One hears a lot of involved , intense debate on Gross Domestic Product, referred to with great reverence as GDP. This then becomes a bench mark and a reference points for ALL market determinants to serve as a credible indicator of the strength of various countries and economies.
GDP is really nothing but the sum total of goods and services of the country, generally calibrated at nominal value.
Among a daunting variety of economic activities, Trading and Manufacturing play a very crucial role…definitely.
While Trading is a different vertical and its fund assessment is relatively easy, based on stock holding and churn ,referred to as Business Cycle, the manufacturing activity presents a far more formidable challenge.
A question can be asked why the use of word “Capital” ? Will Fund not be more appropriate? Yes. The manufacturing units working relentlessly for one objective viz., maximization of profits, which will generate funds for capital formation.
Why and How of it
It may sound a bit clichéd and theatrical , but funds are the blood that course through the veins of businesses and economies, of which industry occupies center stage.
What are funds needed for?
An industrial unit will need money for Land, Plant and Machinery(PM), Office Building and finally for running the unit.
Land , PM etc., are Fixed Assets and are normally funded by the entrepreneurs either through their personal resources OR Term debt, which involves either a one- time disbursal by the lending institution or in tranches , where a Repayment Schedule through Equated Monthly Instalments (EMIs)is fixed for repayment and final liquidation.
Working Capital needs are a bit more detailed, as funds are needed to sustain the business cycle.
What needs to be seen are Risk Factors, such as the over-all business environment ,socio-political developments , work ethics, labour laws, exchange implications, if the unit is cutting across geographies and unarguably the depth and experience of the entrepreneur, with integrity as a factor at the top of the pyramid. It is always preferred that the business man should stick to his knitting.
Working Capital needs are normally assessed on the basis of Credit Monitoring Arrangement and are purveyed on Assessed Banking Finance Basis. In simpler terms , the unit presents its futuristic sales plan for the ensuing year, which has to be realistic , tested on the crucible of last year’s actuals.
So, the unit needs funds for Raw Material, Work –in Process, Finished Goods, Receivables , which normally have a usance tenor of 60-90 days and so on , payment for Sundry creditors and some Administrative and Fixed expenses.
Typically, the Raw Material, having passed through the loop of Work-in Process finds expression in the form of Finished goods and is sent to the Buyer, referred to as Sundry Debtor , who normally negotiates a Credit Period, after which he pays.
Like-wise, on the other side, material bought on cash or credit constitutes a Liability , where payables are required to be honoured.
Tandon Committee constituted by RBI several decades ago, formatted a template which forms the basis of such assessment. The deal is that the borrower will be required to contribute 25% margin on Current Assets, to demonstrate his stake and commitment.
Following ratios are considered hugely reflective of the financial health of the unit.
This is a function of Total Outside Liability / Tangible Net Worth.
It should not be higher than 2: 1..which means that borrowings should NORMALLY not exceed twice the Net worth. Liberal banks are comfortable with a 3;1 ratio as well.
It is worked out by dividing Current Assets with Current Liabilities ( CA/CL) Acceptable normative value is 1.33 : 1.
This allows the borrower to meet his margin of 25 % on Current Assets.
PBT+ Interest*100/ Sales
An industry comparison will test this.
Return on Investment
PBT+ Interest/Capital Employed.
Higher the better.
For industries engaged where seasonality plays an important role, Cash Budgets become more relevant, where Net Profit+ Interest- Depreciation plus Interest form the basis.
Commercial Viability Vs Financial Viability
This watching-from- the-wings ,determinant is often over looked.
Danger in plenty. Yes plenty.
Take the example of a village barber. Alone , in the village he services say, 100 clients. He could be both ensconced commercially and financially in the comfort zone.
Add 2 more barbers in the same village and the whole boat capsizes.
There- fore an over-all , panoramic view of the market situation will only help and save the business from disaster emanating from excess!!!