This is not a good sign for the company since as and when its operations are increasing over the years, it is not able to efficiently manage its working capital to generate more sales. If the company would have maintained the ratio of 2.14 in the year 2009 as well, then by employing Rs. 79,417.88 Millions, it should have generated sales of Rs. 2,08,474.26 Millions as compared to its present sales of Rs. 106,732.29 Millions.
CURRENT RATIO OF VIDEOCON
Current Ratio measures the company’s ability to pay off its current liabilities with the help of its current assets. Higher the current ratio, better it is. This ratio also helps the creditors determine whether a company can meet its short term obligations or not which would help them in making decisions relating to giving credit to the company.
Formula = Current Assets
Current Liabilities
It can be observed from the above table that the current ratio of the firm is increasing over the years from 6.13 in 2007 to 9.7 in 2008 and finally 10.3 in the year 2009. A high current ratio of 10.3 indicates that the current assets of the firm are 10.3 times more than the current liabilities, or to put it in other words, the current assets are 10.3 times sufficient to cover its current liabilities or meet its short term obligations.
FINANCING OF WORKING CAPITAL OF VIDEOCON
Inventories
There are 2 approaches to finance the working capital of an organization which are as follows:
- Conservative Financing Policy
- Aggressive Financing Policy
Conservative Financing Policy:
A Company using this kind of policy for financing its working capital has the following features:
- The company employs more of long term sources of funds and less of bank borrowing to source its working capital
- The cost of funds is higher
- There is a lower probability of technical insolvency.
Aggressive Financing Policy:
A Company using this kind of policy for financing its working capital has the following features:
- The company employs more of short term loans for financing working capital i.e. more of bank borrowing and lesser usage of long term funds
- Lower cost of funds
- Higher probability of technical insolvency
Analysis:
From the above figures and facts, current assets which include inventories like raw materials, WIP, finished goods etc. are high on comparison with the year 2008. Furthermore, the current ratio has increased from 9.7 to 10.3 from the years 2008 to 2009 respectively.
Therefore we can conclude that the company follows conservative policy since it has higher investment in current assets. This leads to lower profitability but at the same time a higher liquidity.
CALCULATION OF OPERATING CYCLE OF VIDEOCON
The operating cycle of a firm refers to the time lag between the company’s time of purchase till the realization of cash from the sales.
The operating cycle contains 5 components which are as follows:
- Raw Material Storage Period
- Conversion Period
- Finished Goods Storage Period
- Average Collection Period
- Average Payment Period
RAW MATERIAL STORAGE PERIOD
Raw Material Storage Period = Average Stock of Raw Materials
Average Daily Raw Material Consumption
Average Stock of Raw Material = Opening Stock + Closing Stock of Raw Material
2
Average Daily Raw Material Consumption = Annual Consumption of Raw Material
360
Raw material storage period refers to the time between the purchases of raw materials till the time of utilization of the same. Lower the raw material storage period, better it is.
It can be observed from the above table that the raw material storage period of Videocon is increasing over the years. It has increased from 56.50 in the year 2007 to 61.33 in the year 2008 to 66.87 days in the year 2009. This shows that the company is blocking more of its funds in the raw materials and might be making bulk purchases so as to avail a nice discount on the raw materials.
CONVERSION PERIOD
Average stock of Work in Progress = Opening stock of Work in Progress + Closing Stock of WIP
2
Annual cost of production = Opening stock of work-in-process + Annual consumption of raw materials + Manufacturing costs such as wages & salaries, power & fuel etc. + Depreciation – Closing work-in-process.
Average Daily cost of production = Annual cost of production
360
Conversion Period = Average Stock of Work-in-Progress
Average Daily Cost of Production
The conversion period refers to how long does it take for the goods in work in progress to be converted into finished goods. Lesser the conversion period, better it is, since more of stock would be produced resulting in a lower cost of production.
From the above table we can observe that the conversion period for Videocon is gradually decreasing from 5.27 days in the year 2007 to 4.63 days in the year 2008 and finally 3.93 days in the year 2009. Therefore, it can be concluded that it takes 3.93 days for the raw materials to get converted into finished goods, and this decrease in the conversion period reflects the increasing efficiency of the firm over the years.
AVERAGE COLLECTION PERIOD
Average Balance of Sundry Debtors = Opening Balance + Closing Balance of A/c Receivable
2
Average Daily Credit Sales = Annual Credit Sales
360
Average Collection Period = Average Balance of Sundry Debtors
Average Daily Credit Sales
The average collection period refers to how long does it take for the company to collect the receivables from its debtors, or how long does it take for a company to collect its sales realizations. Lower the collection period, better it is.
From the above table we can see that the collection period of Videocon is increasing as and when the years pass. It was 52 days in the year 2007 as compared to 53 days in the year 2008 and finally 65 days in the year 2009. This increase in collection period reflects the liberalization of credit policy of the firm, which further results in increase in working capital due to blockage of funds in debtors.
FINISHED GOODS STORAGE PERIOD
Average Stock of Finished Goods = Opening Stock + Closing stock of Finished Goods
2
Average Daily Cost of Sales = Annual Cost of Sales
360
AVERAGE DAILY COST OF SALES:
Finished Goods Storage Period = Average Stock of Finished Goods
Average Daily Cost of Sales
Finished goods storage period refers to the time taken for the finished good to be sold. Lower the storage period better it is, since it will indicate that the sales are made as and when the goods are manufactured and will reduce the cost of storage as well.
From the above table we can observe that the finished goods storage period has increased from 16.81 in the year 2007 to 17.25 in the year 2009. Though it is a minor change, it is not a very positive sign for the company. The company should aim at reducing this time period.
AVERAGE PAYMENT PERIOD
Average Balance of Sundry Creditors = Opening Balance + Closing Balance of Sundry Creditors
2
Average Daily Credit Purchases = Annual Credit Purchases
360
Average Payment Period = Average Balance of Sundry Creditors
Average Daily Credit Purchases
Average payment period refers to the time lag between the purchases made by and organization and making the payment for the same. Higher the payment period, better it is for the company since it gets more time to pay its debts to its creditors.
From the above table it can be observed that the company’s average payment period is declining over the years and it pays off its creditors in an average of 34.66 days of making the purchase in the year 2009 as compared to 35.8 days in the year 2008 and 39.6 days in the year 2007.
OPERATING CYCLE OF VIDEOCON
Gross Operating Cycle = Raw material Storage period + Conversion period + Finished goods storage period + Average collection period
Net Operating Cycle = Gross Operating Cycle – Average Payment Period
It is said that the shorter the operating cycle, the better. But in the above case it can be seen that the operating cycle of Videocon is increasing over the years from 90.98 days in the year 2007 to 99.92 in the year 2008 to 118.39 days in the year 2009.
INVENTORY MANAGEMENT PRACTICES
Annual Report 2009 of Videocon, Pg. 55, Point No. 11
“Inventories are valued at cost or net realizable value whichever is lower. Cost of inventories comprises all costs of purchase, conversion and other costs incurred in bringing the inventories to their present location and condition. Cost is determined on Weighted Average Basis.”
The company follows the weighted average method of inventory management.
Inventory Turnover Ratio
Inventory turnover ratio refers to how many times a company are able to convert its inventory into sales and replace it over a period of time. The formula for inventory turnover is as follows:
Formula = Cost of Goods Sold
Average Inventory
Cost of Goods Sold = Opening Stock + Purchases + Direct Expenses – Closing Stock
Higher the inventory turnover ratio, better it is.
The inventory turnover ratio of Videocon and LG are as follows:
It can be observed from the above table, that the inventory turnover ratio of LG is increasing gradually over the years from 6.14 in the year 2006 to 7.48 in the year 2007 and finally 8.67 in the year 2008. This shows that LG has been able to achieve greater sales over the year.
On the other hand, Videocon’s inventory turnover ratio has declined from 6.47 in the year 2006 to 5.63 in the year 2008. Not only has it declined over the years, but is also lesser than that of LG its main competitor. This indicates that the company has poor sales, in other words the company’s sales are declining over the years, and there might be increase in stock.
Furthermore, a decline in sales might also indicate that the company is losing its customers to its competitors. This is not at all good for the company.
Sources of Inventories of Videocon
INFORMATION ON RECEIVABLE MANAGEMENT OF VIDEOCON
Percentage of Bad Debts in Debtors
NOTE: THE ACTUAL BAD DEBTS ARE NOT MENTIONED IN THE ANNUAL REPORT, SO THEREFORE PROVISION FOR BAD DEBTS IS USED FOR CALCULATION PURPOSES
We can observe from the above table that the percentage of bad debts in the year 2007 was 3.37% which gradually decreased to 3.1% in the year 2008 and finally to 1.6% in the year 2009. This is a very good indication for the company since the debtors prove to be good, and there are lesser bad debts, that means lesser losses for the company.
DEBTORS TURNOVER RATIO:
“Debtor’s turnover ratio / Accounts receivable turnover ratio refers to the velocity of the debt collection of the firm. In simple words it indicates the number of times average debtors (receivable) are turned over during a year.”
Formula for debtor’s turnover ratio = NET CREDIT SALES
AVAERAGE DEBTORS
AVAERAGE DEBTORS = OPENING BALANCE OF DEBTORS + CLOSING BALANCE OF DEBTORS
2
Higher the debtors turnover ratio, better it is. A high debtor’s turnover ratio indicates that the debtors are more liquid, and there is efficient management of debtors on the part of the company. On the other hand, a low debtor’s turnover ratio indicates lack of management of debtors on part of the company, and that the debtors are not that liquid. There is no ideal debtor’s turnover ratio as this varies from company to company and from industry to industry.
Calculation of Debtors Turnover Ratio for Videocon
It can be observed from the above table that the company’s sales have increased gradually from the year 2007 to 2009 from Rs. 87,102.58 Millions to Rs. 106,732.29 Millions respectively. Increase in sales indicates that the company has liberalized its credit policies which have resulted in increase in sales.
The debtor’s turnover ratio for Videocon in the year 2009 is 6.486 which are the lowest in comparison to the three years 2007, 2008 and 2009. This shows that, with the increase in liberalization of credit policy, the debtors have become less liquid as compared to other years.
Comparison of Debtors turnover ratio between Videocon and LG
From the above table we can see that the debtors turnover ratio for videocon is almost half as compared to its rival / comopetitior LG. Therefore, we can conclude that the receivable management of LG is far more efficient than videocon and the company should pay more attention in this parameter.
REFERENCES
- ANNUAL REPORT OF VIDEOCON 2009, 2008, 2007 AND 2006, ANNUAL REPORT OF LG 2009, 2008, 2007, 2006
- http://www.investopedia.com/terms/i/inventoryturnover.asp
- Financial Accounting, Jane L. Reimers
- Financial Management, Prasanna Chandra
http://www.investopedia.com/terms/w/workingcapital.asp
http://www.investopedia.com/terms/w/workingcapitalturnover.asp
Annual Report 2009 of Videocon
http://www.investopedia.com/terms/i/inventoryturnover.asp
http://www.accountingformanagement.com/debtors_or_receivable_turnover_ratio.htm
