[Music] [Music] welcome students so we were talking about the liquidity ratios and in my previous part of discussion I discussed with you that how we calculate the current ratio and what is the meaning of it and what is the relevance of the current ratio as far as the liquidity management is concerned and the first ratio which is we calculate that is by taking the total current assets divided by the total current liabilities and as I told you that the rule of thumb of this ratio is 1 point 3 3 is to 1 the so normally what happens that say why it is 1 point 3 3 is to 1 earlier the rule of thumb was to each to one current ratio the rule of thumb was 2 is to 1 and now the it is a revised rule is 1 point 3 3 is to 1 so why it has been revised and white has been lowered down now I'll discuss with you just for two minutes the background of lowering the ratio now it is acceptable acceptable ratio is 1 point 3 3 is to 1 hourly this ratio was 2 is to 1 so see when we talk about the current assets because current ratio is the current assets divided by the current liability CA is divided by the CL that is a total current assets divided by the total current liabilities so current assets are two times of the current liabilities if the ratio is 2 is to 1 and current testers are expected to be 1 point 3 3 is to 1 when the current ratio is 1 point 3 3 is to 1 so in this situation why the ratio has been lowered down there issue is which is acceptable now is 1 point 3 3 is to 1 R where what was the situation that when we are required to keep the ratio when the industry is required to keep the ratio 2 is to 1 it means the current assets should be equal to the means 2 times of the current liabilities and when you talk about the current assets what are the current assets say we start with inventory in the balance sheet you say it is inventory then they our debtors then there are the bills receivables then there are the say say marketable securities then there are the say prepaid expenses prepaid expenses and then is the cash and when we are expecting the ratio to be 2 is to 1 it means we are expecting the form the industry to maintain this level of current assets as double of the current liabilities but it's very expensive to maintain the high level of current assets very very expensive and no form can afford to keep high amount of the current assets we call them these are the assets we call them these are the assets inventories here debtors are the assets bills are syllables erasers marketable securities are assets prepaid expenses are asset and cash is also asset but and if you say if you talk about these assets you look at the lower part of the balance sheet if you look at the lower part of the balance sheet here we have the current assets and current assets are interest accrued on investments inventories and readers cash loans and advances these all are the current assets now though these assets are called current assets are called as assets they are assets but in the real sense if I am a businessman and if I am given a chance not to keep any amount of the current assets in my balance sheet or in my concern I would be the happiest person why because current assets only have a cost no returns they only have a cost no returns they don't help any miss the form to earn any return on this investment in the current assets so when there is no return on these current assets why should one keep the current assets in the balance sheet now for example how why there is a no return say for example we talked about the inventory when we keep the inventory in the form we keep the inventory because you cannot sell everything in the market whatever we produce part of our production commercially remains unsaleable because we keep on producing the production processes continuous one we cannot stop the production process that okay I have already produced a lot and first I'll sell that in the market and then again I'll resume the production that's not possible you have to continuously produce the production process is to go on plant cannot be stopped but at the same time everything cannot go to the market means we would like to have a symboi sis kind that say raw material is straightway coming from the supply or supplier or suppliers place a truckload of the raw material is coming straight weight is going to the plant in the plant we are converting that into the finished product and finished product from the plant itself 100% finished product is going to the market and nothing to come never coming to the warehouse as the finished goods we are not required to keep any inventory of the finished goods and everything is straight away from the plant is going to the market so it means I am not keeping any inventory of raw material I'm not keeping an inventory of the working process and I am not keeping any inventory of the finished goods so I am the safest one because when you keep inventory of raw material you have the cost of maintaining that inventory you have the cost of go down you have the cost of people who are looking after that inventory you have the cost of say mr. go down the space the building the human resources so maintaining and managing inventory only has a cost and inventory when you talk about the returns it has no returns means only you will be selling that in the market so you sell this inventory today in the market or sell after three months in the market is going to give you the same price sometime when you sell today's inventory when you sell after three months in the market you get less returns on that you get less returns on that maybe sometimes the price may come down or maybe because of the obsolescence quality may be getting deteriorated or anything may be possible so the turns are going to be maximum what you are going to get today you are going to get up three months and if the price falls down the obstinance quality of that finished goods godown packaging gets disturbed then sometimes the price will go down so price is going to remain the same or is going to get reduced but cost is going to increase because maintaining inventory has a cost you must be knowing about that inventory has three kind of the costs first is that say holding cost then is the stock out cost and then we have the say you can call it as a carrying cost carrying or the holding cost then the say stock out cost and then we have the say managing cost of the inventory itself has a cost so it means you have the cost only in the inventory returns no extra returns are available so if I am given a chance to not to keep the inventory of raw material or the finished goods then I would be the happiest person so why should I keep inventory it has a cost only no extra returns similarly you talk about the debtors who are the debtors when the debtors exists in the balance sheet let us only exist in the balance sheet when we sell them on credit and as a true businessman would I like to sell my production or production in my factory in my unit on credit in the market why should I do that I would be the happiest person if allowed to sell everything on cash but that is not possible because you cannot sell everything total production in the market on the cash basis part of the production has to go to the market on credit basis so debtors come up in the balance sheet we call these debtors as asset but I think I will be the last person who would like to have even not even like to have not even out of the debtors know debtors I don't want to sell on credit and the firm's who are having that commanding position in the market they don't sell anything on the credit they don't sell anything on the credit they sell everything on the cash most of the MNCs who are operating in India for example you talk about the sensing now sensing is having good market for their product so largely they are selling their products they're passing it on to the dealers and dealers are to get it on cash from Samsung because Samsung has a market sensing has a demand for the product why Samsung should give the credit to the reader similarly you talk about the car manufacturing company's car manufacturing companies when they sell the cars to the dealers normally these cars are sold on cash they have to send a draft along with the total demand note they have to send the draft of that total amount and once the company receives a draft and the payment then a truckload of cars is sent so if you have a good demand for our product in the market you have a good market for your product then there is no issue you can even sell everything on cash you can refuse to sell on credit but if there is a problem and you see that today we are even in a competitive economy we are in a competitive era then we are in a highly competitive economy because the effect of liberalisation is that after the liberalisation of Indian economy one thing is has happened that it has improved the supply side once it has approved improve the supply side it means competition has intensified when the competition has intensified it means today there is not only one manufacturer who is selling that one product in the market there are the multiple suppliers who are say manufacturing and selling their product in the market so if the one is not selling on credit other will sell so when the competition has increased supply side has improved now people have lot of options available so it means the companies the manufacturers are bound to sell on credit earlier in the Indian market say for example you talk about the electronics industry there were so many people manufacturing see TVs and other electronic products but leading names were only two in the market one was on EDA second was Videocon so Eneida having the best name in the market at that time till 98 99 or maximum till 2000 they were considered as the best product in the market and anita was selling the costliest color TV in the market and largely they're there they're almost a large part of the transactions were on cash nothing on credit but when this multinational Samsung LG Sony came up to Indian market now these companies are white out of the Indian market they are not existing in the inner marker they are they disappeared from the Indian market today nobody buys on a TV though the TV is existing in the market today nobody buys the Videocon TV though the TV is existing in the market so horrid and Videocon today because of the improved supply side because of intensified competition because of having a better product in the market they have to compulsively sell their product on credit and most of their sales 80% of their sales are on credit and because of the sales that has come up they see when debtors are there are these debtors going to earn anything for this form only forms funds are blocked in these credit sales and whatever the amount of funds are blocked in the credit sales they have to arrange for those funds from the other sources and their cost increases but when you sell this product in the market creditors miss debtors who are bought it on credit they are going to pay after two months or 45 days they are going to okay they are going to pay something extra like therefore the interest part but sometimes or most of the time part of the credit sales are not recovered also and they are called as bad debts they are called as bad debts so bad debts are also there so it means when you are creating the debtors in the balance sheet debtors only have a cost they don't have no returns they don't have any returns only cost so we have to be careful that we should sell as low as possible on the credit and our maximum sales should be on cash but that's not possible because we have to sell it on credit at the same time the forms were selling on credit they also buy on credit their raw material comes on credit we see that bills payable are there the bills payable or sandra creditors are what they are the suppliers accounts who have supplied to the form on credit so debtors Boldin is being balanced by creating the creditors in the balance sheet that if the form is bound to sell the product on credit finished product on the credit they are also entitled to have the credit from their suppliers so this is some voices which keeps on working but as a as a as a businessman if I am given a chance to sell my product in the market I would love to sell everything on cash and nothing on credit and if it does that happens debtors will not exist in the balance sheet and my cost will go down similarly you talk about the bills receivable almost same thing then you talk about the will discuss marketable securities later on we talk about the prepaid expenses would you like to pay for anything in other ones why should I pay for anything or knows if my electricity bill is becoming due after 30 days I should pay it after the due date not before the new name is on that you did not before the due date similarly if I am getting some raw material I'm buying some raw material from some source I would like to pay to that source for the raw material only after receiving the material but not before receiving the material but as the material is of that kind of Miss that nature which material is of that nature which is scarce in supply so to ensure my supply I would have to make advance favors I have to make advance payments to the source and so that my supply of the raw material is assured so when I make these unwise Famers am I getting some discount on that I'm not getting so why should I pay in advance rather it has a cost no returns similarly you talk about the cash you keep cash in hand or you keep cash at a bank in both the cases is going to cause you the cost no returns cash in hand earns nothing for us and cash our bank also doesn't give any returns to the business it's a current account in the bank not savings account and current account doesn't earn any interest for the business only savings account earns and that too very nominal only 4% so I will also won't like to keep cash beyond a particular level so it means all these current assets are causing the cost they are not helping anything to earn extra revenue so I would like to keep either zero amount of current assets or minimum amount of current assets or maximum the amount of current asset I would like to keep is that amount which is called as optimum amount of current asset and to fund these current assets I would like to have sufficient current liabilities with me so that my own investment in the business is very very less so if you are required to keep the double amount of current assets as compared to current liabilities you think how much your cost is going to go up and you see that when it was a closed economy India was a closed economy then competition was not that much so at that time we were ignoring the financial cost we were not bothering about how much is the financial cost for us we were only talking about the production costs we were only talking about the marketing cost we were only talking about the distribution and sales and advertising cost but we had the financial cost but we were we were not careful about the financial cost but if you today keep more funds blocked in the current assets by keeping double amount of the current assets against the current liabilities then your investment in the current assets is going to go up and that investment is costly and if you if you invest extra here your cost increases your returns will get affected because these current assets our current assets we are kept only for months not for years so if you save even a single penny here that will reflect into the increase profits if you invest extra money here that will also reflect into the increased cost so it means nothing extra should be kept here and that's why the current ratio is brought down actually why this 1. 33 current ratio is important this current ratio is important only only and only if any firm has to go for seeking the short term finance from the banks it says this is the requirement of the banks this is not a requirement of anybody else there are many companies in the market who are keeping current results less than the current liabilities and they are running the show with the negative working capital but if we have to go for financing our inventory we borrow money from the banks we for financing our debtors we borrow money from the banks for making the prepaid expenses be borrow money from the banks and sometimes even the cash is also the borrowed cash and that Bank penis comes in the three forms in India one is cash credit limit another is a working capital loan third is a discounting of the credit shield bills so when you have to go to the bank and I would like to share with you that in India most of the short term finance most of the working capital finance in the Indian concerns comes from the banks in India we have 10-12 sources of say short term finance of the working capital finance we have bank finance we have a public deposits we have inter-corporate deposits we have factoring we have commercial paper we have derivatives but hardly these sources are of any use in India as far as the working capital finance is concerned most of the requirements for fulfilling the requirements of working capital finance they are fulfilled through the bank finis now when we go to the bank and seek the working capital or the short term finance from the bank's bank would like to make sure that yes we are ready to give you the short term finis but we would like to make sure that your form is maintaining sufficient liquidity sufficient liquidity and for that they demand that your current ratio earlier if they were demanding that the current ratio should be 2 is to 1 you have to keep two times of the current assets as compared to the current liabilities so that even part of the current assets are not convertible into cash immediately even you have sufficient amount of current assets remaining assets sufficient amount of the current assets are there that the form is maintaining liquidity and form will be making the payment of their finance returning it as and when it becomes due that is the principle as well as interest but if there is a liquidity problem with the firm because they are maintaining very low level of current assets and part of the current asset for example inventory does not become convertible into cash sometime debtors also are not convertible into cash similarly marketable securities are also not easily convertible into cash then you have left with the cash and prepaid expenses are means less liquid so it means and if your cash amount is less available with you other assets are not convertible into cash even though the firm wants to make the payment back to the bank on time but form doesn't have the liquidity so Bank wants that there should be a cushion in terms of the extra current assets and there so it was required to keep the current ratio to is to 1 but now because as I told you after liberalisation when the competition has intensified many multinational companies have entered the Indian market and now for Indian companies also is tough to compete in such a competing environment so now they have also realized that even the finance also has a cost and if they are keeping more amount of the current assets in their balance sheet it means their financial cost is going to go up so they request you to the banks that we should be allowed to bring down the level of current assets so that we can manage our financial cost properly and here now that's why the current ratio has been allowed by the banks to be brought down from that route is to one level to the 1.
33 is to one so that still there is a cushion by one third of the level of current assets they have 33 percent current assets more than the current liabilities so that even part of the current tehsils number one because all the current liabilities are not becoming due to be paid on the same date and same time it means only some of them will become do one second thing is if even one third of the current assets are more than the current liabilities it means even some of the current assets are not convertible into cash still Bank form has sufficient current assets which are convert either convertible into cash either they are in the cash form or they are convertible into cash so it means the liquidity problem is solved and the form has sufficient liquidity all the times and the bank can inch be assured that your funds will be paid back to you as an event they become due so they have agreed there okay Note 2 is 2 1 but still you have to keep a positive current ratio and that positive extent is 1. 33 is to 1 you have to maintain the level of current ratio at the level of 1 point three three is to one so but if you don't need to go to the bank if you don't require any working capital from the bank if you don't need any short-term financial support from the bank then this current ratio is not the mandatory requirement you can even keep 0. 5 is 2 1 is the current ratio no problem but then we have to be careful that when we keep the current ratio very low then the firm has to be very careful that as and when the short-term liabilities become due to be paid there should be sufficient liquidity so they have to maintain the liquidity though they can maintain a negative current ratio but they should not be default on the account of making the payment of the current liabilities as in when they become due because if the firm is not able to make the payment on due date then that situation is called as technical insolvent insolvency of the form form is not insolvent but technically the form is insolvent because they are not able to pay for their current liabilities on the due date so that's a very important issue so you maintain any ratio if you don't want to go to the bank but you care be careful that your payments are made on time and you have sufficient amount of cash you have sufficient amount of liquidity so this is the current ratio importance of the current ratio so now the background is unleaded was 2 is to 1 but because of intensified competition now we are allowed to bring this ratio down and the ratio up to 1.
3 3 is also acceptable and by keeping 33% extra current assets the show can be run so we have discussed the current ratio misser in my previous part of discussion we have calculated the current ratio for the Grasim industries and we found that the current ratio in case of the gresham Industries was somewhere around 1. 25 so [Music] is not a very high amount of the current ratio and we have found it that they are able to maintain the current ratio at this level less than one point three three because they are hardly going to the bank if you look at this they have the short-term pourings they have taken the short-term borings but overall the company's position is so good that it may not be centrally the bank finis it may be from other sources so if they're using the other sources they are not with it specified in the balance sheet that they have the bank borings so when they don't have the bank boring so you look at the current liabilities current liabilities the amount is say 1266 486 corrodes and it is mentioned in the additional information given here that secured loans include short term debt that is 330 1. 2 and unsecured is seventy five point five one so one reason could be that the it's not a bank furnace and even if it is a bank financed then maybe the bank has permitted them to keep the ratio less than one point three three because their overall performance is very good excellent so it means still it's a positive ratio though note though not one point three three to one but normally if a normal firm not like this but not having the sound financial position like this but if a normal form has to go to the market and miss go to the banks for raising the working capital finance in that case they will have to maintain the current ratio 1.
3 3 is to 1 now we will calculate the other issues for Grasim industries and if you calculate the ratios for the Grasim industries the other ratios other liquidity ratios say for example the next ratio is the quick ratio quick ratio this is the quick ratio so if you calculate miss you have to calculate the quick ratio for the Grasim industries and in my previous discussion I told you that the formula for calculating that to Treasury's current assets minus inventory current assets minus inventories divided by the current liabilities this was the formula I discuss with you in my last part of discussion but it can be further more refined further more refined could be that in the denominator also we can make some change and here you can take that current assets - inventories divided by the current liabilities plus short-term debt plus current liabilities dovey when we arrived we were writing when the short-term debt we are writing here the current liabilities increase it means we are including everything we are including the short-term debt also but sometimes for a further refinement of this ratio has been done recently and I would like to make some MSA what we discussed earlier I would like to share with you that you can correct this ratio and calculate by this way that in the denominator you can take that is a current liabilities plus short-term loan net off working capital limit net of working capital limit bottom that only we include that short term debt which is a borrowed money not a working capital limit if some company is having a cash credit limit then that limit is not considered as a current liability because there in the working capital limit in the CC limit we keep on I'll discuss with you the CC limit also that in the next part of discussion but in the CC limit is not a boring kind of only it happens on the continuous basis that whenever you need funds you borrow from that account but whenever you get surplus means you get the sales collection you deposit the funds back into that account that is a CC limit account or the working capital limit account so that much part should be subtracted from the short term debt because their withdrawal so next day we deposit also withdrawal so deposit also but also deposit also so it means that's not a loan that it will become due to be paid after three months or after six months and then then we should have to have the liquidity know we have drawing also we are depositing also we're drawing also depositing also so in that situation that amount should be subtracted so we are writing here current liabilities plus short-term loan net of the working capital limit and if any working capital limit is being used there from the short-term debt that much of the amount should be reduced so this is the formula of calculating the quick ratio so in this case here we talked about the quick ratio here we will say that what is the level of the current assets we have seen earlier and the level of current asset was two three four two point three nine minus inventory and inventories amount is eight twenty four point one four we have to subtract that and in the denominator we have the total amount of the current liabilities is how much one two six six so total is plus provision so it is one four five 0. 06 this is amount of the current liabilities right this is amount of current liabilities and in this we have for calculating the current ratio we added the amount that is four zero six point seven one corrodes that was added as the say short-term debt but if the short-term debt part of ms that part of the short-term debt which is through a working capital limit should be subtracted so let's see is there any amount as a working capital limit we are using so it is given here in the additional information that all short-term debts they represent working capital borings all short-term debts represent the working capital borrowings it means we have not to take the short-term debt into account here so only current liabilities will be taking in the denominator and if we take the current liabilities in the denominator this works out as one four five 0.
