PROFIT PLANNING IN SMALL ENTERPRISE

INTRODUCTIONProfit planning is one of the vitally important methods to assess the operational efficiency of a project and its profitability. Profit is the basic objective of a business enterprise. Profit may be described as the amount left over for the entrepreneur after the goods and materials have been paid and the bills met.

Definition “Profit is a particular species of monetary gain- a monetary gain assured in a particular way. To make a profit in the sense here relevant, implies performing an entrepreneur’s function, hiring the services of other men and selling the products or the goods and obtaining as a reward the difference between outlay and receipt.”

CHARACTERISTICS1) Future

planning2) Dynamic3)

Organisation

4) Performance

5) Participation

6) Individual recognition

7) Excellent direction and control

8) Responsibility reporting

9) Entrepreneurship by exception

10) Standards11) Effective

communication12) Realistic13) Significance14) Feedback

Steps in preparation

of profit

planning

1) A sales budget is prepared

first , then

2) A production budget

3) Direct material budget

4) Purchas

es budget

5) Direct labour

law budget

6) Manufacturing expenses or overhead

budget

7) Invento

ry budgets

8) Distribution and

administrative expense budgets

Other steps follow:

All the data from the above mentioned steps are consolidated into the budgeted income statement

The capital additions budget indicates the planned capital extensions , repairs to be capitalized , building and machinery acquisition and other permanent capital additions

The budgeted balance sheet indicates the effects of planned operations on the assets ,liabilities and capital if the enterprise

The profit plan is put into operation

TECHNIQUES OF PROFIT PLANNING A) BREAKEVEN ANALYSIS: The operational strategy is concerned with

the interplay of project operating costs and operating revenues it can be evaluated in terms of cost-volume-profit(CVP) relationship and operational leverage. The CVP relationship defines the manner in which profits from a project vary with the changes in the levels of the project activity. The operational leverage defines the manner in which the project fixed costs offset these changes.

BREAKEVEN ANALYSIS

B) Ratio analysis: Ratio indicating profitability are calculated on the basis of profit and loss account ; those indicating financial position are computed on the basis of balance sheet and those which show operating efficiency or productivity or effective use of resources are calculated on the basis of figures in the profit and loss account and the balance sheet of enterprise.

Profitability ratios:

These ratios are calculated to learn about the end results of the business activities. With the help of these rations the overall efficiency of a business concern can be assessed. The following are the important profitability ratios.

1) Gross profit ratio•Gross profit ratio=gross profit

/net sales*100

2) Operating ratio

•Operating ratio=operating cost/net sales*100

3) Operating profit ratio•Operating profit

ratio=operating profit/net sales*100

4) Expenses ratio

•Particular expense ratio=particular expenses/net sales*100

5) Net profit ratio•Net profit ratio= net

profit after tax/net sales*100

6) Return on capital employed ratio•Return= net profit/ capital employed*100

7) Return on equity capital ratio•Return= net profit after tax –

preference dividend/ paid up equity share capital*100

C) BUDGETARY CONTROL: Modern business world is full of competition, uncertainty and exposed to different types of risks. The complexity of managerial problem had led to the development of various managerial tools, techniques and procedures useful for the management in managing the business successfully.

CLASSIFICATION OF BUDGET

coverage

capacity

condition

periodparticipatio

n

• Functional• Master• Fixed• Flexible• Basic• Current• Long term• Short term• Authoritative• Participative

Growth strategies

and diversification

INTRODUCTION Growth is always essential for the

existence of a business enterprise whether big or small. An enterprise is bound to die in absence of expansion of its activities. A business firm may be considered to be growing when there is permanent increase in its sales turnover,assets,volume of output etc. Business growth is a natural and on-going process. Many business enterprises started initially small and have become big through continuous growth.

Causes of growth1.Elimination of competition and

Price war.2.Economies of Large scale

business.3.Effect of trade cycles.4.Rise of joint stock companies.5.Improved means of transport

and communication.6.Technological progress.

7.Requirement of large capital.

8.Influence of tariffs and protection policy.

9.Desire to enjoy monopoly power.

10.Rationalization11.Personal ambition.12.Desire for self

sufficiency.13.Government pressure

Different stages of growth The enterprise has to pass

through different stages in their lives just like a human being. It is known as ENTERPRISE LIFE CYCLE.

INTRODUCTION GROWTH EXPANSION MATURITY DECLINE

GROWTH

Enterprise life cycle consists the following five stages:1)INTRODUCTION STAGE: This stage is

also known as start-up stage. It involves the birth and emergence of an enterprise.

Features:

• Production at limited scale.• No competition.• Profits earned.

2) GROWTH STAGE:

The introduction stage is followed by the growth stage. During this stage, the enterprise is known to the market and is widely accepted by the market.Features:•Increase in Production .•Increase in sales.•Increase in profits.•Competitors start entering in the market.

3) EXPANSION STAGE:

During this stage the Business enterprise expands by way of opening its branches and introducing new product lines in this stage.

Features:• Business activities are diversified to reap benefits from the available business opportunities .• New product line is launched in the market.

4) MATURITY STAGE:Expansion stage follows maturity stage. During this stage sales increases at a decreasing rate due to keen competition. As a result, profits of firm decline.

Features:•Increase in sales at decreasing rate.•Decrease in profits.•Keen competition

5) DECLINE STAGE: It is the final stage of business enterprise’s

life cycle. At this stage, the business enterprise finds it difficult to survive either due to the gradual replacement of enterprise product or due to some new innovations or an account of change in customer behaviours.

Features:• Sales drop abruptly.• Enterprise incur losses at an increasing

rate.• Enterprises decide to close production,

at times even business.

Definitions•Strategy- means to achieve objectives. It helps in pursuing activities which move an organization to move from the current position to desired future state.

•Growth Strategy- An organization substantially broadens the scope of one or more of its business in terms of their respective customer group, customer functions and alternative technologies to improve its overall performance.

Main type of growth strategies

Strategic alliance

Joint venture

Acquisition

Merger

MERGERS• In merger two firms, agree to move ahead and exist as a single new company. Merger can be merger of equals : both companies are of equal sizes. •Merger of unequal's : large company merge with smaller one

Voluntary process : consent of both companies. Name of new merged entity is usually a combination of both parent companies Mergers are mostly financed by a stock swap . Both companies surrender their stocks and stock of the new company is issued as a replacement.

TYPES OF MERGER:Horizontal merger : When two merging companies are of the same industry and produce similar products. Example : Footwear Company Merging with Footwear company

Vertical merger : When two companies are producing the same goods, but are at different stages, it is vertical merger. Example : Footwear Company Merging with Leather Tannery

Concentric merger: When two companies are related to each other in terms of customer functions or customer groups. Example : Footwear Company Merging with another specialty Footwear Company .

Conglomerate merger: When two companies operate in different industries. Example : Footwear Company Merging with Pharmaceutical Firms .

ARE ALL MERGERS SUCCESSFUL? HINDALCO-NOVELIS (FAILURE)

Hindalco ( metal maker of Birla group) acquired Novelis for a staggering $ 5.76 billion. Novelis , on a net worth of $ 322 million, had a debt of $ 2.33 billion.

Hindalco took $ 3.13 bn loan to aquire Novelis. Right after the acquisition hindalco came on a rough road.

oWith the debt market tightening , the metal maker is left with no choice but to dilute its equity through a 1:3 rights issue. o Further, high interest costs, which rose by over 490 % loan increased from Rs 3.13 billion in FY 07 to Rs 18.49 billion in FY 08.o Finally Hindalco’s earning per share in FY08 dropped to Rs.15.76, from Rs. 26.73 in FY07 , a fall of 41%

AQUISITIONAcquisition is a deal when one company

takes over another company and buyer becomes sole proprietor.

At times takeover occurs when the target company does not want to be purchased. However with better offering of prices shareholder are attracted by acquirer.

In legal terms, the target company ceases to survive. The buyer swallows the company and the buyer's stock continues to be traded.

Unlike mergers which are friendly, acquisitions can be friendly and unfriendly.

Why M&A OCCUR ? To reduce competition. To increase growth rate & capture a greater market share. To acquire resources to stabilize operations.Disadvantages of M&A Increase of prices. Job losses for employees. Interest of minority shareholders is not protected

JOINT VENTUREAn entity formed between two or more parties to undertake a specified activity together. Parties agree to create a new entity by both contributing equity, and they then share revenue, expenses, and control of the enterprise. The venture can be for one specific project only or a continuing business relationship Eg: Sony Ericsson.

Unlike mergers and acquisitions, in joint venture the parent companies does not cease to exist.

Types of Joint Ventures Between 2 Indian org. in one industry Between 2 Indian org. across different industries. Between an Indian org. & a foreign org. in India. Between an Indian org. & a foreign org. in that foreign country. Between an Indian org. & a foreign org. in third country.

Joint Venture Maruti Udyog Ltd. & Suzuki Motor Corp.Maruti Suzuki is one of India's leading automobile manufacturers and the market leader in the car segment, both in terms of volume of vehicles sold and revenue earned.

Until recently, 18.28% of the company was owned by the Indian government, and 54.2% by Suzuki of Japan.

The Indian government held an initial public offering of 25% of the company in June 2003.

As of May 10, 2007, Govt. of India sold its complete share to Indian financial institutions. With this, Govt. of India no longer has stake in Maruti Udyog. During 2007-08, Maruti Suzuki sold 764,842 cars, of which 53,024 were exported. In all, over six million Maruti cars are on Indian roads since the first car was rolled out on December 14, 1983.

Strategic alliances A strategic alliance is a form of affiliation that involves a mutual sharing of resources or “partnering” to improve efficiency.

In strategic alliances, the focus is on “sharing” of resources rather than seeking change in control. Equity investment in each others company is not any focus.

Types of strategic alliance• Pre competitive alliance : vertical value chain alliances b/w manufacturers and suppliers. • Non competitive alliances : Intra industry partnerships b/w noncompetitive firms like two firms in same industry but different geographical locations. • Competitive alliance : partnerships which brings two rival firms in a cooperative arrangement where intense interaction is necessary. • Pre competitive alliance : partnerships which brings two firms of different industry together to work on well defined industries such as new technology development.

REASONS FOR STRATEGIC ALLIANCE:oMarket entry -A strategic alliance can ease entry into a foreign market . Eg: strategic alliance between British Airways and American Airlines. o Share risk & expenses -firms involved can share risks. Skills+ brand + market knowledge+ assets= synergizing effect .o Gaining Competitive Advantage

PITFALLSo Lack of trust & commitment. o Perceived misunderstanding among partners. o Conflicting goals & interests. o Inadequate preparation for entering into partnership. o Hasty implementation of plans.

Finance management in current operation

INTRODUCTION

Finance for current operations is that capital with which a business works. In fact this capital is that part of the total capital which is used for meeting routine and repetitive expenses of day-to-day business operations.

Definitions: “Working capital means current assets” -

Mead ,Mallot and Field“Working capital is a descriptive of that capital

which is not fixed. But the more common use of the working capital is to consider as the difference between the book value of the current assets and current liabilities.” - Hoagland

DIAGRAMMATIC REPRESENTATION FOR THE FLOW OF WORKING CAPITAL

CLASSIFICATION OF WORKING CAPITAL

z Working capital

Regular Variable

Permanent Reserve Seasonal Special

SOURCES OF WORKING CAPITAL

Fixed working capital1. Shares 2. Debentures3. Public deposits4. Retained earnings5. Loans from financial institutions Variable working capital1. Commercial banks2. Indigenous banks3. Advances4. Trade credit5. Installment credit

WORKING CAPITAL FINANCING AND BANKING POLICY

The bank credit has been subject to regulation in recent years with a view to ensure its equitable distribution to various sectors of Indian economy. In this regard the following reports submitted by three committees are very significant:

1) Dehejia Committee report , 1969

2) Tandon Committee report , 1975

3) Chore Committee report , 1980

DEHEJIA COMMITTEE

1. Dehejia Committee report: in order to ascertain “the extent to which credit needs of industry and trade are likely to be inflated and how such trend could be checked ”, a committee was constituted in 1968 under the chairmanship of Shri V.T. Dehejia. The committee submitted its report in 1968.

TANDON COMMITTEE

2. The recommendations of the Dehejia committee for the improvement of the existing credit system remained unimplemented. Consequently, banks ‘oversold credit’ of which a large part remained unutilized. Mean while in July 1969,14 major commercial banks were nationalized. Nationalization called for a new policy regarding credit system. Accordingly it was felt that there was an urgent need to review the existing credit system. With this end in view, the Reserve Bank of India, in July 1974 set up a study group under the chairmanship of Shri P.L. Tandon to frame the guidelines for the follow up of bank credit. This committee, being headed by Shri P.L. Tandon came to be known as the Tandon committee.

CHORE COMMITTEE

3. The Chore committee was constituted by the Reserve bank of India in April 1979 under the Chairmanship of Shri K.B. Chore, Chief Officer, Department of banking operations and development, Reserve Bank of India to review the then existing system of cash credit and credit management policy pursued by the banks.

PART:IVFINANCE MANAGEMENT IN

EXPANSION OF CAPITAL

Topics covered :• Introduction• Sources of finance

• Ownership securities• Creditorship

securities• Internal

financing• Term loans

INTRODUCTION All businesses need money to finance business activity.

Set up costsDay-to-day running costsCost for expansionList goes on…Business can raise this money by obtaining bank loans or by selling unused assets.

The term ‘expansion of capital’ stands for that amount of capital which is required to create production facilities through purchase of fixed assets such as plant ,machinery , land etc. Fixed capital is required not only for the acquisition of fixed and non-current assets at the start of the business, but is also required for the development, expansion and permanent working capital.

SOURCES OF FINANCE:1) OWNERSHIP SECURITIES: The term ownership securities represents shares.The capital of a company is divided into a number of equal parts

known as shares. Kinds of ownership securities:A) EQUITY SHARES: Also known as ordinary shares represent

the owner’s capital in a company. The holders of these shares are the real owners of the company and have control over the working of the company. The rate of dividend on these shares depend on the profits of the company. Equity capital is paid after meeting all other claims including that of preference shareholders. Equity shareholders take risk both regarding dividend and return of capital.

ADVANTAGES• High Return• Easily Transferable.• These can be easily liquidated.• Right to vote• Right to choose the board of directors.DISADVANTAGES• High Risk• In worst cases less privilege given to equity share holders.

B) PREFERENCE SHARES:As the name suggests, these shares have certain preferences as

compared to the other type of the shares. Shares, often with no voting rights, which receive their dividend before all other shares and are repaid first at face value if the company goes into liquidation are known as Preference shares.

TYPES OF PREFERENCE SHARESPreference shares are divided into:• Cumulative & Non cumulative shares• Redeemable & Non-redeemable• Convertible & Non-convertible shares• Participating and non-participating

ADVANTAGES• These yield fixed rate of returns• It’s a hybrid instrument having some of the characteristics of debentures and equity shares.DISADVANTAGES• They do not provide the investor with any of the voting rights.• If the company gets huge profits then they won’t get any extra bonus.

2) CREDITORSHIP SECURITIES:The term creditorship securities, also known as debit capital,

represents debentures and bonds.

A DEBENTURE or a bond is an acknowledgement of a debt issued by a company under its seal.

ADVANTAGES:

1. Control of company is not surrendered to debenture holders because they do not have any voting rights.

2. Interest on debenture is an allowable expenditure under income tax act, hence incidence of tax on the company is decreased.

3. Debenture can be redeemed when company has surplus funds.

DISADVANTAGES:1. Cost of raising capital through debentures is high of high stamps duty.

2. Common people cannot buy debenture as they are of high denominations.

3. They are not meant for companies earning greater than the rate of interest which they are paying on the debentures

TYPES OF DEBENTURES:

Simple or Unsecured Debentures.

Secured or Mortgaged Debentures.

Bearer Debentures. Registered Debentures. Redeemable Debentures. Irredeemable Debentures. Convertible Debentures. Unconvertible Debentures. First Debentures and Second

Debentures. Guaranteed Debentures. Collateral debentures.

INTERNAL FINANCING: RETAINED EARNINGS OR PLOUGHING BACK OF

PROFITSThe ‘Ploughing Back of Profits’ is a technique of

financial management under which all profits of a company are not distributed amongst the shareholders and dividend, but a part of the profits is retained or re-invested in the company. This process of retaining profits year after year and their utilization in the business is also known as ploughing back of profits.

NECESSITY OF PLOUGHING BACK1) For Replacement of old assets.2) For growth and expansion.3) For meeting fixed and working capital needs.4) For repayment of loans.

MERITS OF PLOUGHING BACK OF PROFITS

To the company:• A cushion to absorb the shocks of economy.• Economical method of financing.• Aids in smooth running of business.• Helps in following stable dividend policy.• Flexible financial structure.• Makes the company self-dependent.• Enables to redeem long-term liabilities.

To the shareholders:• Increase in the value of shares.• Safety of investments.• Enhanced earning capacity.

Term loan: A term loan is granted on the basis of a formal agreement between the burrower and the lending institution. It is for a fixed period and is to be paid back out of cash generations from the operations.

Sources of term lending are:1) Specialised Financial Institutions For Development

Banks. a) Industrial Finance Corporation Of India (IFCI) b) Industrial Credit And Investment Corporation Of

India(ICICI) c) State Financial Corporations (SFCS) d) State Industrial Development Corporations (SID’S) e) Industrial Development Bank Of India (IDBI) f) Unit Trust Of India (UTI) g) Small Industries Development Bank Of India (SIDBI) 2) Commercial Banks

SUMMARY…

As we all know finance is the life blood of any enterprise…..

So in this presentation we have explained from the basic steps of planning to its growth and strategies and finally to its financial aspects in the small scale enterprise….