Lesson No – 16 – Appraisal of Proposals

Lesson No – 16 – Appraisal of Proposals

 

Financial statements gives an insight into the performance of the unit.This is reflected in the Balance Sheet and Profit and Loss ac.and Funds flow/Cash flow statements.
We therefore restructure these statements in the form of CMA or Balance Sheet Spread and Operating statement.
We examine the firm's performance 
thru 
1 Growth in Sales= Current y's sales - Previous y's / Previous y's sales *100%
Normally there will be increase in sales, it may be in Units or Increase in SP or both. Comment on the trends by comparing ratios for 3 years
2 Margin of Profit
a) Gross margin= GP/Net Sales %
b) Operating profit margin = 
Opr profit/NS %
c) NP Bef.Intt.and Tax/NS%
d) Net profit margin = NP/NS%
Higher the margin higher will be the ratios reflecting better control over expenses /rise in no of units and better operating efficiency.
(NS- net sales;GP gross profit; NP net profit; NPBIT net profit before interest and tax)

2 Utilization of Assets.

A unit invests funds in L and B, P and M, CA like RM,Debtors etc for generating profits.The ratios reflect how these assets have been utilized by the unit
a)Total Asset Turnover = NS/TA
(TA total assets= CA+ FA)
This ratio reflects a rupee invested will yield how much sales.
b) FA turnover ratio =Sales/FA
c) CA turnover ratio = Sales/ CA
Thus gives insight into the efficiency of assets from year to year; improvement will be a boon. Negative trend will have to be studied for causes and correction. Of course too high a ratio especially CA turn over ratio may reflect inadequate investment in CA for the level of sales.

3) Number of Months ratios 
They are closely related with efficiency of utilisation of various CA
i) No of months of RM holdings =
Closing Stocks of RM * 12 /RM consumed
(It can be in days if 360 is used for 12 months)
ii) No of months of SFG holding = Cl stock of SFG* 12 /Total cost of production
For period in days use 360 for12
iii) No of months of holding of FG = CLG.Stock of FG*12/ Total cost of sales
For period in days use 360for 12
iv) No of months to Realisr debtors or credit given for FG = Debtors*12/Gross Sales.
For period in days use 360 for12

Example.: - Say
Closing stock of RM= 150; SFG=102.5 ; FG,= 200;Debtors=600
RM consumerd =1800
Cost of Prod,= 2460 Cost Of Sales=2400 ; Gross Sales= 3600 then
I) RM holding =150*12/1800= 1 month
Ii) SFG period = 102.50*12/2460= 0.5 or half a month
III) FG holding period =200*12/2400= 1 month
Iv) Debtors period = 600*12/3600= 2 months
Thus Working Capital Cycle = 1+0.5+1+2=4.5 months or 150 days
It means for from purchase of RM to Cash he requires 4.5 months or 150 days. Lower the rato better the utilisation of CA and hence profits.
This equation is useful in finding out the Total requirements of Working Capital.
We desire that in projected year at least this trend will be maintained.
If say Debtors period is projected higher reasons be supported by justification. (Say market trends have changed or competitors are giving such a period ; it also may mean that quality of FG is not up to mark or sllugish market etc.

  1. vi) We also work out the
    Credit period availed =
    Sundry Creditors*12/RM Purched.
    Say= 500*12/3000= 2 months of RM on credit.
    This help in determining the Working Capital limit as requirement will be reduced to the extent by which credit for RM is availed.
    The customer always desire to show Minimum Credit period for RM and maximum Debtors period to get Sanction for maximum Working Capital finance/limit.
    The answer to this lies in below mentioned aspects
    (1)If we are accepting that past trends will continue WC should be sanctioned based on past period or no of fays of RM/SFG/FG/Deb/Creditors.
    (2) If we accept any change than past trends customer should give supporting facts and you should be agreeable for it. You should furnish proper logical and factual analysis.
    Each proposal is unique in itself there is no thumb rule but past trends has much more bearing unless fundamentals has undergone changes. Appraisal is therefore not only Science but Art also.
    Now go back to our discussion on Credit report, the market standing and the relationship between the Credit period available and given can be established.
    I will close this aspect assuring u that I will come back tomorrow on Balance Sheet Ratios
    Thanks and good by.