Welcome students. So, we are discussing the financial statement
analysis with the help of ratio analysis and in the morning we discussed the first two
categories of ratios, these two categories were return on investment ratios and then
the solvency ratios. . So, with the help of RoI ratios we try to
know the return on investment made by any stake holder may be the share holder or the
say especially the share holders who are the internal owners of the company, internal members
of the company, internal suppliers of the company and return on their investment that
with the help of this we try to find out that how much return is going to be available that
is a profit after tax and then we talked about the say EPS earning per share and the EPS
ratios and then the solvency ratios which help us to understand the overall you can
call it as the strength fullness of the business that how strength full the business is, how
powerful the business is. . So, these two ratios, these two set of ratios
and now we moving to the third set of ratios that is liquidity ratios, liquidity ratios,
liquidity ratios. So, when we talk about the liquidity ratios
liquidity means cash ability of the firm, cash ability of the firm, that how liquid
the firm’s assets are, how liquid the firm’s assets are we try to study the liquidity position
because liquidity is a very important part in the firms, liquidity is a very important
part in the firms because if you have the profits, but they are not the liquid profits
you do not have the cash profits then these profits are of no use. Similarly, if you have the assets and these
all assets are the fixed assets we do not have the current assets or we do not have
the cash has one of the assets, so it means those assets are of no use for us. So, because we have to make the payments if
you look at the balance sheet here this is the balance sheet of the firm and in this
balance sheet we see that we have different type of the liabilities and assets here we
talk about the liabilities, here we talk about the assets and when we talk about the liabilities
here is the capital then we have the long term loans different sources then the current
liabilities, current liabilities or the short term liabilities you can say and in the current
liabilities you have the sundry creditors similarly we have the bills payable then we
have some other expense creditors, expense creditors means like your salaries outstanding
salaries, wages or some bills utility bills like these are some of the liabilities. So, when we talk about the current liabilities
here is the sundry creditor’s, bills payable expense creditors then the outstanding salaries
outstanding wages and outstanding bills of the utilities different things are there. Apart from these liabilities we could have
some say short term loans also short term loans and when we talk about the short term
loans yes they are also important source of funding you have the long term source of funding
capital very long then the long term loans which are for 5 to 10 years, then we have
the short term loans which are say if we should put it in this order; this the order is like
when we talk about the current liabilities here are the current liabilities and first
we say for example, the short term loan. So, these are the current liabilities. So, we are a phone is using the long term
sources also then they are very long then the long term source is then they are using
the short term source is as the short term finance as the short term borrowings from
the banks. Then we have the spontaneous finance this
is the third category of the finance there is a sundry creditor’s bills payable and
then the some expense creditors like you are on outstanding salaries, outstanding wages,
outstanding bills of power, electricity, similarly the water of the kind of things. So, these are the source from where the funds
are being generated and when the funds are being generated especially when you talk about
this lower part the current liabilities part here the funds being generated from these
sources they have to be paid in a short time as well, maximum within a period of 12 months
or maximum within a period of 1 year we have to return it back. If we do not pay these funds back to the sources
then its spoils the reputation of the firm and if you have to make the payment on the
due date if you the firm never wants to default in that case we need the proper liquidity. Now, from where the liquidity will come? Say here you talk about we have the fixed
assets, here we have the fixed assets and the fixed assets if you talk about we have
the land buildings plant machinery furniture fit fittings and so many other kind of things. So, these things cannot be sold to repay these
current liabilities it means we have to have some other kind of the assets and these assets
which are used as a source of funding current assets and in the current assets first of
all we take the inventory, inventory is the stock all kind of stocks that is of the raw
material that is of the work in process and that is of the finished goods all three kind
of the stocks are there. Then we take here as the sundry debtors. Sundry debtors are the one other current asset
then we take the bills receivables, bills receivables they are also current assets then
we have say the marketable securities and then we have the cash – cash in hand and cash
at bank, cash at bank and then we have the say prepaid expenses, prepaid expenses, prepaid
expenses. So, see these assets when they are converted
in to cash they generated the cash and this cash is used to pay the first current liability,
short term liabilities and then they are used for the long term liabilities right. So, it means to know the liquidity position
of the firm we have to look at the asset side of the balance sheet of the firm and if you
look at the upper part of the balance sheet you will give you the fixed assets and fixed
assets are of no use as such as for as a liquidity of the short term paying capacity or the firm
is concerned. It means we have to come down to the lower
part and we have to compare this balance sheet where the current liabilities and the current
assets are of importance to us as well as the liquidity ratios are concerned. Only this part of the balance sheet, we do
not care for the upper part of the balance sheet, we do not care how much fixed assets
firm has how much capital and how much long term loans firm has we are only concerned
with how much short term assets firm has, how much short term liabilities firm has,
because if you do not to make the proper use of the fixed assets you need the sizeable
amount of the current assets also right acceptable amount optimum amount of the current assets. And if you want to raise the fixed assets
you need the long term sources and to make the proper use of these long term sources
and to make the proper use of the fixed assets you need the short term sources also and short
term sources are always available and they are continuous in supply, they are always
available to the firms if they are being regularly paid back as in when these current liabilities
are becoming due and they are only possible to be paid if you have the liquid current
assets here. Now, when you talk about the overall liquidity,
we take all the current assets in to account because inventory is also kind of a short
term asset is a current asset within a month two three or four months you can easily convert
that inventory in to the cash or you can sell that inventory in the market. So, maybe we are not selling the inventory
on cash we are selling it on credit. So, maybe we are giving a credit of sale maximum
of two months. So, we will sell the inventory today and even
you sell it on credit. So, after say 60 days you will get this funds
back will be converted in to the cash because inventory first will be converted in to sundry
debtors and sundry debtors will be converted in to cash and if you talk about the time
period in India the credit sales period is normally from 45 to 60 days we do not get
normally in the normal circumstance the form is doing well and their product is equally
acceptable in the market and if there is no issue especially with the product and services
of the firm in that case the normal credit period is from one and half months to the
two months. Now, after two months that inventory will
miss the first inventory will be converted inventory sold today may be on credit will
be converted in to sundry debtors today itself and after two months that will be converted
in to cash. Similarly the sundry debtors already we are
saying that two months maximum, within two months that will be converted in to cash,
same with the case with a bills receivables then we have the another current asset is
the marketable securities. Marketable securities are basically very short
term investment almost liquid investments what happens that when you keep more amount
of cash in hand and cash at bank that does not generate any interest for us, we does
not generate any income for us this cash has no income it does not generate any income
or any output because cash in hand is useless is not generating any income we have kept
it for a day to day expenses. Similarly, when you talk about the cash at
bank, cash at bank also business cash for the cash or the business firms is in the bank
that is in the current account and the current account does not I mean earn any interest
from the side of the bank that is only for keeping the safe amount of the cash. So, whenever you need to have receipt and
payments you can have the receipt and payments through that bank account, but on that bank
account bank does not pay any interest it is not a saving account saving account is
for a individuals and when any firm is having for the short term current receipt and payments
any account they open that is called as the current account. So, current account is also not earning any
interest rather sometime bank charges from the firm for using the current account more
than or beyond a permissible level of transactions. On any transaction current account the number
of transactions permitted per day by the bank is fixed say 3 4 5 transactions, but when
for makes more than the permitted number of transactions in that case the bank has to
charge or the firm has to pay to the bank has the charges for using the current account
beyond the permissible limits. So, this also does not any income and then
we, it means what happens that there is no point to keeping the cash more cash or cash
more than the optimum level in the cash form may be the cash in hand or cash at bank. So, what the firms do that after certain in
that how much cash we normally requires say we go for the process of cash budgeting and
cash budgeting may be if the firm is really very good having very good resources then
the cash budgeting can be on the weekly basis, you make the budget for one week cash budget
for one week you can easily make out that, how much cash we are going to receive in this
week, how much cash we are going to pay in this week and what is going to the difference. If the receipts are going to be more than
the payments in that case we do not need the cash from the bank or in hand. So, we what we do we convert that cash in
to the marketable securities surplus cash in to marketable securities. Marketable securities are like even very short
term investments say called deposits as in when you get the deposits that money to some
other form in the market use and may be as in when you ask within 24 hours that can be
asked back and you can make use of it and for that period of time for which the firm
will make use of this money they will pay the interest. Or sometime it can be weekly deposits fortnightly
deposits or monthly deposits can be given investments or securities can be bought from
the market. So, its better because keeping the cash in
hand or at the bank is not going to earn any interest and we are sure with the help of
cash budgeting that we are not going to earn any interest on we are not requiring cash
beyond particular amount in that case you convert that in to marketable securities and
marketable securities are also current assets very short term assets as in when you go to
convert that in to cash you can sell those securities in the market and convert them
in to cash and then we have the cash itself as I talk to you, but when we talk about the
prepaid expenses they do not generate any cash for us. So, setting this aside, prepaid expenses we
can have cash in hand and cash at bank marketable securities sundry debtors and bills receivables
and inventory these are the all current assets. So, when you have now to maintain balance
between this and this side because if you are having the short term sources to be used
in the firm it means when we are borrowing the money from these sources we have to pay
it back very quickly also and in a very short period we have to return it back also and
that return is only possible when the firm has the sufficient amount of the current asset
because they are the sources of liquidity. So, if you are keeping a sufficient amount
of the current assets and then you have the equal amount of the current liabilities then
any time any current liability becomes due that any means you have sufficient amount
of cash and when the cash adjust we convert the marketable securities in to cash and when
they are also over we can have the sundry debtors. Now, sundry debtors normally the amount will
come on the date of expire on the expiry of the credit period, but there is a source of
funding with the help of sundry debtors that these debtors can be sold to the banks or
may be got discounted from the banks. When we have the sundry debtors and we have
sold the goods some goods firm in the market in that case will be the money is coming after
two months because we have given the credit period to the buyers, but here those bills
can be taken to the bank before the due date we can discuss with the bank that we are sold
these goods to this firm or these different firms they are expected to pay a after two
months or one and half month so, but we need the cash today. So, please keep these sundry debtors with
you or bills with you or invoices with you, give us the money and on the due date when
the firm will pay us we will return your money to you and will settle the account. So, if the buyer is good these sundry debtors
are good accounts who have bought from the firm, from this firm in that case banks may
feel that yes this investment is safe and secured so this no harm in discounting these
bills. So, bank will keep these bills and immediately
up to 80 percent of the bills amount can be given to the firm and on the due date when
the buyer or the say debtor will pay back to the firm either directly the debtor can
pay back to the bank because bill is discounted from the bank. So, seller informs buyer that on the due date
it send the amount to the bank and if it comes to the seller the creditor then the seller
goes to the bank that we have got now the cash and we have received our credit sales
amount. So, you can settle the account at that time
bank will say calculate the first the interest on that 80 percent amount which is given as
advance and then some administrative charges plus commission. So, these three heads bank will charges own
expenses plus interest and after remaining 20 percent it is something is left then it
is paid return back to the firm it is not left to the 20 percent is the banks cost then
at least the firm got 80 percent of the advance 45 or 60 days before. So, sundry debtors are also almost cash they
can easily converted in to cash provided we are sold our goods to the good quality buyers
or the good credible buyers then there is no issue there is no problem as such. And inventory is the least liquid we can say,
but still we are saying that the life of the inventory is also in a few months. We can convert the that inventories sell that
in the market either we can sell it on cash then there is no issue, but we sell it on
credit we converted it into sundry debtors and sundry debtors as I told you can we got
discounted from the bank if we need the funds before the due date. So, this side current assets are funded by
current liabilities, but when the current liabilities become due to be paid cash is
generated by converting this current assets into cash and then cash is used. So, we want to study with the help of liquidity
ratios that what is the extent of the liquidity in the firm. So, it means whether whatever the current
liabilities or spontaneous finance sources the firm has used, if the firm in the position
to pay it as and when as in when they become due to be paid. So, that is the study of liquidity and if
the liquidity position of the firm is good in that case nobody would be bothering about
say for example, we are the suppliers. The two companies – one is xyz limited they
are the buyers of particular raw material and abc limited is the supplier of their raw
material. Now, xyz wants the raw materials supply on
credit and the credit period for two months in that case the abc also has no problem they
can supply the material to xyz limited, but they wanted to be sure that on the expiry
of the credit period whether xyz limited would be able to pay it back to abc or not. And if the abc is sure that yes the firm is
not going to default because sufficient liquidity exist from the, it can be seen from the say
current assets position in that case this firm will be get the automatic supply regular
supply of raw material and as in when the bills become due they have sufficient liquidity
on this side and then the bills can be paid on the due date and the this some invoices
can go on the continuous basis. Similarly, when we talk about the say even
there is expenses credits or sometimes we talk about the say salaries to the employs
salaries also, means employees also do not care they means without any condition, they
keep on giving the services to the firm at least for a period of 30 days. So, the firm gets spontaneous credit of for
30 days, but employees are only sure if there is a sufficient cash available on this side,
if the cash is not available employees may be under the doubt that whether we will get
the salaries paid after 30 days or not. So, we talk about whose other who is the supplier,
similarly talk about the short term loan. Now firm takes short term loan from the banks
normally in India the short term financing to the manufacturing sector firms to any business
sector firms comes from the banks, there is no other source means hardly there is use
of other source. We are 9 10 total source of the short term
finance like you have this loans from banks or cash credit limit from the banks in total
the short term finance from the banks. Second we have the factory, we are forfeiting,
we have public deposits, we have inter corporate deposits, we have commercial paper, we have
the now derivatives also short term derivatives, but hardly these other sources are of any
use in the Indian scenario nobody uses these I mean the other short term sources of finance
because the bank finance in India is very easily available to fulfill the to fulfill
the short term requirements of the firms. But once when banks get short term finance
to the firms they also make the liquidity analysis of the firms. They see that yes we are ready to give you
the working capital loan or working capital in the firm or short term finance in the form
of the cash credit limits, but are we going to get our funds back from you on time or
not. If some loan is given for three months then
yes that loan should be returned by the firm on the expiry of 3 months, there should not
be any default similarly some CC limit is cash credit limit is sanctioned by the bank
to the firm then they should be both the things when you need money you would withdraw the
funds, but when you have to surplus you deposit the funds back in the CC limit. So, these all this liquidity analysis is of
the interest to many stake holders like the banks as the suppliers of the short term finance
may be in the form of the short term loan may be in the form of CC limit or may be has
a discounter of credit sale bills. They need to be sure that yes that firm is
going to have sufficient liquidity and that liquidity is going to have the firm to return
our funds back one. Then is the sundry creditors: sundry creditors
are suppliers generally who has the sundry creditors and they also have the bills means
the firm has the bills payable in favor of them. So, both means all kind of suppliers before
supplying to the firm make the liquidity analysis of the firm that we are ready to supply you,
but are you able to make the payment on the due date may be on the expiry of the credit
period or not. If you are not able to make the payment on
the expiry of the credit period then they will stop the supply of raw material. So, before entering in to any kind of agreement
a long term agreement for supply of raw material their payment should be assured and they also
make the liquidity analysis. Similarly your salaried means employees workers
and similarly the other say suppliers of these utilities they can also make the utility this
liquidity analysis of the firm’s financial position that they will give you may be without
any condition without any kind of the varying factor that we should supply the inputs to
this firm provided the firm is going to make us the payment on the due date and we are
not going to have any problem with regard to the receipt of the payment. So, it means this all the lower part of the
balance sheet is important for us then we are to going to talk about the liquidity analysis
of there that we are going to make the liquidity analysis of the firm. We are only going to talk about the current
assets, and we are going to talk about the current liabilities and with the help of the
current assets and current liabilities, we are going to make sure that whatever the short
term source is or spontaneous finance source firm is going to use the firm is going to
make the payment of these sources on the due date as an when these payment to these sources
becoming due we have the sufficient funds with us and we will be able to make the payment. If this is assured by the firm then would
bothers whether it is bank whether it is supplier ,whether it is employees, whether it is creditors,
anybody is there they will be able to have the better relation with the firm. And another important aspect of looking at
the liquidity position of the firm is that if the firm has a sufficient good liquidity
position in that case the source is from there the long term funds are generated they will
also be little confident that whenever loan will become due to the paid by the firm, the
firm will have the sufficient liquidity and when the interest will be due to be paid by
the firm one of long term loan then they will not be a problem the firm will be able to
make the payment. Similarly, in case of the share capital when
you talk about when the people make investment in the shares of the companies and people
are desiring good amount of the dividend. So, dividend can be paid by the firms who
have the sufficient liquidity and liquidity comes only when the firms has a larger amount
of the sales on cash not on credit and the maximum amount of the profit is in cash. So, that they are also interested in the liquidity
part and then another important component is a fixed assets if the firm has only fixed
assets or very good amount of fixed assets the use of the those fixed assets to a larger
extent will depend upon if the firm has sufficient amount of the liquidity or not. For example if you not have the inventory,
if you your sales are not going to the market if your say sufficient amount of the cash
is not available in that case what these fixed assets will do. So, if you want to make the proper use of
the fixed assets and if you would not to improve it turnover ratio which will be the next set
of discussion for us turnover ratios. So, if you want to maximize use of the fixed
assets you need the sufficient amount of the optimum amount of the current assets. So, liquidity position is important, study
of the liquidity position is important for all and different stake holder you talk it
about that is the suppliers or the employees or the investors or the lenders everybody
is interest in the liquidity then the firm is maintaining sufficient amount of the liquidity
then it is fine nobody bothers they sure that their payments will be made on due date. But when the liquidity is a problem with the
firms then in that case everybody thinks twice or may be thrice or four times whether they
should do business with a particular firm or not. And it has been seen that due to the lack
of liquidity many good firms many properly running firms have become the sick firms. So, study of the liquidity position of the
firm is very very important and they will be analyzing the liquidity position of the
firm, different firms and we will learn how to analyze the liquidity position of the firm
and we will use make use of certain ratios for that and with the help of those ratios
you can easily make out whether the firm is maintaining sufficient liquidity in itself
or not. And this solve all the ratios the liquidity
ratios which are of interest to us and use to us I will be discuss discussing with you
in the next lecture. Thank you very much.