Professional Documents
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As we all know that the world is changing vary fast, within no time new technology emerges and so the speed with which it is updated is increasing consequently. The practical training in an organization is the great opportunity to apply class room study in to practical scenario. It has enabled me to learn how most of the theory concepts are implemented in the organization. I have visited the company so that as a management student I can get a clear picture of the real world of the business & operations of industry in the training age. I have prepared this report so far as my knowledge is concerned. This report is carried out to have a real & practical experience being the student of the MBA with finance as a specialization. Thus the report is prepared as per our syllabus and the necessary guidance & instruction given by our professor. The report is prepared as per the requirement of the MBA(post graduation) degree.
ACKNOWLEDGEMENT
First and foremost I would like to thank almighty for anything and everything. It give me a great pleasure & satisfaction in presenting this report as a part of the partial fulfillment for the internship program @ Indu Management Institute (IMI), Vadodara. Affiliated by Gujarat Technological University (GTU). I would like to take this opportunity to express my sincere gratitude to several people without whose help and encouragement it would have been impossible for me to carry out the desired work. My special thanks to our director DR. Manish Vyase, my project guide Miss. Harshita Samrani & Mr. Divyesh Patel who helped me in listing of good thoughts & ideas to make this project profile. I would like to thank Mr. Naresh Prajapati, the CMA officer & head of the finance dept of the Kemrock industries and export limited who allows me to take training in this dept and giving me this great opportunity. I would like to thank my parents, all my teachers, friends and colleagues who had directly or indirectly struggled to my glory of work. Thank you
Krunal modi
INTRODUCTION
Kemrock Industries & Exports Ltd. manufactures and exports FRP/GRP (Composite) Products for major industrial sectors such as aerospace, defense, renewable energy, wind energy, railways, chemical processing, oil and gas, water and waste water management, infrastructure, construction, electrical and electronics, marine, telecommunications and many more... A leader in the field of composites in India, the company delivers standard as well as customized solutions that are ideal replacements for conventional materials. The State-of the-Art facility, located close to Vadodara in the western part of India, provides high-quality engineered advanced composite solutions and reliable services, complying with customer specifications as well as national and international standards. The company operates using principles of Total Integrated Management (TIM), ensuring complete customer satisfaction. An end-to-end solution provider, it encompasses conceptual design, prototype development, testing, manufacturing, logistic support, installation and comprehensive after sales service. Kemrock has the unique distinction of commissioning India's first Carbon Fibre Manufacturing facility to cater to Defence, Aerospace & Infrastructure Sectors. Kemrock has established a reputation as a major supplier to key industries by manufacturing first quality material, consistently. In order to do that, a full and wide ranging Quality Assurance Team oversees the manufacture of products at Kemrock, ensuring complete traceability. The Integrated management system is certified under ISO 9001:2008, ISO 14001: 2004 and OSHAS 18001:2007. Kemrock is also proud to be Indias First and only IRIS Certified Company (IRIS - International Railway Industry Standard). Kemrock's state-of-the-art design studio for design and development is endowed with the most talented and experienced team of design engineers who are proficient in the application of advanced software packages for industrial design. Kemrock also boasts of a fully equipped test center,
supporting the needs of its customers and associates. Mechanical Testing and Product Performance Testing Capabilities are supplemented with the most sophisticated material analysis equipment. Kemrock is listed on Bombay Stock Exchange (Scrip Code 526015 and Scrip ID KEMIE) and National Stock Exchange of India (ISIN Code INE99B01012) and has been the proud recipient of many awards along with the prestigious Export Award from The Plastic Export Promotion Council for the years 2003-04 to 2008-09.
BOARD OF DIRECTORS
Mr. Kalpesh Patel (Chairman & Managing Director)
Mr. Kaushik Bhatt Mr. Mukund Bakshi (ceased w.e.f. 28.08.2010) Mr. Navin Patel Mr. Tushar Patel Mr. K. K. Rai Mr. S. M. Hegde (ceased w.e.f. 15.01.2010) Mr. Mahendra R. Patel (appointed w.e.f. 03.06.2010)
CFO
Ms. Usha Moraes
COMPANY SECRETARY
Mr. Dinesh Patel
AUDITORS
H. K. Shah & Co.,Ahmedabad
BANKERS
Allahbad Bank Andhra Bank Axis Bank Exim Bank ICICI Bank Indian Bank Punjab National Bank State Bank of India
HISTORY
2011 2010
Kemrock & DSM sign MOU for Manufacturing of Specialty Resins in India Former President of India Dr APJ Abdul Kalam inaugurated, India's first Carbon Fiber Plant, on 9th May 2010. SAERTEX-KEMROCK India Limited is established as a JV with SAERTEX, GERMANY to serve the Aerospace Market. Kemrock establishes a GLOBAL COMPOSITE VILLAGE at its Vadodara facility New Mass Transportation Division Plant established Continuing expansion to establish one of the largest and most integrated GRP composite manufacturing facilities in the World. Kemrock signs an MOU to Purchase the majority stock in Top Glass SpA Kemrock establishes the Wind Energy Division Resin Plant expansion. Commercial production of filament wound pipe, up to 1.5 metres in diameter. In April 2007, in the face of severe competition from Indian based multinationals, KIEL was awarded by the Indian Government, a contract to manufacture carbon fibre under license, and in collaboration with the National Aerospace Laboratory (NAL). Georgia Pacific & KIEL formed Georgia Pacific Kemrock international private limited to manufacture & supply thermosetting resins to the Indian subcontinent & the GCC countries of the Middle East. KIEL signed a license agreement with Top Glass s.p.a in Italy to manufacture centrifugally cast composite poles. KIEL bought a state of the art machine for the manufacture of Sheet Moulding Compounds (SMC). National Aerospace Laboratories (NAL), a constituent of Council of Scientific and Industrial Research (CSIR), is India's pre-eminent civil R&D establishment in aeronautics and allied disciplines
y y
2009
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2008
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2007
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2006
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2005
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KIEL began Production of Unsaturated Polyester and Vinylesters Commenced Production and Sale of all types of resins
Established a joint venture with Top Glass s.p.a. for manufacture of high end pultruded products and lighting Poles. Obtained ISO 9000-2001 certification KIEL licensed the Production of Phenolic Resins from Georgia Pacific Resins, Inc. This enabled KIEL to become the first manufacturer outside of North America to gain US Coast Guard approval for its grating products. Kemrock Industries and Exports Ltd moved from its limiting city location to a new site at Asoj village, north east of Baroda. KIEL entered into a strategic alliance with Stoncor Group, Inc for the licensed manufacture and supply of moulded & pultruded grating along with pultruded standard structural shapes to Fibergrate, Inc. KIEL manufactured the cable racking on behalf of Fibergrate Inc., thereby beginning their relationship. Kemrock signs a license agreement with Creative Pultrusions, Inc to produce pultruded structural shapes under license. Manufactured Wind Mill Nacelle Covers for Suzlon Energy Ltd. Kemrock Industries and Exports Limited established.
2004
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2003
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PRODUCT DESCRIPTION Carbon fibre:- Kemrocks carbon fibre manufacturing facility is fully integrated, including
polymerisation, wet spinning, oxidation and carbonisation of the fibre as well as all utilities for effluent and waste management.
Mass transportation products 1 Rail coach solutions :- Kemrocks Mass Transportation Division was Indias first IRIS
Certified facility..
2 Bus interiors :- Kemrocks experience in the use and application of composites is bringing
new and innovative ideas to the mass transportation market.
Wind Energy 1 Rotor blades :- Rotor blade production is by resin infusion, manufactured to the highest
international standards in moulds equipped with sophisticated in-built heating, a dedicated vacuum system and pneumatic controls for accurate mould profile alignment.
2 Nacelle covers and Nose cone :- The production of rotor blades is complemented with
nose cone and nacelle cover mouldings, thereby providing a complete composites package for wind energy applications.
Gratings and Pultrusion 1 2 3 4 1 2 3 4 Moulded gratings Handrails & Ladder systems Access systems Cooling Towers Telecom Towers Car park systems Modular houses & shelters Cable management system
Thermosetting Resins
1 Phenolic Resins:- Under the license of Georgia-Pacific Chemicals LLC, USA, GPK offers a
range of Fire Safe Phenolic Resins for specialized high-temperature and fire safe application.
2 Epoxy Resins:- GPK offers a range of versatile Epoxy resins and Hardner systems for
application in industry segments like wind energy, construction/civil engineering, industrial floorings, electrical insulators, adhesives and coatings. Specialty Epoxy resin and Hardner system for manufacture of windmill blades are "Germanischer Lloyd (GL)" approved.
3 Unsaturated polyester Resins :- These are highly effective resins for FRP composites
because they have excellent mechanical and corrosion resistance properties.
Piping system 1 GRP pipes :- Kemrock Corrosion resistant Fibre Glass Reinforced Polymer Composite Pipes
meet the demanding needs of industry to transport corrosive and non-corrosive fluids for various applications including Oil and Gas, Petrochemical, Power Generation, Desalination, Potable Water, Municipal and General Industries.
2 Flanges & Fittings :- Kemrock also manufactures a complete range of composite fittings,
using a variety of connections such as Reka ring, bell and spigot, butt wrap and bolted flange fittings.
2008
INDUSTRY 2.0 for Top Indian SMB in plastic & plastic products
2007
FGI Award for excellence Outstanding Entrepreneur from Federation of Gujarat Industries Vadodara.
INTRODUCTION
A financial performance engagement is an analysis of a companys past and current financial performance and compares such performance to similar sized companies within its industry providing insight into a companys historical growth, profitability, debt capacity and overall liquidity. All such factors can be important indicators of a companys ultimate value. We analyze the past fiveyear history of financial statements as well as financial information relative to your industry. We calculate financial ratios (liquidity, coverage, leverage and operating) for the company, prepare common size financial statements, and analyze the information on a trended and composite basis. A financial performance analysis may provide the following benefits:
y y y y y
Identify financial strengths and weaknesses and evaluate financial performance in relation to the industry performance as a whole, and acquire useful information concerning competitors. Historical financial ratio analysis can be used as an effective preliminary step in preparing a budget or in making a forecast. Evaluate past performance and set objectives for future performance. Also provides an ongoing means to evaluate a companys performance financially. Evaluate a proposed sale, merger or acquisition. Determine the financial strengths and weaknesses of the company and ultimately the transaction. A greater awareness of financial statements and their interrelationship can lead to improved profitability or cash flow.
An 8-10 page report (without financial statement exhibits) is generated. The basis of the comparative analysis may be affected by the nature of the business, its size, geographic location, business practices, and other factors that may introduce differences between the client company and the comparable companies.
This means we need to not only be able to read the financials and see trends, but we also must be able to understand the underlying causes of those trends.
We must be able to compare their cooperative financials to industry benchmarks, peer performance, and company projections. We will then use this information to build strategic plans and financial projections for the coming year. Much of this analysis is common sense analysis. We should be able to scan the cooperatives financial statement and identify factors that impact each statement. The factors that impact long-term growth are most important. The cooperative should pay particular attention to the local savings (loss) of the cooperative. This means that the cooperative only looks at ratios calculated from the earnings and expenses of the main cooperative, not the patronage received from regional investments. Once this common sense analysis is complete, the board can move on to a more in depth study of the cooperative, utilizing common size analysis, peer analysis, an in-depth ratio analysis, working capital analysis, and cash flow analysis.
Peer Analysis
A peer analysis involves comparing the cooperatives performance with the performance of other cooperatives of a comparable size, industry, and primary business type. This is an excellent tool for highlighting the strengths and weaknesses of cooperatives. The peer data to compare to can be obtained from universities, state statistic services, or the companys banker will have some of the data.
Hence, ratio analysis facilitates intra firm comparison. i.e. comparison of your companys performance in the current year with your companys performance in the previous year. It also facilitates inter firm comparison. i.e. comparison of your companys performance in the current year with your competitors performance in the current year. Peer review, as this is called, helps you benchmark your performance with your peers. Ratios help in ascertaining the financial health of the company and also its future prospects. These ratios can be classified under various heads to reflect what they measure. There may be a tendency to work a number of ratios. But we believe that being thorough in the computation and interpretation of a few ratios (Say 20-25) would be ideal, since too much of analysis could lead to paralysis.
Computing Ratios
When a ratio has a P&L figure both in the numerator and in the denominator or has a balance sheet figure both in the numerator and in the denominator it is called a straight ratio. Where it has the P&L figure in the numerator and the balance sheet figure in the denominator or the balance sheet figure in the numerator and the P&L figure in the denominator it is called a cross or hybrid ratio.
Classification of Accounting Ratios / Financial Ratios (A) Traditional Classification or Statement Ratios y Profit and loss account ratios or revenue/income statement ratios Balance sheet ratios or position statement ratios Composite/mixed ratios or inter statement ratios (B) (C) Functional Classification or Significance Ratios or Ratios Classification According to According to Importance Tests y Profitability ratios y Primary ratios y Liquidity ratios y Secondary ratios y Activity ratios y Leverage ratios or long term solvency ratios
A. LIQUIDITY RATIOS
Liquidity refers ti the ability of a concern to meet its current obligations as and when there becomes due. the short the short term obligation of a firm can be met only when there are sufficient liquid assets. The short term obligation are met by realizing amounts from current, floating (or) circulating assets. the current asset should either be calculated liquid (or) near liquidity, they should be convertible into cash. To measure the liquidity of he firm the following ratios can be calculated and analyzed. 1. Current ratio 2. Quick ratio (or) acid test ratio 3. Cash position ratio (or) absolute liquid ratio.
Current Ratio = Current Assets / Current Liabilities Or Current Assets : Current Liabilities
Components :
Current assets
Cash in hand Cash at bank Bills receivable Inventories Work in progress Marketable securities Short term investment Sundry debtors Prepaid expenses
Current liabilities
Outstanding (or) accrued expenses Bank overdraft Bills payable Short term advances Sundry creditors Dividend payable Income tax payable
Components
Quick assets
Cash in hand Cash at bank Bills receivable Marketable securities Short term investment Sundry debtors Prepaid expenses
Current liabilities
Outstanding (or) accrued expenses Bank overdraft Bills payable Short term advances Sundry creditors Dividend payable Income tax payable
B. LEAVERAGE RATIO
The leverage or solvency ratio refers to the ability of a concern to meet its long term obligation. Accordingly, long term solvency ratio indicate firms ability to meet the fixed interest and costs and repayment schedules associated with its long term borrowing. The following ratio serves the purpose of determining the solvency of the concern. 1. Debt equity ratio 2. Proprietor ratio 3. Fixed assets to long term fund
Equation :
Debt Equity Ratio = External Equities / Internal Equities Or Outsiders funds / Shareholders funds
Components:
Outsiders fund
Borrowing fund
Shareholders fund
Equity share capital Reserves and surplus
Components:
Shareholders fund
Equity share capital Reserves and surplus
Total assets
Fixed assets Current assets
Equation :
Fixed Assets to long term Fund = Fixed Assets / long term Fund
C. ACTIVITY RATIO
Funds are invested in various assets in business to make sales and earn profits. The efficiency with witch assets are managed directly affects the volume of sales. An activity ratio measures the efficiency assets these ratios are called turnover ratios because they indicate the speed with which assets are converted or turned in to sales. 1. 2. 3. 4. 5. Inventory turnover ratio Debtors turnover ratio Working capital turnover ratio Fixed assets turnover ratio Creditors turnover ratio
Equation :
Inventory Turnover Ratio = Cost of goods sold / Average inventory at cost Or Net Sales / Inventory
Equation :
Working Capital Turnover Ratio = Cost of Sales / Net Working Capital Working capital = Current assets Current liabilities
Equation :
Fixed Assets Turnover Ratio = Cost of Sales / Net Fixed Assets Net fixed assets = Fixed assets Depreciation
D. PROFITABILITY RATIO
The primary objective of business undertaking is to earn profits. Because profit is the engine, that drives the business enterprise. The important ratio which highlights the profitability of the firm would be as follows. 1. 2. 3. 4. 5. 6. 7. Gross profit ratio Net profit ratio Operating ratio Return on total assets Reserves and surplus to capital ratios Earning per share Return on investment.
Gross Profit Ratio = (Gross profit / Net sales) 100 Net sales = Sales Sales return, Gross profit = net sales COGS
Equation :
Operating Ratio = [(Cost of goods sold + Operating expenses) / Net sales] 100
ROTA = EBIT/ Total assets EBIT= Net income + Interest expenses + Taxes
It reveals the policy pursued by the company with regard to growth shares. A vary high ratio indicates a conservative dividend policy and increased plugging back to profit. Higher the ratio better will be the position. Equation :
Earnings per share (EPS) Ratio = (Net profit after tax Preference dividend) / No. of equity shares
The earnings per share is a good measure of profitability and when compared with EPS of similar companies, it gives a view of the comparative earnings or earnings power of the firm. EPS ratio calculated for a number of years indicates whether or not the earning power of the company has increased.
It is the ratio of net profit to share holder's investment. It is the relationship between net profit (after interest and tax) and share holder's/proprietor's fund. This ratio establishes the profitability from the share holders' point of view. The ratio is generally calculated in percentage. Equation :
Return on share holder's investment = [Net profit (after interest and tax) / Share holder's fund] 100
Net working capital can be positive or negative. When the current assets exceeds the current liabilities are more than the current assets. Current liabilities are those liabilities, which are intended
to be paid in the ordinary course of business within a short period of normally one accounting year out of the current assts or the income business. CONSTITUENTS OF CURRENT LIABILITIES 1) Accrued or outstanding expenses. 2) Short term loans, advances and deposits. 3) Dividends payable. 4) Bank overdraft. 5) Provision for taxation, if it does not amount to approximate of profit. 6) Bills payable. 7) Sundry creditors.
The gross working capital concept is financial or going concern concept whereas net working capital is an accounting concept of working capital. Both the concepts have their own merits.
PERMANENT OR FIXED WORKING CAPITAL Permanent or fixed working capital is minimum amount which is required to ensure effective utilization of fixed facilities and for maintaining the circulation of current assets. Every firm has to maintain a minimum level of raw material, work- in-process, finished goods and cash balance. This minimum level of current assts is called permanent or fixed working capital as this part of working is permanently blocked in current assets. As the business grow the requirements of working capital also increases due to increase in current assets. TEMPORARY OR VARIABLE WORKING CAPITAL Temporary or variable working capital is the amount of working capital which is required to meet the seasonal demands and some special exigencies. Variable working capital can further be classified as seasonal working capital and special working capital. The capital required to meet the seasonal need of the enterprise is called seasonal working capital. Special working capital is that part of working capital which is required to meet special exigencies such as launching of extensive marketing for conducting research, etc. Temporary working capital differs from permanent working capital in the sense that is required for short periods and cannot be permanently employed gainfully in the business.
SOLVENCY OF THE BUSINESS: Adequate working capital helps in maintaining the solvency of the business by providing uninterrupted of production. Goodwill: Sufficient amount of working capital enables a firm to make prompt payments and makes and maintain the goodwill. Easy loans: Adequate working capital leads to high solvency and credit standing can arrange loans from banks and other on easy and favorable terms. Cash Discounts: Adequate working capital also enables a concern to avail cash discounts on the purchases and hence reduces cost. Regular Supply of Raw Material: Sufficient working capital ensures regular supply of raw material and continuous production. Regular Payment Of Salaries, Wages And Other Day TO Day Commitments: It leads to the satisfaction of the employees and raises the morale of its employees, increases their efficiency, reduces wastage and costs and enhances production and profits. Exploitation Of Favorable Market Conditions: If a firm is having adequate working capital then it can exploit the favorable market conditions such as purchasing its requirements in bulk when the prices are lower and holdings its inventories for higher prices. Ability To Face Crises: A concern can face the situation during the depression. Quick And Regular Return On Investments: Sufficient working capital enables a concern to pay quick and regular of dividends to its investors and gains confidence of the investors and can raise more funds in future. High Morale: Adequate working capital brings an environment of securities, confidence, high morale which results in overall efficiency in a business.
EXCESS OR INADEQUATE WORKING CAPITAL Every business concern should have adequate amount of working capital to run its business operations. It should have neither redundant or excess working capital nor inadequate nor shortages
of working capital. Both excess as well as short working capital positions are bad for any business. However, it is the inadequate working capital which is more dangerous from the point of view of the firm. DISADVANTAGES OF REDUNDANT OR EXCESSIVE WORKING CAPITAL 1. Excessive working capital means ideal funds which earn no profit for the firm and business cannot earn the required rate of return on its investments. Redundant working capital leads to unnecessary purchasing and accumulation of inventories. Excessive working capital implies excessive debtors and defective credit policy which causes higher incidence of bad debts. It may reduce the overall efficiency of the business. If a firm is having excessive working capital then the relations with banks and other financial institution may not be maintained. Due to lower rate of return n investments, the values of shares may also fall. The redundant working capital gives rise to speculative transactions
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DISADVANTAGES OF INADEQUATE WORKING CAPITAL Every business needs some amounts of working capital. The need for working capital arises due to the time gap between production and realization of cash from sales. There is an operating cycle involved in sales and realization of cash. There are time gaps in purchase of raw material and production; production and sales; and realization of cash.
Thus working capital is needed for the following purposes: For the purpose of raw material, components and spares. To pay wages and salaries To incur day-to-day expenses and overload costs such as office expenses.
To meet the selling costs as packing, advertising, etc. To provide credit facilities to the customer. To maintain the inventories of the raw material, work-in-progress, stores and spares and finished stock. For studying the need of working capital in a business, one has to study the business under varying circumstances such as a new concern requires a lot of funds to meet its initial requirements such as promotion and formation etc. These expenses are called preliminary expenses and are capitalized. The amount needed for working capital depends upon the size of the company and ambitions of its promoters. Greater the size of the business unit, generally larger will be the requirements of the working capital. The requirement of the working capital goes on increasing with the growth and expensing of the business till it gains maturity. At maturity the amount of working capital required is called normal working capital. There are others factors also influence the need of working capital in a business.
2. SIZE OF THE BUSINESS: Greater the size of the business, greater is the requirement of working capital. 3. PRODUCTION POLICY: If the policy is to keep production steady by accumulating inventories it will require higher working capital. 4. LENTH OF PRDUCTION CYCLE: The longer the manufacturing time the raw material and other supplies have to be carried for a longer in the process with progressive increment of labor and service costs before the final product is obtained. So working capital is directly proportional to the length of the manufacturing process. 5. SEASONALS VARIATIONS: Generally, during the busy season, a firm requires larger working capital than in slack season. 6. WORKING CAPITAL CYCLE: The speed with which the working cycle completes one cycle determines the requirements of working capital. Longer the cycle larger is the requirement of working capital.
7. RATE OF STOCK TURNOVER: There is an inverse co-relationship between the question of working capital and the velocity or speed with which the sales are affected. A
firm having a high rate of stock turnover wuill needs lower amt. of working capital as compared to a firm having a low rate of turnover. 8. CREDIT POLICY: A concern that purchases its requirements on credit and sales its product / services on cash requires lesser amt. of working capital and vice-versa.
9. BUSINESS CYCLE: In period of boom, when the business is prosperous, there is need for larger amt. of working capital due to rise in sales, rise in prices, optimistic expansion of business, etc. On the contrary in time of depression, the business contracts, sales decline, difficulties are faced in collection from debtor and the firm may have a large amt. of working capital. 10. RATE OF GROWTH OF BUSINESS: In faster growing concern, we shall require large amt. of working capital. 11. EARNING CAPACITY AND DIVIDEND POLICY: Some firms have more earning capacity than other due to quality of their products, monopoly conditions, etc. Such firms may generate cash profits from operations and contribute to their working capital. The dividend policy also affects the requirement of working capital. A firm maintaining a steady high rate of cash dividend irrespective of its profits needs working capital than the firm that retains larger part of its profits and does not pay so high rate of cash dividend. 12. PRICE LEVEL CHANGES: Changes in the price level also affect the working capital requirements. Generally rise in prices leads to increase in working capital. Others FACTORS: These are: Operating efficiency. Asset structure. Irregularities of supply. Import policy. Management ability. Importance of labor.
WORKING CAPITAL ANALYSIS As we know working capital is the life blood and the centre of a business. Adequate amount of working capital is very much essential for the smooth running of the business. And the most important part is the efficient management of working capital in right time. The liquidity position of the firm is totally effected by the management of working capital. So, a study of changes in the uses and sources of working capital is necessary to evaluate the efficiency with which the working capital is employed in a business. This involves the need of working capital analysis. The analysis of working capital can be conducted through a number of devices, such as:
1. 2. 3.
Ratio analysis
It is an effective management tool to study the changes in financial position (working capital) business enterprise between beginning and ending of the financial dates.
2. Ask for partial payment up front. Instead of waiting to invoice until a job is completed, ask for a percentage of the bill to be paid before the work starts. For instance, you might charge 40% of the bill as a retainer or proof of good faith with the remainder due on completion of the task. Or break the bill into thirds, asking for a third before work starts, a third while the project is ongoing and a third upon completion. It's a common business practice and one you should be taking advantage of if you can. 3. Give a reward for quick payment. Money you are owed but don't collect is a real cash flow drain. You can get some customer and/or clients to pay immediately by offering them a discount if they pay within a certain time frame, giving your cash flow a nice boost. A 2% discount for paying within ten days is the most common scenario. 4. Go after receivables. Make it a regular practice to review your receivables and identify accounts that are late paying or overdue. Then make the phone call or send out the letter or email requesting payment. Some clients and/or customers just need reminding. And when reminding doesn't work? Time to put the collections agency to work. 5. Pay bills only when they're due. Check your suppliers' payment terms and determine when payment is due (30, 60 or 90 days). Then wait to pay until whenever the due dates are rather than paying right away. Timing your business' bill payments this way will help keep your cash flow flowing, as it will keep the cash in your business longer. These are just some of the things you can do to get your cash flow moving again - some of the quicker, easier things. The other things you can do can take longer to implement but are well worth doing, especially if you are having or anticipate having cash flow problems.
INTRODUCTION
From a commercial standpoint, Economic Value Added (EVA) is the most successful performance metric used by companies and their consultants. Although much of its popularity is a result of able marketing and deployment by Stern Stewart, owner of the trademark, the metric is justified by financial theory and consistent with valuation principles, which are important to any investor's analysis of a company. To many, the EVA metric (also known as "economic profit") basks in a mystique of complexity. But this tutorial will show you that this complexity is only an illusion. In fact, the entire metric is a development of three simple ideas: cash is king; some expense dollars are really investments in "disguise"; and equity capital is expensive. To help you understand EVA and its components, we exploring a different conceptual aspect of economic value added (EVA) and demonstrating the associated calculations. Over the course of these chapters, we build an EVA calculation for the kemrock industries and exports limited (KIEL), a manufacturing company, using recent financial statements. And, at the end of this study of EVA, we compare it to other performance metrics. By the end of this chapter, you will not only be able to calculate EVA for yourself, but also, importantly, understand its strengths and weaknesses, observing how it is ideal for some situations, but also - contrary to some dogma - not necessarily the best performance metric for many other situations. Because the term EVA is trademarked, for conveniences sake, we will instead refer to it as economic profit throughout the chapter. This is a common practice and, for our purposes, there is no difference.
OVERVIEW
Examining the components of economic profit and studying the finer points of its calculation require an understanding of its underlying principles. Here we look at how it matters as a performance measure - which is distinct from a wealth metric - and how it is closely related to market value added (MVA). Finally, in establishing an overall picture of economic profit, we help you undo any perceived complexity by showing how all of the calculations surrounding economic profit originate from three main ideas. To understand economic profit, it helps to distinguish between a performance metric and a wealth metric. A performance metric refers to a measure under company control, such as earnings or return on capital. A wealth metric, on the other hand, is a measure of value that - such as equity market capitalization or the price-to-earnings (P/E) multiple -depends on the stock market's collective and forward-looking view. Now, although these two types of metrics are distinct, they are related. The key criterion for the pairing of a performance and wealth metric is consistency: each half of the pair should reference the same group of capital holders and their respective claims' on company assets. For example, EPS by definition concerns the allocation of earnings to common shareholders; the P/E multiple refers to equity market capitalization, which is the value held by shareholders. Below is a chart listing a few performance metrics and their corresponding wealth metrics. Note that economic profit's corresponding wealth metric is market value added (MVA). We explore this relationship below as we come to understand specifically what economic value is and how works:
Performance metric Return on Equity (ROE), EPS growth Return on Capital (ROC or ROIC), Operating Income Growth Economic Profit Free Cash Flow
Market Value Added (MVA) Equity Market Capitalization (price x common shares outstanding) Total Shareholder Return (TSR)
Economic profit is based on the same idea of the Traditional approach. The only difference is that, under economic profit, the intrinsic value of the firm is broken into two parts: invested capital, plus the present value of future economic profits. Here is the comparison: Traditional Approach Intrinsic Value = Present Value of Future Free Cash Flows
Economic Profit Intrinsic Value = Invested Capital + Present Value of Future Economic Profits As it breaks intrinsic value into parts, you can see why economic profit is often called "residual profit" or "excess earnings". Let's see how this works in Figure 2 below. We are using the same hypothetical assumptions, and the value of the firm's equity remains $40. In this case, however, the green bars in years one through five represent future economic profits, which represent a part of the future free cash flows will therefore always be less than the free cash flows. Later in this chapter we explain the economic calculation of the economic profits, but for now, it's enough to understand that they represent profits earned above the cost of capital.
Economic profits represent the portion of free cash flows after a capital charge is subtracted. In this example, the future economic profits (which we're lucky enough to know) is discounted to a present value of $20 as represented by the tall green bar stacked on top of the dark blue bar, which represents the invested capital portion of $20. Together these contiguous bars show how economic profit divides a company's intrinsic value into two pieces.
The final step in understanding the relationship between these two pieces concerns MVA, which represents how the market values the firm above its invested capital. In our example it is simply the name given to the present value of the future economic profits - the tall green $20 bar. If, for example, this company happened to earn zero future economic profits (zero excess profits), the MVA would be zero, and the company's total value would simply be equal to its invested capital.
Now of course the market does not predict future cash flows (or economic profits) perfectly, so we can speak of MVA in two different ways: the MVA as set by the market and the intrinsic (or theoretical) MVA as set by expected future economic profits. But, just as, according to the traditional valuation model, the firm's market valuation is expected to converge with its discounted free cash flow, the observed MVA is expected to converge with its discounted economic profit value. And here, by "observed MVA" we mean the equity market capitalization, minus the invested capital.
COMPONENTS OF EVA
NOPAT: - Net Operating Profit After Tax
Capital: - Net working capital, net PP&E, goodwill, and other assets y y Net operating assets adjusted for certain accounting distortions Asset write-downs, restructuring charges, Net operating assets: Cash, receivables, inventory, prepaid Trade payable, accruals, deferred taxes Net property, plant, and equipment Non-operating assets: Marketable securities, investments.
Capital charge: - Cost of capital * capital y y y Represents a rental charge for the use of the operating capital Minimum rate of return the operating capital should earn Calculated as the firms weighted average cost of capital
CALCULATING EVA
Three easy steps to find EVA are as follows. 1> 2> 3> Calculation of NOPAT Calculation of invested capital Pulling it all together
1> CALCULATING NOPAT In finding economic profit, the essential step is to calculate net operating profit after taxes (NOPAT), and this chapter looks at how to do it. We get to NOPAT by translating - through a series of adjustments - an accrual-based income statement number into a cash-based profit number. Although there are three basic steps in the process of finding NOPAT, there is no single correct method for arriving at a final number.
The method an investor uses is a matter of how approximate or precise he or she wants to be. Some critics lament that economic profit requires 50-150 adjustments - but many users of economic profit agree that most of the answer is found after a dozen or even fewer adjustments. In fact, beyond a handful of adjustments, you are really only fine-tuning the NOPAT number. And, from an investor's standpoint, a multitude of adjustments simply are not necessary.
In using economic profit, the investor's priority is consistency and comparability. In other words, calculating economic profit with 99.9% precision is less important than ensuring the method of calculation is consistent from year to year and from peer to peer. The Stages of the Process Getting to NOPAT takes three basic steps: 1. Start with earnings before interest and taxes (EBIT). 2. Make the key adjustments - these come in two flavors: a. Eliminating accounting distortions (convert accrual to cash). b. Reclassifying some expenses as investments (i.e. capitalizing them to the balance sheet). 3. Subtract cash operating taxes.
2> CALCULATING INVESTED CAPITAL Calculating invested capital is an important step in finding economic profit because a key idea underlying this metric is charging the company for its use of capital. In order for the company to generate a positive economic profit, it must cover the cost of using the invested capital. There is more than one way to get to invested capital, but here we use the following three-step method: 1. Get invested book capital from the balance sheet. 2. Make adjustments that convert accounting accruals to cash. 3. Make adjustments that recognize off-balance-sheet sources of funds. You will notice that steps 2 and 3 are mirror equivalents of steps we took in earlier chapter to calculate net operating profit after taxes (NOPAT).
3> PULLING IT ALL TOGETHER As a reminder, here is the basic economic profit calculation: Economic Profit = NOPAT - Capital Charge (Invested Capital x WACC) Economic profit is NOPAT minus a capital charge, which represents a sort of rental fee charged to the company for its use of capital. In other words, economic profit is the profits (or returns) our company must generate in order to satisfy the lenders and shareholders who have "rented" capital to the company. Keep in mind that economic profit is a period metric, like earnings or cash flow. The only step that we need to perform before the ultimate economic profit calculation is to estimate the capital charge. As a reminder, here is the basic economic profit calculation: The only step that we need to perform before the ultimate economic profit calculation is to estimate the capital charge. Capital Charge Equals Invested Capital Multiplied by WACC We already have discussed the calculation of invested capital in this chapter. Now we need to estimate weighted average cost of capital (WACC). This is the average return expected by the blended investor base. In order to calculate WACC, we need a cost of debt and a cost of equity.