LIQUIDITY AND PROFITABILITY TRADEOFF 21

4.1 Introduction 21

4.2 Multiple Regression Introduction 21

5 DATA ANALYSIS 23

5.1 Analysis of Working Capital Management ratios 23

5.2 Ratio Analysis 24

Liquidity Ratios 24

Leverage Ratios 28

Profitability Ratios 31

Turnover Ratios 34

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5.3 Analysis of Liquidity and Profitability Tradeoff 37

5.4 Multiple Regression Analysis 38

5 FINDINGS 42

6 CONCLUSION 42

7 RECOMMENDATIONS 43

8 REFERENCES 44

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EXECUTIVE SUMMARY

Analysis of current performance of the company by calculating financial ratios as these ratios can used to identify areas where performance has improved or deteriorated over the time period. Working capital management, tradeoff between Profitability and Liquidity which can be used to find that portion of a company’s capital, which is required for minimum stock of raw material to maintain continuity in production, minimum stock of finished goods to fulfill future demand, payment of wages and salaries of labors and employees, the working capital needs for the company by analyzing conversion cycles, debts standing in the balance sheets with respect to the payment period, tendency of bad debts and advising regarding credit period and receivables. And also finding the relation between the profitability and liquidity by using Multiple Regression of Technochem Engineers Private Limited.

I K.Sai Bhargav got an opportunity to work for Technochem Engineers Private Limited at Hyderabad during my summer internship program and took a project on Analysis of Working Capital Management and Financial Performance.

Technchem Enigineers Pvt. Ltd. (TEPL) is a manufacturing company. The main activity of the company is to supply turnkey projects & manufacturing of continuous solvent extraction plants, vegetable oil refineries, physical distillation units, oil derivatives, material handling equipments, aqua / cattle feed equipments, oil expelling units, vanaspathi units, bio diesel plants and also consultants for the same.

Objectives of the project were:

To study the present financial system at TEPL. To determine the Profitability, Liquidity, Leverage Ratios. To analyze the capital structure of the company with the help of Leverage ratio. To analyze various aspects of working capital by calculating net and gross operating

cycles. To offer appropriate suggestions for the better performance of the organization. To find out the Liquidity and Profitability Trade off by using Multiple Regression.

Background:

Oil is the major consumption of all the people in the world. Oil Extraction manufacturing industries is one of the leading businesses in India. The Solvent Extractors' Association of India was formed in 1963 to help and foster the development and growth of Solvent Extraction Industry in India. At present the Association is having 875 members including about 350 working solvent extraction plants having combined oilcake/oilseed processing annual capacity of about 30 million tons.

Methodology:

The project has the analytical approach, entailing within the various concepts of Finance and marketing with emphasis on Ratio Analysis, Working capital management and finding the relation or tradeoff between profitability and liquidity through secondary data such as financial statements provided by the company.

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INTRODUCTION

Objectives, Limitation and Methodology:

Objectives:

To study the present financial system at TEPL. To determine the Profitability, Liquidity, Leverage Ratios. To analyze the capital structure of the company with the help of Leverage ratio. To analyze various aspects of working capital by calculating net and gross operating

cycles. To offer appropriate suggestions for the better performance of the organization. To find out the Liquidity and Profitability Trade off by using Multiple Regression.

Limitations:

The study provides an insight into the financial aspects of TEPL. Every study will be bound with certain limitations.

Since TEPL is not a listed company the analysis is made based on 9 years. One of the factors of the study was lack of availability of ample information. Most of the

information has been kept confidential as per the policy of company. Providing data only of Technochem Engineers Pvt. Ltd. and no other companies. So it is

a drawback for me as I cannot diversify myself and bring out analysis only of one company and cannot compare it.

Methodology:

DATA COLLECTION METHOD

To fulfil the objectives of my study, I have taken both into considerations via primary and secondary data.

Primary data:

Primary data has been collected through direct contact with the employees.

Secondary data:

The data is collected from the financial statements and Literature reviews. The various sources that were used for the collection of secondary data are internal files & materials.

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Introduction to Technochem Engineers Private Limited:

Technchem Enigineers Pvt. Ltd. (TEPL) is a manufacturing company. The company main activity is to supply turnkey projects & manufacturing of continuous solvent extraction plants, vegetable oil refineries, physical distillation units, oil derivatives, material handling equipments, aqua / cattle feed equipments, oil expelling units, vanaspathi units, bio diesel plants and also consultants for the same.

Having good experience in the production & projects execution for the past 22 years incepted their own workshop with all fabrication / machining facilities by all the three directors technically qualified specialized in oil technology & practically experienced, started this firm in 1992 and executed more than 150 projects. TEPL come up with the latest modified developments so as to achieve better results where the consumption of utilities can be saved. Recently developed physical distillation section suitable for palm oil as well as high free fatty acid rice bran oil is being a success by its quality output with better efficiency

Established in the year 1992, Technochem Engineers Private Limited, are the celebrated manufacturer, supplier, and exporter of a vast line of solvent extraction plants and vegetable oil refinery. In addition to this efficient product range, provide installation, up gradation, technical services, and engineering solution services. Company product collection consists of Solvent extraction Plants, Oil Milling Plants, and Vegetable Oil refining Plants. Since their inception, they have focused on providing the exact requirements of their valued customers by using the best possible raw materials, and following the industry standards and procedures. Our spacious infrastructure has supported them in coming up with a broad product range that is used in different industries. TEPL have equipped infrastructure with different machinery and equipment that provide them with small and large scale plants that produces supreme quality results.

It hired a team of professionals who are experienced and well trained to collect the basic requirements of their customers and to offer them the exact solutions of the problems. Their entire team is upgraded with information on the latest market trends by the several knowledge enhancing programs that we conduct from time to time. They never compromise with the quality that they provide and wish to continue fulfilling the diverse demands of their customers in the manner that they have been following from the very beginning of their establishment, a private Limited Company under the able mentorship of Mr. Srinivas Vay whose magnificent industry knowledge has helped them to achieve new heights in the industry. TEPL is a reputed name among customers and aim to be their topmost priority in the future too.

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Solvent Extraction Industry Profile:

History:

From ancient time, vegetable oils were obtained by crushing oilseeds in village ghanis / kolhus / chekkus in the country. At the beginning of the 20th century the vegetable oils industry was based on some 500,000 bullock-driven ghanis producing about 800,000 tons of oils. Slowly, in addition to these ghanis, power driven ghanis (rotary ghanis made indigenously) imported expeller and imported hydraulic press plants started crushing oilseeds. Around this time many European countries and United States of America had established huge solvent extraction plants for recovering directly almost all the available oil in the oilseeds like Cottonseed and Soybean. On this background, just 2 years before independence, in 1945, a lone small Solvent Extraction Plant commenced operation in Bhavnagar for extracting oil from oilseed cakes and oilseeds. And gradually such units increased. They faced common problems, which brought them together to form Association with all the 40 units operating at that time, in 1963.

Association:

The Solvent Extractors' Association of India was formed in 1963 to help and foster the development and growth of Solvent Extraction Industry in India. At present the Association is having 875 members including about 350 working solvent extraction plants having combined oilcake/oilseed processing annual capacity of about 30 million tons. The Association is an all India body to solvent extractions industry and premier vegetable oil Association in the country having wide representative membership consisting of processors of Rice bran, Oilcakes, Minor Oilseeds and Soybean. Associate Membership of the Association includes apart from processors, also merchant exporters, oil millers, refiners, Vanaspati manufacturers, importers of edible oils, brokers, traders, plant & machinery manufacturers, clearing & forwarding agents, surveyors, regional associations etc. With such wide cross section of membership, SEA is a broad based, all India apex body of solvent extraction industry and at present practically all working solvent extraction units are its members. The affairs of the Association are being managed by the Managing Committee, headed by the President. The Association continuously gives feedback to the members about development taking place in the country and world over by various circulars. Monthly New circulars, E-Mail & through periodical zonal meetings. SEA was the first Association in India successfully to launch Website http://www.seaofindia.com to provide up to date information on trade & industry and statistical data backed by its exhaustive data bank. SEA is financially autonomous and functions entirely as private sector body.

SEA is the first Association in Vegetable Oil & Oilseed sector and may be one of the few Associations / Chambers in India to receive quality standard ISO 9001:2000 registration. The Certification was issued by M/s. Orion Registrar Inc. USA with ANSI-RAB, USA as well as Russia and Netherlands accreditation.

Objectives of the Association:

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To promote and protect the trade, commerce, manufacturing and exporting, trading and other activities of the solvent extraction industry.

To encourage and promote the use of solvent extracted oil and their byproducts in India and abroad and with that aim to publicize, propagate and advocate their uses through various publicity media including organizing seminars/conventions.

To represent and make known members point of view and the interests of the solvent extraction industry as a whole before governmental and quasi-governmental authorities trade or industrial bodies, chambers of commerce, foreign trade and industrial interest and other organizations.

To establish, promote, operate, maintain, increase and encourage directly or indirect steady and stable expansion of the export of deoiled cakes/meals and for that purpose to carry on such activities and implement such schemes by such methods as may be necessary.

The main purpose of the Association is to foster the development and growth of the solvent extraction industry in particular and overall development of Veg. oil industry in the country in order to increase vegetable oil availability in the country, to make the country self-reliance in vegetable oils to meet the growing demands of the large population, with scientific outlook.

Growth of the Association:

With the development of Rice bran and Rice bran oil industry in Japan, the Association had a big role in raising India's Rice bran availability and its extraction facilities. As expelling of Rice bran was not at all viable, the solvent extraction industry grew very fast scattering all over the country. And today, the number of units in the country has grown to 600 with varying installed capacities totaling to 30 million tons. During this period, the shortage of edible oils in the country, led the Association to explore minor oils for industrial uses to release edible oils for edible purposes. The amount of oils in these seeds was so low that only solvent extraction process could extract these oils from such materials. And in the process some minor edible oils like Sal, Mango kernel, having Cocoa butter like properties, were also made available to the world.

The primary aim was to recover maximum amount of oils from the oil bearing materials. However, huge stocks of byproduct namely extractions needed to be gainfully disposed of, very good quality edible materials rich in proteins were made available for human consumption. The edible extractions not so good for human consumption found the way to animal and poultry feed. Some were given special detoxification treatments. But our requirements for animal feed is mainly for milk cattle's, while there is a huge market for animal feed in world over where mutton consumption is high. This led to opening of export market for our extractions. The solvent extraction industry has to fulfill the mission to provide sufficient oil and protein for the growing population and to raise the per capita availability of the oils and proteins from whatever cultivated vegetable oil seeds and tree borne seeds in the forest. Over the year per capita consumptions of oils and fats has grown from 4.9 kg in 1960 to 16.5 kg in 2004. The Association was the canalizing body for export of deoiled Rice bran from 1970-71 to 1983-1984 and has been a registering authority thereafter until April 1995 for the Ministry of Commerce for exports of various meals, Rice bran and other extractions, compound cattle feed and poultry feed and minor oils of tree and forest origin.

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SWOT ANALYSIS

Strengths

• Good relationships with the suppliers.

• Economies of scale through complete integration.

• Customization.

• Wide geographical presence.

Weakness

• Less productive machines in process.

• There are no efforts to improve advertising effectiveness of the company.

• No up gradation of Techniques that are used

• Lack of CRM.

Opportunities

• Changing oil extraction scenario

• Global demand of oil extraction machineries.

• Price Competitiveness

• Cheap Labour

• Product Diversification

Threats

• Competition from global player

• Decline in exports

• Cheap import from china ,Bangladesh, Thailand

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• Rise in raw material price

WORKING CAPITAL MANAGEMENT

Introduction:

The primary objective of working capital management is to ensure that sufficient cash is available to:

Meet day-to-day cash flow needs; Pay wages and salaries when they fall due; Pay creditors to ensure continued supplies of goods and services; Pay government taxation and providers of capital as dividends; and Ensure the long term survival of the business entity.

A company invests its funds for long term purposes and short term operations. That portion of a company’s capital, which is required for minimum stock of raw material to maintain continuity in production, minimum stock of finished goods to fulfill future demand, payment of wages and salaries of labors and employees is called Working Capital. In other words, working capital is that part of the firm’s capital which is required for financing short term or current assets such as debtors, inventories, marketable securities and cash.

There are numerous concepts of working capital as given by various accountants, financial experts, entrepreneurs and economists. Important among them are

Balance Sheet or Traditional Concept Operating Cycle Concept

ON THE BASIS OF B/S CONCEPT

According to this concept, working capital is calculated on the basis of the balance sheet prepared at a specific date. It is further classified it two forms- gross and networking capital.

GROSS WORKING CAPITAL

The gross working capital refers to the firm’s investment in current assets. The sum of current assets is a quantitative aspect of working capital which emphasizes more on quantity than its qualities.

NET WORKING CAPITAL

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Net working capital is the difference between the current assets and the current liabilities or the excess of total current assets over total current liabilities. Net working capital may also be defined as, that part of a firm’s current assets which is financed with long term funds.

The net working capital may either be positive or negative. When current assets exceed current liabilities, working capital is positive and negative when current liabilities exceed current assets.

ON THE BASIS OF TIME

Working capital is the amount required in different forms at successive stages of operation during the net operating cycle period of an enterprise. The duration or time required to complete the sequence of events right from purchase of raw materials/goods for cash to the realization of sales in cash is called the operating cycle or working capital cycle. On the basis of time working capital may be classified as

o Permanent or regular working capital o Variable or temporary working capital.

PERMANENT OR REGUALR WORKING CAPITAL

It represents the irreducible minimum amount that is permanently blocked in the business and cannot be converted into cash in the normal course of business. It has following characteristics

It keeps on changing its form from one current asset to another The size of working capital grows with the growth of the business As long as the firm is a going concern, this part of working capital cannot substantially be

reduced.

VARIABLE OR TEMPORARY WORKING CAPITAL

Any amount over and above the permanent working capital is variable or temporary working capital. It fluctuates as per the change in the production and sale activities.

COMPONENTS OF CURRENT ASSETS AND CURRENT LIABILITIES

CURRENT ASSETS

A. Inventories

Raw Materials Work In Progress Value of Incomplete Job

B. Sundry debtors

C. Cash and Bank balance

D. Loans and Advances

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E. other current assets

Total current asset = A+B+C+D+E

CURRENT LIABILITIES AND PROVISIONS

A. Current liabilities

B. Provisions

Total current liability = A+B

Working capital = Current Assets – Current Liabilities

CURRENT ASSETS

Current assets are those assets of the company which are either held in the form of cash or can be easily converted into cash within one accounting period, usually a year. Examples of Current Assets are:

Cash Short term investments Sundry Debtors Stock Loans Advances etc.

Valuation of Inventories

Stores and spare parts, loose tools, goods in transit, raw materials and work in progress are valued at cost

The finished goods including those manufactured by the company are valued at cost of estimated market value, whichever is lower.

Incomplete job contracts are valued at direct cost incurred on such contracts.

For an individual the current asset are the asset held in form

Cash Short Term Investments

CURRENT LIABILITIES

Current Liabilities are the liabilities of the company which have to be paid within one accounting period, usually a year. Examples of Current Liabilities are:

Sundry Creditors Bills Payable

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Outstanding Expenses Short Term Loans etc.

For an individual the current liabilities are:

Expenses, loans etc. Working Capital Management Strategies:

At the time of adopting working capital strategy of a firm, the financial manager should emphasis on the following two important dimensions of working capital management.

Relative Asset Liquidity (or level of CA) - It is measured by Current Assets to Total Assets ratio. The greater the ratio the less risky as well as less profitable will be the firm and vice-versa

Relative Financing Liquidity [or level of short term financing (STF)] - It is measured by the short term financing to total financing ratio. The lower this ratio the less risky as well as less profitable will be the firm and vice-versa.

In connection with the tradeoff between liquidity, risk and profitability a company may adopt three types of working capital strategies viz.: (a) conservative strategy, (b) aggressive strategy and (c) moderate strategy.

The firm following conservative working capital strategy combines a high level of current assets in relation to sales with a low level of short term financing. Excess amount of current assets enable the firm to absorb sudden fluctuations in sales, production plans and procurement time without disturbing the continuity in production. The higher level of current assets reduces the risk of insolvency. But at the same time lower risk translates into lower profit.

The firm following aggressive working capital strategies, on the other hand, would combine low level of current assets with a high level of short term financing. This firm will have high profitability and greater risk of insolvency.

The moderate firm would like to combine moderate level of current assets in relation to sales with moderate level of short term financing to maintain a fine balance between the risk of insolvency and profitability.

Thus, the considerations of assets and financial mixes are very much crucial to the working capital management of a firm.

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RATIO ANALYSIS

INTRODUCTION:

FINANCIAL ANALYSIS

Financial analysis is the process of identifying the financial strengths and weaknesses of the firm and establishing relationship between the items of the balance sheet and profit & loss account.

Financial ratio analysis is the calculation and comparison of ratios, which are derived from the information in a company’s financial statements. The level and historical trends of these ratios can be used to make inferences about a company’s financial condition, its operations and attractiveness as an investment. The information in the statements is used by

Trade creditors, to identify the firm’s ability to meet their claims i.e. liquidity position of the company.

Investors, to know about the present and future profitability of the company and its financial structure.

Management, in every aspect of the financial analysis. It is the responsibility of the management to maintain sound financial condition in the company.

RATIO ANALYSIS

The term “Ratio” refers to the numerical and quantitative relationship between two items or variables. This relationship can be exposed as

• Percentages• Fractions• Proportion of numbers

Ratio analysis is defined as the systematic use of the ratio to interpret the financial statements. So that the strengths and weaknesses of a firm, as well as its historical performance and current financial condition can be determined. Ratio reflects a quantitative relationship helps to form a quantitative judgment.

STEPS IN RATIO ANALYSIS

The first task of the financial analysis is to select the information relevant to the decision under consideration from the statements and calculates appropriate ratios.

To compare the calculated ratios with the ratios of the same firm relating to the pas6t or with the industry ratios. It facilitates in assessing success or failure of the firm.

Third step is to interpretation, drawing of inferences and report writing conclusions are drawn after comparison in the shape of report or recommended courses of action.

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BASIS OR STANDARDS OF COMPARISON

Ratios are relative figures reflecting the relation between variables. They enable analyst to draw conclusions regarding financial operations. The use of ratios as a tool of financial analysis involves the comparison with related facts. This is the basis of ratio analysis. The basis of ratio analysis is of four types.

Past ratios, calculated from past financial statements of the firm. Competitor’s ratio, of the some most progressive and successful competitor firm at the

same point of time. Industry ratio, the industry ratios to which the firm belongs to Projected ratios, ratios of the future developed from the projected or pro forma financial

statements

NATURE OF RATIO ANALYSIS

Ratio analysis is a technique of analysis and interpretation of financial statements. It is the process of establishing and interpreting various ratios for helping in making certain decisions. It is only a means of understanding of financial strengths and weaknesses of a firm. There are a number of ratios which can be calculated from the information given in the financial statements, but the analyst has to select the appropriate data and calculate only a few appropriate ratios. The following are the four steps involved in the ratio analysis.

Selection of relevant data from the financial statements depending upon the objective of the analysis.

Calculation of appropriate ratios from the above data. Comparison of the calculated ratios with the ratios of the same firm in the past, or the

ratios developed from projected financial statements or the ratios of some other firms or the comparison with ratios of the industry to which the firm belongs.

INTERPRETATION OF THE RATIOS

The interpretation of ratios is an important factor. The inherent limitations of ratio analysis should be kept in mind while interpreting them. The impact of factors such as price level changes, change in accounting policies, window dressing etc., should also be kept in mind when attempting to interpret ratios. The interpretation of ratios can be made in the following ways.

• Single absolute ratio• Group of ratios• Historical comparison• Projected ratios• Inter-firm comparison

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GUIDELINES OR PRECAUTIONS FOR USE OF RATIOS

The calculation of ratios may not be a difficult task but their use is not easy. Following guidelines or factors may be kept in mind while interpreting various ratios are

• Accuracy of financial statements • Objective or purpose of analysis• Selection of ratios• Use of standards

IMPORTANCE OF RATIO ANALYSIS

• Aid to measure general efficiency• Aid to measure financial solvency• Aid in forecasting and planning• Facilitate decision making• Aid in corrective action• Aid in intra-firm comparison • Act as a good communication• Evaluation of efficiency• Effective tool

LIMITATIONS OF RATIO ANALYSIS

• Differences in definitions • Limitations of accounting records• Lack of proper standards• No allowances for price level changes• Changes in accounting procedures• Quantitative factors are ignored• Limited use of single ratio• Background is over looked• Limited use• Personal bias

CLASSIFICATIONS OF RATIOS

The use of ratio analysis is not confined to financial manager only. There are different parties interested in the ratio analysis for knowing the financial position of a firm for different purposes. Various accounting ratios can be classified as follows:

Traditional Classification Functional Classification Significance ratios

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Traditional Classification

Balance sheet (or) position statement ratio: They deal with the relationship between two balance sheet items, e.g. the ratio of current assets to current liabilities etc., both the items must, however, pertain to the same balance sheet.

Profit & loss account (or) revenue statement ratios: These ratios deal with the relationship between two profit & loss account items, e.g. the ratio of gross profit to sales etc.,

Composite (or) inter statement ratios: These ratios exhibit the relation between a profit & loss account or income statement item and a balance sheet items, e.g. stock turnover ratio, or the ratio of total assets to sales.

Functional Classification

These include liquidity ratios, long term solvency and leverage ratios, activity ratios and profitability ratios.

Significance ratios

Some ratios are important than others and the firm may classify them as primary and secondary ratios. The primary ratio is one, which is of the prime importance to a concern. The other ratios that support the primary ratio are called secondary ratios.

In the view of functional classification the ratios are,

1. Liquidity ratio

2. Leverage ratio

3. Activity ratio

4. Profitability ratio

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LIQUIDITY AND PROFITABILITY TRADEOFF:

Liquidity and profitability-risk trade-off may be discussed in the light of firm's net working capital position. The level of net working capital of a firm has a bearing on its liquidity, profitability as well as non-insurable risk and uncertainty.

Liquidity is a two-dimensional concept – time and risk. Time dimension of liquidity is concerned with the speed of convertibility of different current assets (other than cash) into cash.

Risk dimension of liquidity indicates the degree of certainty about the conversion of current assets into cash without suffering any loss or with as little sacrifice in price as possible.

The term 'Profitability' used in this context is measured by profit after expenses. It is expressed as the ratio of profit after expenses to the invested capital (i.e. Fixed Asset + Net Working Capital). In the light of profitability of a firm the risk may be understood as the probability of technical insolvency.

Technical insolvency occurs whenever a firm is unable to meet its cash obligations when they become due for payment. This risk of becoming technically insolvent is measured by detailed analysis of any change in the level of current assets and current liabilities (i.e. the change in the Net Working Capital).

Any change in Net Working Capital brings about a considerable change in the quantum of profit after expenses of the firm. The evaluation of profitability-risk trade off in relation to NWC is based on the following three assumptions:

1. The firm under consideration is a manufacturing firm;

2. Current assets of the firm are less profitable than non-current assets; and

3. Short term financing is less costly than the long term financing.

Under these assumptions, the tradeoff can be identified by using the ratio of current assets to total assets (CATA) which indicates the percentage of current assets in total assets. The higher the ratio of CATA the lower will be the profitability and risk and vice-versa. This trade off can also be demonstrated by using the ratio of current liabilities to total assets (CLTA). This ratio reflects the percentage of total assets financed by current liabilities. The higher the ratio of CLTA, the higher will be the profitability and risk and vice-versa. The combined effect of these two ratios reflects the true profitability-risk trade off of a firm.

Multiple Regression Analysis:

Multiple regression is used to find out the relationship between one dependent variable which is model and number of Independent variables known as parameter estimates. It statistical

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technique that uses several explanatory variables to predict the outcome of a response variable. The goal of multiple linear regression (MLR) is to model the relationship between the explanatory and response variables.

The model for MLR, given n observations, is:

yi = B0 + B1xi1 + B2xi2 + ... + Bpxip + Ei where i = 1,2... n

MLR takes a group of random variables and tries to find a mathematical relationship between them. The model creates a relationship in the form of a straight line (linear) that best approximates all the individual data points.

MLR is often used to determine how many specific factors such as the price of a commodity, interest rates, and particular industries or sectors, influence the price movement of an asset. For example, the current price of oil, lending rates, and the price movement of oil futures, can all have an effect on the price of an oil company's stock price. MLR could be used to model the impact that each of these variables has on stock's price.

In this study Multiple Regression is used to find out the tradeoff between Profitability and Liquidity in SAS 9.2.

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DATA ANALYSIS:

WORKING CAPITAL MANAGEMENT

YEAR 2006 2007 2008 2009 2010 2011 2012 2013 2014ICP 159 120 63 78 20 11 98 100 117DCP 142 208 135 155 61 71 211 58 46GOC 302 328 199 233 82 82 309 159 163CCP 250 256 144 168 62 98 293 111 119NOC 52 72 55 65 20 -16 17 48 44

Inventory Conversion Period (ICP) : It is the average time to convert raw materials into finished goods. It is calculated by dividing average inventory opening stock of the current year and closing stock of the by total expenses/365. There was increase and decrease in the inventory Conversion Periods. Since TEPL is a manufacturing company they have to customize the products and make the products according to the client requirements and it also depends on which type of project they have undertaken.

Debtor Conversion Period (DCP) : It is the total time taken to sell a product and receive the amount. Most of the companies sell their product on credit. In TEPL assuming 100% credit sales the debtor conversion period is calculated. DCP is calculated by dividing average debtors of current and last year by total credit sales/365. The DCP was very much high in the year 2012, 2009, 2007, 2006 because of the average debtors of those years were very much higher compared to other years and the company does not follow any strict credit policy.

Gross Operating Cycle (GOC) : It is the total time taken to convert raw materials into finished goods and sell the product and receive the amount. It is the addition of Inventory conversion period and Debtors conversion period.

Creditor Conversion Period (CCP): It is the average time taken to pay your purchasers. It is calculated by dividing average creditors of current and last year by total credit purchases/365. In TEPL the CCP was highest in the year 2012, 2006 and 2007 due to increase in the average credit purchases in the year 2011.The company used to pay the creditors first and then receive the amount from debtors.

Net Operating Cycle (NOC): It is the difference between Gross Operating Cycle and Creditors Conversion Period that is the average time taken to convert raw materials into finished goods and sell the goods, receive the amount minus the average time taken to pay the creditors. In TEPL the NOC is positive all the years that means the company is paying creditors first and then receiving the amount from debtors which can affect the liquidity of the company. In the year 2011 the

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NOC was negative which means the company received the amounts from debtors first and then paid to the creditors which is good for the company. The company has to borrow short term loans in order to protect the liquidity till the payment of the debtors are made

RATIO ANALYSIS:

LIQUIDITY RATIOS:

Current Ratio: It is calculated by dividing current assets to the current liabilities

Interpretation

As a rule, the current ratio with 2:1 (or) more is considered as satisfactory position of the firm.

There is an increase in the current ratio due to increase in the inventories and trade receivables in

the current asset and decrease in the other current liabilities for tax from 2006 to 2009. The

sundry debtors have increased compared to the year 2006. The increase in sundry debtors

resulted an increase in the ratio and decrease of the ratio in 2010 and 2011 is due to increase in

current liabilities. The ratio is still below the bench mark of 2:1 which shows the company is less

liquid.

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Year Current Ratio

2006 1.082007 1.19

2008 1.132009 1.26

2010 1.122011 1.11

2012 1.63

2013 1.272014 1.39

GRAPHICAL REPRESENTATION:

Quick Ratio:

It is calculated by dividing (current assets-Inventories) with current liabilities. It shows that how the current assets other than inventories are able to meet current liabilities, since inventories take longer time to convert into cash.

Year Quick Ratio2006 0.682007 0.972008 0.832009 0.982010 1.032011 1.042012 1.062013 0.882014 0.76

Interpretation: Quick assets are those assets which can be converted into cash within a short period of time, say to six months. So, here the inventories which are with the long period does not include in the quick assets.

The Ratio increased from 2006 to 2011 due to less current liabilities and inventories compared to other years. The Quick ratio is decreased from 2012 to 2014 because the inventories which cannot be readily converted into cash has been increased.


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2014 2013 2012 2011 2010 2009 2008 2007 2006 2005

0.760.88

1.06 1.04 1.03 0.98

0.830.97

0.68

0.51

Quick ratio

year

Ratio

Net working capital: It is calculated by taking the difference between the current assets and current liabilities.

Year Net working capital2006 8797932007 12703912008 14007442009 23942022010 41739652011 45151022012 146112102013 99954322014 8186257

Interpretation:

The Net working capital shows whether the company’s current assets are exceeding current liabilities or not. If Net working capital is positive then the liquidity position is good.

In TEPL the Net working capital is positive all the years and it is increasing till 2012 due to increase in current assets and decrease in current liabilities and vice versa in the years 2013 and 2014.


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2014 2013 2012 2011 2010 2009 2008 2007 2006 20050.00

2000000.00

4000000.00

6000000.00

8000000.00

10000000.00

12000000.00

14000000.00

16000000.00

Net working capital

year

Curr

ent a

sset

s-Cu

rren

t lia

biliti

es

Interval Measure: It is calculated by dividing Quick assets (current assets-inventories) with average daily Expenses.

Year Interval Measure2006 3042007 2532008 2412009 2452010 2532011 1632012 2932013 2362014 136

Interpretation: It shows that for how many days Quick assets (current assets excluding inventories) are able to meet average daily operating expenses. The interval Measure is high in all the year from 2006 to 2014.


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2014 2013 2012 2011 2010 2009 2008 2007 20060.00

50.00

100.00

150.00

200.00

250.00

300.00

350.00

Interval Measure

Axis Title

Ratio

CAPITAL STRUCTURE RATIOS:

Debt Equity ratio: It is calculated by dividing total debt with Shareholders equity.

Year Debt Equity Ratio2006 1.272007 1.442008 1.242009 1.122010 1.232011 0.412012 1.012013 0.222014 2.82

Interpretation:

This ratio shows how much debt is over shareholders equity. If the ratio is greater than 1 it means the debt is higher than the equity which effects the liquidity of the company. However in TEPL the debt is taken from their own directors and there is no interest paid to them, so it is safe for the company.

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2014 2013 2012 2011 2010 2009 2008 2007 20060.00

0.50

1.00

1.50

2.00

2.50

3.00

Debt equity ratio

Year

Ratio

Proprietary ratio: It is calculated by dividing Shareholder’s fund with the Total assets.

Year Proprietary ratio2006 0.062007 0.092008 0.082009 0.132010 0.062011 0.112012 0.222013 0.212014 0.09

Interpretation

The proprietary ratio establishes the relationship between shareholder’s funds to total assets. It determines the long-term solvency of the firm. This ratio indicates the extent to which the assets of the company can be last without affecting the interest of the company.

There is no increase in the shareholders capital from the year 2006. The shareholder’s funds include capital and reserves and surplus. The reserves and surplus is decreased due to the decrease in balance in profit and loss account, which is caused by the decrease of income from services from 2009 to 2011 and increase of ratio from 2011 to 2012 is because of increase in current assets (trade receivables).

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Total assets, includes fixed and current assets. The fixed assets are reduced because of the depreciation and there are no major increments in the fixed assets. The current assets are decreased from 2013 to 2014 due to which the total assets have been decreased because of decrease in trade receivables which resulted a decrease in the ratio than older.


2014 2013 2012 2011 2010 2009 2008 2007 20060.00

0.05

0.10

0.15

0.20

0.25

Propriety ratio

Year

Ratio

Fixed Asset Ratio: It is calculated by dividing Fixed Assets to the total Capital Employed.

Year Fixed Asset Ratio2006 0.482007 0.352008 0.442009 0.282010 0.272011 0.292012 0.102013 0.032014 0.03

Interpretation: This ratio indicates how much of the fixed assets are used to the total capital employed. In TEPL the ratio is decreased from 2011 to 2014. It indicates that out of total capital employed only a minor portion of amount is kept in fixed assets which effects the operating Efficiency of the company.

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2014 2013 2012 2011 2010 2009 2008 2007 20060.00

0.10

0.20

0.30

0.40

0.50

0.60

Fixed asset ratio

Year

Ratio

PROFITABILITY RATIOS:

Net profit ratio: It is calculated by dividing Net profit to the Net sales.

Year Net profit Ratio2006 0.0042007 0.012008 0.022009 0.032010 0.022011 0.032012 0.12013 0.032014 0.03

Interpretation:

The net profit ratio is the overall measure of the firm’s ability to turn each rupee of income from

services in net profit. If the net margin is inadequate the firm will fail to achieve return on

shareholder’s funds. High net profit ratio will help the firm service in the fall of income from

services, rise in cost of production or declining demand.

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The net profit ratio has been increased from 2011 to 2012 due to decrease in the purchase of

stock (which is an expense) and overall profit has been increased due to decrease in expenses

which resulted in the increase of the ratio. Similarly due to increase in expenses which resulted

in the decrease of the net profit the ratio from 2012 to 2013.And also the low ratio from 2006 to

2010 is due to high expenses.


2014 2013 2012 2011 2010 2009 2008 2007 20060.00

0.02

0.04

0.06

0.08

0.10

0.12

Net profit marigin

Year

Ratio

Earnings per Share: It is calculated by dividing net profit by total number of shares.

Year Earnings per share2006 42007 52008 312009 45.522010 982011 2962012 3632013 1272014 124

Interpretation:

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Earnings per share ratio are used to find out the return that the shareholder’s earn from their shares. After charging depreciation and after payment of tax, the remaining amount will be distributed by all the shareholders.

Net profit after tax is decreased due to the decrease in the net sales and huge increase in the expenses. That is the amount which is available to the shareholders to take. There are 10000 shares of Rs.10/- each. The share capital is constant from the year 2011. Due to the increase in net profit the earnings per share is increased from 2006 to 2012. And decrease in the Net profit and increase in the expenses resulted in the decrease of the EPS in 2013 and 2014.


2014 2013 2012 2011 2010 2009 2008 2007 20060.00

50.00

100.00

150.00

200.00

250.00

300.00

350.00

400.00

EPS

Year

Ratio

Return on Total Assets: It is calculated by dividing Net profit with total assets.

Year Return on Total assets 2006 0.0032007 0.0062008 0.0242009 0.0362010 0.0242011 0.0592012 0.0882013 0.0262014 0.039

Interpretation:

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This is the ratio between net profit and total assets. The ratio indicates the return on total assets in the form of profits.

The net profit is increased in the year 2011 and in 2012 due to increase in profits and decrease in total assets due to depreciation and in 2013 there was a decrease in net profit and increase in total assets compared to 2012. The fixed assets are reduced due to the charge of depreciation and increments in fixed assets but the current assets are increased because of sundry debtors and that effects an increase in the ratio compared with the last year i.e. 2011.


2014 2013 2012 2011 2010 2009 2008 2007 20060.0000.0100.0200.0300.0400.0500.0600.0700.0800.0900.100

Return on assets

Year

Ratio

TURNOVER RATIOS:

Fixed assets turnover ratio (FATR): This ratio is calculated by dividing Net sales with fixed assets.

Year FATR

2006 11.21

2007 13.55

2008 12.80

2009 14.97

2010 31.44

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2011 45.57

2012 18.11

2013 33.75

2014 29.64

Interpretation:

Fixed assets are used in the business for producing the goods to be sold. This ratio shows the firm’s ability in generating sales from all financial resources committed to total assets. The ratio indicates the account of one rupee investment in fixed assets.

The income from services is very much higher in the year 2011 and it has reduced in the year 2012 due to decrease in the net sales.


2014 2013 2012 2011 2010 2009 2008 2007 20060.005.00

10.0015.0020.0025.0030.0035.0040.0045.0050.00

Fixed asset turn over ratio

Year

ratio

Total assets turnover ratio (TATR): It is calculated by dividing Net sales to the Total assets.

Year TATR

2006 0.71

2007 1.06

2008 1.07

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2009 1.11

2010 1.19

2011 2.04

2012 0.84

2013 1.03

2014 1.38


2014 2013 2012 2011 2010 2009 2008 2007 20060.00

0.50

1.00

1.50

2.00

2.50

Total asset turnover ratio

Year

Ratio

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Liquidity and Profitability Analysis:

In the following table the relationship between liquidity and profitability is analyzed with the help of rank correlation.

Source: Financial statements of TEPL (calculated values)

Year CA TA CE EBIT CATA%Rank on CATA(x1)

Return on CE%

Rank on ROCE(x2)

d2=(x1-x2)2

2006 12240646 13064444 13064444 100769 93.69 3 0.5 8 25

2007 8001458 8686469 1955402 99629 92.11 6 2.6 7 1

2008 11629986 12561571 2506725 454536 92.58 5 12.5 3 4

2009 12101431 13207411 3325787 670157 91.63 8 13.7 2 36

2010 38605820 39537405 5686767 1434749 97.64 1 17.2 1 0

2011 46903137 50178137 50178137 4307517 93.47 4 5.9 5 1

2012 37681880 41436517 41436517 5307045 90.94 9 8.8 4 25

2013 46557628 49247791 49247791 1875023 94.54 2 2.6 6 16

2014 29115333 31905685 31905685 1794512 91.25 7 0.4 9 4

112

The relationship between liquidity (measured by Current assets to Total assets (CATA)) and profitability (measured Return on Capital Employed (ROCE)) of TEPL over the period of 9 years is presented in above table. This relationship is established by using Spearman's Rank Correlation Coefficient.

Spearman’s Rank Correlation Coefficient:

Spearman’s Rank correlation coefficient is used to identify and test the strength of a relationship between two sets of data. It is often used as a statistical method to aid with either proving or disproving a hypothesis

The rank correlation between Current assets to Total assets (CATA) and Return on Capital Employed (ROCE) is computed by applying the formula

r (rank) =1-(6 sigma(d2)/n(n2-1) where d=difference in rank and n = number of pairs of observations.

Putting the respective values of d and n in rank correlation formula above we obtain r = 0.067 which indicates that there is a low positive correlation between liquidity and profitability of the company.

To find out the significance of the above result we test the hypothesis as under:

Null Hypothesis: There is significant no direct relationship between Liquidity and Profitability of TEPL i.e. p=0.

Alternate Hypothesis: There is significant direct relationship between Liquidity and Profitability of TEPL i.e. p≠0

tp,n-2=r*under root (n-2)/under root (1-r2)

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By substituting the values of n=9 and r=0.067 we get t=0.18.

Since computed value of t (0.18) is less than the table value of t (i.e. 2.365 at 5% level and 3.499 at 1% level of significance), the null hypothesis, H0: p=0 is accepted both at 5% and 1% level of significance and thus, the alternative hypothesis, H1:p≠ 0 is rejected both at 95% and 99% level of confidence. Therefore, we may conclude that there is no direct significant relationship between liquidity and profitability of the firm under study. This relationship is not statistically significant both at 5% and 1% level.

Multiple Regression Analysis:

In order to find out the influence of liquidity ratios under consideration on profitability of the firm the following linear multiple regression model is used where Dependent variable is y and independent variables are (x1, x2, x3, x4, x5, x6)

y = Return on Capital Employed (ROCE),

x1= Current Ratio (CR),

x2= Quick Ratio (QR),

x3= Current assets to Total assets (CATA),

x4= Working Capital Turnover Ratio (WCTR),

x5= Inventory Turnover Ratio (ITR) and

x6= Debtors Turnover Ratio (DTR).

In this study CR, QR, CATA, WCTR, ITR and DTR have been taken as the explanatory variables and ROCE has been used as the dependent variable.

For selecting the explanatory variables the correlation matrix is constructed giving the correlation coefficients between the explanatory variables and the dependent variables. It revealed that there is a strong correlation between all the variables and are used in multiple regression analysis.

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Liquidity and Profitability Analysis by Using Linear Multiple Regression.

Year

Return on CE(y)

CR(x1)

QR(x2)

ROTA(X3)

WCTR(x4)

ITR(x5)

DCR(x6)

20060.005

0 1.8 0.68 0.003 10.49 2.13 2.39

20070.026

0 1.19 0.97 0.006 7.35 3.06 1.75

20080.125

0 1.13 0.83 0.024 10.11 6.03 2.69

20090.137

0 1.26 0.98 0.036 5.82 4.85 2.353

20100.172

0 1.12 1.03 0.024 11.39 16.75 5.93

20110.059

0 1.11 1.04 0.059 22.62 32.21 5.13

20120.088

0 1.63 1.06 0.088 2.38 4.25 1.72

20130.026

0 1.27 0.88 0.026 5.07 3.67 6.24

20140.004

0 1.39 0.76 0.039 5.39 3.22 7.85

The multiple regression equation is

Y=b0+b1x+b2x2+b3x3+b4x4+b5x5+b6x6 where b1, b2, b3, b4, b5, b6 are the coefficients of x1, x2,x3,x4,x5,x6 respectively

The Multiple Regression is performed by using SAS 9.2 version and by writing the code

The code used was:

(Proc reg data= work. Analysis;

Model ROCE=CR QR CATA WCTR ITR DCR;

run;

quit;)

Here “Analysis” is the Input Data set and “Work” is the Temporary Location of storing Data files and when the regression was performed the output was as follows

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From the output, the multiple regression equation is

Y=3.43-0.26x1-2.32x2-4.23x3-0.13x4+0.09x5-0.09x6

R-squared: It is a statistical measure of how close the data are to the fitted regression line. It is also known as the coefficient of determination, or the coefficient of multiple determination for multiple regression.

The definition of R-squared is fairly straight-forward; it is the percentage of the response variable variation that is explained by a linear model. Or:

R-squared = Explained variation / Total variation

R-squared is always between 0 and 100%:

0% indicates that the model explains none of the variability of the response data around its mean.

100% indicates that the model explains all the variability of the response data around its mean.

R2 in this model is 98.16% which indicates that 98.16% of variation in dependent variable Return on Capital Employed is explained by the six Independent variables (Current Ratio (CR), Quick

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Ratio (QR), Return on Total Assets (ROTA), Working capital Turnover Ratio (WCTR), Inventory Turnover Ratio (ITR) and Debtors Conversion Ratio (DCR))

You can calculate a regression equation by using the same number of data points as you have equation coefficients. However, the regression equation will not be as universal as a regression equation calculated using three times the number of data points as equation coefficients.

Adjusted R 2 : To correct the R2 for such situations, an adjusted R2 takes into account the degrees of freedom of an equation. When you suspect that an R2 is higher than it should be, calculate the R2 and adjusted R2. If the R2 and the adjusted R2 are close, then the R2 is probably accurate. If R2 is much higher than the adjusted R2, then probably model do not have enough data points to calculate the regression accurately.

The formula for adjusted R2:

Adjusted R2 = 1-(1-R2) ((n-1)/(n-m-1))

Where n is the number of data points and m is the number of independent variables.

Then in the output the t value for all the independent variables or Parameter estimates is greater than 1.96 at 95% Level of Significance. It indicates that all the independent variables are significantly contributing in explaining the dependent variable.

The multiple correlation coefficient of ROCE on CR, QR, CATA, WBTR, ITR and DTR is 0.98 which reveals that the profitability of the firm was highly influenced by those explanatory variables. The value of R2 indicates that the explanatory variables taken together contributed about 98% of the variations in the profitability of the company. The regression analysis results also show that goodness of fit of the regression equation is statistically significant at 5% level.

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FINDINGS AND CONCLUSIONS FROM THE STUDY

The working capital management of the company is analyzed and found that the company does not follow any strict credit policies and all the products are customized. The Gross operating cycle and Net operating cycles depend on the type of project they have undertaken.

From the Liquidity ratios it is found that the company is less liquid maintaining current ratio less than 2 and Quick ratio less than 1 which will affect the solvency of the company in long term.

From the financial statements it is found that debt is provided by the company directors without charging an Interest.

From the Profitability ratios it was found that the company’s profit is fluctuated based on the demand for the products and the profit was increasing from 2006 and there was a tremendous increase in the EPS of the company.

Then the relation between Liquidity and Profitability of TEPL by using Spearman’s Rank Correlation Coefficient and by t- test it was found that there was no significant direct relationship between liquidity variable (Current assets to the Total assets) and Profitability variable (Return on Capital Employed).

Then by forming multiple regression between profitability variable (Return on Capital Employed) and the six Independent liquidity variables (Current Ratio (CR), Quick Ratio (QR), Return on Total Assets (ROTA), Working capital Turnover Ratio (WCTR), Inventory Turnover Ratio (ITR) and Debtors Conversion Ratio (DCR)) and found that the multiple correlation coefficient of ROCE on CR, QR, CATA, WBTR, ITR and DTR is 0.98 which reveals that the profitability of the firm was highly influenced by those explanatory variables.

RECOMMENDATIONS:

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The company should keep on revising its Credit Policy which will help company’s effort

to correct the course of the policies and it should tighten its credit policies to the

customers.

The top management should make modifications to the procedural guidelines required for

implementation of the Credit Policy as they may become necessary from time to time on

account of organizational needs.

The company has to invest more in the fixed assets in order to increase their operational

efficiency.

The company should spend in advertisements effectiveness

The company need to increase their workforce especially in sales to acquire bigger chunk

of the market.

The company need to invest and update its IT infrastructure for speedy process.

The company should implement Customer Relationship Management (CRM) as they

have to provide after sales service.

Automated Inventory Management techniques should be updated for easy management of

inventory.

The optimum level of current assets must be maintained in order to minimize the risk of

ideal cash and at the same time protecting its long term solvency.

A separate department for the management of receivables should be established.

REFERENCES:

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BOOKS

1. Financial management , I M Pandey2. Financial Management, Prasanna Chandra3. Corporate Finance, Ivo Welch

PUBLISHED PAPERS/REPORTS

1. A Liquidity Profitability model for Working Capital Management , Mihir Das and Rani Hanuman

2. Linear Goal Programming and its solutions3. Liquidity Management and Profitability of listed Manufacturing Companies 4. Concepts and Approaches of Working Capital Management5. Annual Reports of the company6. http://www.greatlakes.edu.in/pdf/Herald/Vol4/

Impactofworkingcapitalmanagementonliquidityprofitabilityandnon-insurableriskanduncertaintybearing.pdf

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http://www.greatlakes.edu.in/pdf/Herald/Vol4/Impactofworkingcapitalmanagementonliquidityprofitabilityandnon-insurableriskanduncertaintybearing.pdf



Documents

Final Report