92 INTRODUCTION Financial Management is broadly concerned with the acquisition and use of funds by a business firm. The entire giant of managerial efforts concerned with raising of funds at optimum cost and their effective utilization with a view to maximum the wealth of the shareholders. Financial Management is concerned with the efficient use of an important economic resources; namely, capital funds. Thus, Financial management includes - Anticipating Financial needs, Acquiring financial Resources and Allocating Funds in Business ( i.e. Three A's of Financial Management) The importance of financial management in an enterprise may very well be realized by the following words; Financial Management is properly viewed as an integral part of overall management rather than as a staff specially concerned with fund raising operation. In addition to raising funds, financial Management is directly concerned with production, marketing and other functions within an enterprise whenever decisions are made about the acquisition or distribution of assets"
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INTRODUCTION
Financial Management is broadly concerned with the acquisition and use of funds by a
business firm. The entire giant of managerial efforts concerned with raising of funds at
optimum cost and their effective utilization with a view to maximum the wealth of the
shareholders. Financial Management is concerned with the efficient use of an important
economic resources; namely, capital funds. Thus, Financial management includes -
Anticipating Financial needs, Acquiring financial Resources and Allocating Funds in
Business ( i.e. Three A's of Financial Management)
The importance of financial management in an enterprise may very well be realized by the
following words; Financial Management is properly viewed as an integral part of overall
management rather than as a staff specially concerned with fund raising operation. In
addition to raising funds, financial Management is directly concerned with production,
marketing and other functions within an enterprise whenever decisions are made about the
acquisition or distribution of assets"
The finance function mainly deals with the following functions.
Investment Decisions
Investment decision is concerned with the allocation of capital it has to show the funds can
be invested in assets which would yield benefits in future. This is a decision based on risk
and uncertainty. Finance manager has to evaluate the investment in relation to their expected
return and risk to determine whether the investment is feasible or not. Besides the financial
manager is also entrusted with the management on existing assets. The whole exercise is
called "Capital Budgeting".
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Finance Decisions
This decision is concerned with the mobilization of finance for investment. The finance
manager has to take decisions regarding the acquisition of finance. Whether entire capital
required should be raised in the form of equity capital, the amount should be borrowed totally
or a balance should be struck between equity and borrowed capital has to be decided. Even
the timing of acquisition of capital should also be perfectly made. While determining the
ratio between debt and equity, the finance manager should ascertain the risk involved in
obtaining each type of capital.
Dividend Decision
This decision is concerned with the divisible profits of the company.
i) How much profit is to be flown back by capitalization?
ii) How much cash dividend should be paid to the shareholders?
iii) Maintenance of stable rate over the period, are some of the issues connected with
this decisions
The dividend decision involves the determination of the percentage of profit earned by the
enterprise which is to be paid to its shareholders. The dividend payout ratio must be
evaluated in the light of the objective of maximizing shareholders wealth. Thus, the dividend
decision has become a vital aspect of financial decision.
The inter relationship between market value, financial decisions, risk-return and tradeoff is
depicted in the chart.
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Financial Manager
Maximization of Share Capital
Financial Decisions
FundsRequirement
Decision
FinancingDecision
InvestmentDecision
DividendDecision
Return Risk
Trade Off
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IMPORTANCE OF FINANCIAL MANAGEMENT
Financial Management is indeed the key to successful business operations. Without proper
administration and effective utilization of finance, no business enterprise can utilize its
potentials for growth and expansion.
Successful Promotion
Successful promotion of a business concern depends upon efficient financial management. It
the plan adopted fails to provide adequate capital to meet the requirements of fixed and
working capital and particularly the later, the firm cannot carry on its business successfully.
Smooth Running
Finance is required at each stage of the business such as promotion, incorporation,
development, expansion and management of day-to-day expenses, proper financial
administration becomes necessary for the smooth running of a business enterprise.
Decision Making
Financial Management provides scientific analysis of all facts and figures through various
financial tools such as ratio analysis, variance analysis, budgets etc.
Solutions to financial Problems
Financial Management helps the top management by providing solutions to the financial
problems faced by it.
Measure of Performance
Financial management is considered as a yard stick to measure the performance of the firm.
The field of capital budgeting is both comprehensive and challenging. It is clearly plays a
vital role in assigning most business firms to achieve there various goals (e.g., profitability,
growth, stability, risk reduction, social goals, etc) it has been closely allied to the economic
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problem. This is rather broadly defined as the allocation of scarcer resources among
competing alternatives.
Capital budgeting is the process of making investment decisions in capital expenditures. A
capital expenditure may be defined as an expenditure the benefits of which are expected to be
received over period of time exceeding one year. The main characteristic of a capital
expenditure is that the expenditure is incurred at one point of time whereas benefits of the
expenditure are realized at different points of time in future. In simple language we may say
that a capital expenditure is an expenditure incurred for acquiring or improving or improving
the fixed assets, the benefits of which are expected to be received over a number of years in
future.
This project presents two versions of heuristic algorithm to solve a model of capital
budgeting problems I a decentralized multidivisional firm involving no more than two
exchanges of information between headquarters and divisions. Head quarter make an
allocation of funds to each division based upon its cash demand and its potential growth rate.
Each division determines which projects to accept. Then, an additional iteration is performed
to define the solution. To take up a new project, involves a capital investment decision and it
is the top management’s duty to make a situation and feasibility analysis of that particular
project and means of financing and implementing it financing is a rapidly expanding field,
which focuses not on the credit status of a company, but on cash flows that will be generated
by a specific project.
The capital budgeting decisions procedure basically involves the evaluation of the
desirability of an investment proposal. It is obvious that the firm must have a systematic
procedure for making capital budgeting decisions. The procedure for making capital
budgeting decisions must be consistent with objective of wealth maximization.
In the form of either debt or equity, capital is a very limited resource. There is a limit to the
volume of credit that the banking system can create in the economy. Commercial banks and
other lending institutions have limited deposits from which they can lend money to
individuals, corporations, and governments. In addition, the Federal Reserve System
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requires each bank to maintain part of its deposits as reserves. Having limited resources to
lend, lending institutions are selective in extending loans to their customers. But even if a
bank were to extend unlimited loans to a company, the management of that company would
need to consider the impact that increasing loans would have on the overall cost of financing.
In reality, any firm has limited borrowing resources that should be allocated among the best
investment alternatives. One might argue that a company can issue an almost unlimited
amount of common stock to raise capital. Increasing the number of shares of company stock,
however, will serve only to distribute the same amount of equity among a greater number of
shareholders. In other words, as the number of shares of a company increases, the company
ownership of the individual stockholder may proportionally decrease.
The argument that capital is a limited resource is true of any form of capital, whether debt or
equity (short-term or long-term, common stock) or retained earnings, accounts payable or
notes payable, and so on. Even the best-known firm in an industry or a community can
increase its borrowing up to a certain limit.
Faced with limited sources of capital, management should carefully decide whether a
particular project is economically acceptable. In the case of more than one project,
management must identify the projects that will contribute most to profits and, consequently,
to the value (or wealth) of the firm. This, in essence, is the basis of capital budgeting.
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Definitions
“Capital Budgeting is along term planning for making and financing proposed capital
outlays”
- T. Horn green
“ A budget is an estimate of future needs arranged according to at an orderly basis covering
some or all the activities of an enterprise for a definite period of time.”
- George R. Terry
“Budget as a financial and / or quantitative statement prepared to a definite period of time, of
the policy to be pursued during that period for the purpose of attaining given objective.”
- ICMA, London
Need of capital budgeting:
The importance of capital budgeting can be well understood from the fact that unsound
investment decision may prove to be fatal to the very existence of the concern. The need,
significance or importance of capital budgeting arises mainly due to the following.
Large investments
Long – term commitment of funds
Irreversible nature
Long – term effect on profitability
Difficulties of investment decisions
National importance
Objectives for capital budgeting:-
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1. It determines the capital projects on which work can be started during the budget period
after taking into account their urgency and the expected rate of return on each project.
2. It estimates the expenditure that would have to be incurred on capital projects approved
by the management together with the sources from which the required funds would be
obtained.
3. It restricts the capital expenditure on projects with in authorized limits.
Types of capital budgeting decisions:-
Capital budgeting decisions are of paramount importance in financial decision making. In
first place they affect the profitability of the firm. They also have a bearing on the
competitive position of the firm because they relate to fixed assets. The fixed assets are true
goods than can ultimately be sold for profit. Generally the capital budgeting of investment
decision includes addition, disposition, modification and replacement of fixed assets.
TYPES OF CAPITAL BUDGETING
EXPANSION OF EXISTING BUSINESS
EXPANSION OF NEW BUSINESS
REPLACEMENT& MODERNIZATION
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EXPANSION OF EXISTING BUSINESS:
A company may add capacity to its existing product lines to expand existing operations. For
example I.C.M Pvt Ltd may increase its plant capacity to manufacture more detergents soaps
& powder. It is an example of related expansion.
EXPANSION OF NEW BUSINESS:
A firm may expand its activities in a new business expansion of a new business requires
investment and new kind of production activating with in the firm. If packing manufacturing
company invests in a new plant and machinery to produce ball bearings, which the firm has
not manufactured before, this represents expansion of new business or unrelated
diversification. Sometimes accompany acquires existing firms to expand its business.
REPLACEMENT AND MODERNIZATION:
The main objective of modernization and replacement is to improve operating efficiency
reduce costs. Cost saving will reflect in the increased profits, but the firm’s revenue may
remain unchanged. Assets become outdated and absolute with technological changes. The
firm must decide to replace those with new assets that operate more efficient and economical
assets and therefore, are also called cost – reduction investment.
However replacement decision that involve substantial modernization and technological
improvements expand revenues as well as reduce costs. Yet another useful way to classify
investment is as follows:
Mutually exclusive investment
Independent investment
Contingent investment
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CAPITAL BUDGETING INVOLVES:
Committing significant resources
Planning for the long term 5 to 50 years.
Decision making by senior management
Forecasting long term cash flows
Estimating long term discount rates & analyzing risk.
FACTORS FOR CAPITAL BUDGETING:-
Cost of acquisition of permanent asset as land and building, plant and machinery,
goodwill etc.
Cost of addition, expansion, improvement or alteration in the fixed assets.
Cost of replacement of permanent assets.
Research and development projects cost, etc.
SIGNIFICANCE OF CAPITAL BUDGETING:-
Capital budgeting decisions deserve to be treated in a different manner as there are
conceptual problems involved which necessarily makes the decision process more complex,
which this makes things more difficult for the decision process maker, it also makes the
problem more challenging. There are several practical reasons for placing greater emphasis
on capital expenditure decisions.
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1. LONG TERM PERIOD:-
The consequences of capital expenditure decisions extended far into future. The scope of
current manufacturing activities of a organization is governed largely by capital expenditures
in the past. Likewise, current capital expenditures decision provides the frame work for
future activities.
2. IRREVERSIBILITY:
The markets are used for capital equipment in general is ill – organized. Further, for some
types of capital equipment, custom made to meet specific requirements, the market may
virtually be non – existent.
3. SUBSTANCIAL OUTLAY:
Capital expenditure usually involves substantial outlays. An integrated steel plant, for
example, involves an outlay of several thousand millions. Capital costs tend to increase with
advanced technology.
CAPITAL BUDGETING PROCESS:-
The preparation of the capital budget is a process that lasts many months and is intended to
take into account neighborhood and bough needs as well as organization wide. The process
begin in the fall, when each of the segment holds public hearings, each community board
submits a statements of its capital priorities for the next fiscal year to the managing director
and appropriate borough chairmen. The capital budgeting process involves 8 steps explained
in theoretic as follows:
Identification of investment proposals
Screen proposals
Evolution of various proposals
Fixing priorities
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Final approval
Implementing proposals
Performance review
Feed back.
1) IDENTIFICATION OF INVESTMENT PROPOSALS:-
The capital budgeting process begins with the identification of investment proposals. The
investment proposals may originated from the top management or from any officer of the
organization. The department head analyses the various proposals in the light of the
corporate strategies and submit the suitable proposal to the capital budgeting committee in
case of the organizations concerned with process of long – term investment proposals.
Identification of investment ideas it is helpful to :
Monitor external environment regularly to scout investment opportunities.
Formulate a well defined corporate strategy based on through analysis of strengths,
weaknesses, opportunities and threats
Share corporate strategy and respective with persons.
Motivate employees to make suggestions.
2) SCREEN PROPOSALS:-
The expenditure planning committee screen the various proposals received from different
departments in different angles to ensure that these are in selection criteria of the
organization and also do not lead to department imbalances.
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3) EVALUTION OF VARIOUS PROPOSALS:-
The next steps in capital budgeting process in to evaluate the probability of various
probability the independent proposals are those which do not complete with one another and
the same way be either accepted or rejected on the basic of a minimum return on investment
required.
4) FIXING PRIORITIES:-
After evaluating various proposals, the unprofitable or uneconomic proposals may be
rejected straight away. But it may not be possible for the organization to invest immediately
in all the acceptable proposals due to limitations of funds. Hence, it is very essential to rank
the various proposals and to establish priorities after considering urgency, risk & profitability
involved the criteria.
5) FINAL APPROVAL:-
Proposals meeting the evaluation and other criteria are finally approved to be included in the
capital expenditure budget. However proposals involving smaller investment may be
decided at the lower levels for expeditious action. The capital expenditure budget lay down
the amount of estimated expenditure to be incurred on fixed assets during the budget period.
6) IMPLEMENTING PROPOSALS:-
Preparation of a capital expenditure budgeting & incorporation of a particular proposals in
the budget does not itself authorize to go ahead with implementation of the project. A
request for authority to spend the amount should be made to be the capital expenditure
committee which may like to review the profitability of the project in changed
circumstances. In the implementation of the projects networks techniques such as PERT &
CPM are applied for project management.
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7) PERFORMANCE REVIEW:-
In this stage the process of capital budgeting is the evaluation of he performance of the
project. The evaluation is made through post completion audit by way of comparison of
actual expenditure on the project with the budgeted one and also by comparing the actual
return from the investment with the anticipated return. The unfavorable variances if any
should be looked into and the causes the same be identified so that identified so that
corrective action may be taken in future.
It throws light on how realistic were the assumptions underlying the project.
It provided a documented log of experience that is highly valuable for decision making.
8) FEEDBACK:-
The last step in the capital budgeting process is feedback from employee involved in the
organization. If any consequences are there the process come to 1st step of the process.
GUIDELINE FOR CAPITAL BUDGETING:-
There are many guidelines for capital budgeting process either it is long – term plan.
The major points are:
Need and objectives of owner
Size of market in terms of existing & proposed product lines and anticipated growth of
the market share
Size of existing plants & plans for new plant sites and plant
Economic conditions which may affect the firm’s operations and
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Business and financial risk associated with the replacement & existing assets of the
purchases of new assets.
CONTENTS OF THE PROJECT REPORT:-
Raw material
Market and marketing
Site of project
Project engineering dealing with technical aspects of the project
Location and layout of the project building
Building
Production capacity
Work schedule
CRITERIA FOR CAPITAL BUDGETING:-
Potentially, there is a wide array of criteria for selecting projects. Some shareholders may
want the firm to select projects that will show immediate surges in cash flow, others may
want to emphasize long - term growth with little importance on short – term performance
viewed in this way, it would be quite difficult to satisfy the differing interests of all the
shareholders. Fortunately, there is a solution.
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METHODS FOR EVALUATION:-
In view of the significance of capital budgeting decisions, it is absolutely necessary that the
method adopted for appraisal of capital investment proposals is a sound one. Any appraisal
method should provide for the following.
a) A basis of distinguishing between acceptable and non acceptable project.
b) Ranking of projects in order of their desirability.
c) Choosing among several alternatives
d) A criterion which is applicable to nay conceivable project.
e) Recognizing the fact that bigger benefits are preferable to smaller ones and early
benefits to later ones.
There are several methods for evaluating the investment proposals. In case of all these
methods the main emphasis is one the return which will be derived on the capital invested in
the project.
The following are the main methods generally used:
Capital Budgeting Techniques
NDCF criteria DCF criteria
Pay back period (PBP) Net present value (NPV)
Accounting rate of return (ARR) Internal rate of return (IRR)
Profitability index (P.I)
NDCF criteria:
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(a) Pack Back Period:
The pay back period one of the most popular and widely recognized additional method of
evaluation investment proposals. Pay back period is number of years required to recover the
original cash outlay invested in a project.
If the project generates constant annual cash flows, the pay back period can be computed by
dividing cash outlay by the annual cash inflows.
Pay back period =
Co = Initial investment
C = Annual cash inflows
In the case of un equal cash inflows, the pay back period can be found out by adding up the
cash inflow until the total is equal to the initial cash outlay.
Merits:-
1) This method is simple to understand and easy to calculate.
2) Surplus arises only if the initial investment is fully recovered. Hence, there is no
profit on any project unless the pay back period is over.
3) When funds are limited, projects having shorter payback period should be
selected, since they can be rotated more number of times.
4) This method is focuses on projects which generates cash inflows in earlier years.
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Limitations:
1. Administrative difficulties may be faced in determining the maximum acceptable pay
back period.
2. it stresses on capital recovery rather than profitability
3. it does not consider the return from the project after its payback period.
(b) Accounting Rate of Return (ARR):
The accounting rate of return (ARR) also known as the return on investment (ROI) uses
accounting information, as revealed by financial statements, to measure to profitability of an
investment. The accounting rate of return is the ratio of the average after fax profit divided
by the average investment if it were depreciated constantly.
ARR =
Merits:-
1) This method is simple to understand
2) It is easy to operate and compute
3) Income throughout the project life is considered.
4) It can be readily calculated using the accounting data.
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Limitations:-
1) It does not consider cash inflows which is important project evaluation rather than
PAT
2) It takes the rough average of profits of future years. The pattern or fluctuations in
profits are ignored.
3) It ignores time value of money, which is important in capital budgeting decisions.
DCF Criteria:
(a) Net Present Value (NPV)
The Net Present Value (NPV) method is the classic method of evaluating the investment
proposals. If is a DCF technique that explicitly recognizes the time value at different time
periods differ in value and comparable only when their equipment present values – are found
out.
NPV =
NPV =
Where
NPV = Net Present Value
Cfi = Cash flows occurring at time
K = The discount rate
n = life of the project in years
Co = Cash outlay.
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Merits:
1) NPV method takes account the time value of money
2) All cash inflows are considered
3) All cash inflows are converted into present value
4) It satisfies value additively principle i.e., NPV of two or more projects can be added.
Limitations:
1) It may not satisfactory answer when the projects being compared involved different
amounts of investment.
2) It is difficult to use
3) It may lead when dealing with alternative projects or limited funds.
4) It involves difficult calculations
5) In involves forecasting cash flows and applications of discount rate.
(b) Internal Rate of Return (IRR):
The internal rate of return (IRR) method is another discounted cash flow technique which
takes account of the magnitude and thing of cash flows, other terms used to describe the IRR
method are yield on an investment, marginal efficiency of capital, rate of return over cost,
time – adjusted rate of internal return and so on.
NPV =
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Where
Cfi = Cash flows occurring at different point of time
K = The discount rate
n = Life of the project in year
Co = Cash out lay
SV & WC = Salvage value and working capital at the end of the n years.
IRP =
Where
L = Lower discount rate at which NPV is positive
H = Higher discount rate at which NPV is negative
A = NPV at lower discount rate, L
B = NPV at higher discount rate, H
Merits:-
1) This method considers the time value of money.
2) All cash flows are considered.
3) It has psychological appeal to the users.
4) The percentage figure calculated under this method is more meaningful and
acceptable, because it satisfies them in terms of rate of return on capital.
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Limitations:
1) It may not give unique answer in all situations.
2) It is difficult to understand and use in practices.
3) It implies that the intermediate cash inflows generated by the project.
(c) Profitability index (PI)
Yet another time – adjusted method of evaluating the investment proposals is the benefit –
cost (B/C) ratio or profitability index (PI) required rate of return, to the initial cash out of the
investment.
PI =
Where
PV = Present Value
Merits:-
1) This method considers the time value of money.
2) All cash inflows are considered.
3) It is better evaluation technique than NPV.
Limitations:-
It fails as a guide in resolving capital rationing when projects are indivisible.
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COMMITTEE IN CAPITAL BUDGETING
CAPITAL COMMITMENT PLAN:-
The progress of project included in the capital budget, a capital commitment plan is issued
three times a year. The commitment plan lays out the anticipated implementation schedule
for there current fiscal and the next three years. The first commitment plan is published
within 90 days of the adoption of the capital budget. Updated commitment plans are issued
in January & April along with the company’s budget proposals.
The commitment plan translates the appropriations approved under the adopted capital
budget into schedule for implementing individual projects. The fact that funds are
appropriated for a project in the capital budget does not necessarily mean that work will start
or be completed that fiscal year. He choice of priorities and timing f projects is decided by
office management & budget in consultation with the agencies along with considerations of
how much the managing director thinks the organization can afford to append on capital
projects overall.
The capital commitment plan lays out the anticipated implemented schedule for capital
projects and is one source of information on how far along projects are although not a
consistent or always useful one. The adopted commitment plan is usually published in
September, & then updated in January & April.
CHIEF EXECUTIVE
BUDGET OFFICER
BUDGET COMMITTEE
PRODUCTION MANAGER
SALES MANAGER
FINANCE MANAGER
ACCOUNTS MANAGER
PERSONNEL MANAGER
R & D MANAGER
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In the capital budgeting for every two adjacent years there will be gap. The gap between
authorized commitments and the target is presented in capital commitment plan as
diminishing over the course of the year plan, in practice many of the “ Unattained
commitments” will be rolled over into the next year’s plan, so that the current year gap will
remain large. The gap has grown in recent year exceeding in last two executive capital
plants.
KINDS OF CAPITAL BUDGETING:-
Capital budgeting refers to the total process of generating, evaluating, selecting and
following up an capital expenditure alternatives. The firm allocates or budgets financial
recourses to new investment proposals. Basically, the firm may be confronted with three
types of capital budgeting decisions:-
The accept or reject decision
The mutually exclusively decision and
The capital rationing decision
DIFFICULTIES OF CAPITAL BUDGETING:-
While capital expenditure decisions are extremely important, they also pose difficulties
which stem from three principal sources:
Identifying & measuring the costs & benefits of a capital expenditure proposal tends to
be difficult.
There is great deal of uncertainty for capital expenditure decision which involves cost &
benefits that extend far into the future.
It is impossible to product exactly what will happen in the future.
The time period creates some problems in estimating discount rates & establishing
equivalences.
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LIMITATIONS OF THECAPITAL BUDGETING:-
Capital budgeting techniques suffer from the following limitations:
1) All the techniques of capital budgeting presume that various investment proposals
under consideration are mutually exclusive which may not practically be true in some
particular circumstances.
2) The techniques of capital budgeting require estimation of future cash inflows and
outflows. The future is always uncertain and the data collected for future may not be
exact. Obliviously the results based upon wrong data may not be good.
3) There are certain factors like morale of the employees, good will of the firm, etc.,
which cannot be correctly quantified but which other wise substantially influence the
capital decision.
4) Urgency is another limitation in the evaluation of capital investment decisions.
5) Uncertainty and risk pose the biggest limitation to the techniques of capital budgeting.
COST EFFECTIVE ANALYSIS:-
In the cost effectiveness analysis the project selection or technological choice, only costs of
two or more alternatives choices are considering treating the benefits as identical. This
approach is used when the acquisition of how to minimize the costs for undertaking an
activity at a given discount rates in case the benefits and operating costs are given, one can
minimize the capital cost to obtain given discount.
PROJECT PLANNING:-
The planning of a project is technically pre – determined set of inter related activities
involving the effective use of given material, human, technological and financial resources
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over a given period of time. Which in association with other development projects result in
the achievement of certain predetermined objectives such as the production of specified
goods and services.
Project planning is spread over a period of time and is not a one shot activity. The important
stages in the life of a project are:
It’s identification
It’s initial formulation
It’s evaluation
It’s final formulation
It’s implementation
It’s completion and operation
The time taken for the entire process is the gestation period of the project. The process of
identification of a project begins when we are seriously trying to over come certain problems.
They may be non – utilization to overcome available funds. Plant capacity, expansion etc.,.
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LITERATURE REVIEW AND
OBJECTIVES AND METHODOLOGY
Factors Affecting Capital Budgeting:
While making capital budgeting investment decision the following factors or aspects should
be considered.
The amount of investment
Minimum rate of return on investment (k)
Return expected from the investments. (R)
Ranking of the investment proposals and
Based on profitability the raking is evaluated I.e., expected rate of return on investment.
Factors Influencing Capital Budgeting Decisions:
There are many factors, financial as well as non-financial, which influence that Budget
decisions. The crucial factor that influences the capital expenditure decisions is the
profitability of the proposal. There are other factors, which have to be in considerations such
as.
1. Urgency:
Sometimes an investment is to be made due to urgency for the survival of the firm or
to avoid heavy losses. In such circumstances, the proper evaluation of the proposal cannot be
made through profitability tests. The examples of such urgency are breakdown of some plant
and machinery, fire accident etc.
2. Degree of Certainty:
Profitability directly related to risk, higher the profits, Greater is the risk or uncertainty.
Sometimes, a project with some lower profitability may be selected due to constant flow of
income.
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3. Intangible Factors:
sometimes a capital expenditure has to be made due to certain emotional and intangible
factors such as safety and welfare of workers, prestigious project, social welfare, goodwill of
the firm, etc.,
4. Legal Factors.
Any investment, which is required by the provisions of the law, is solely influenced by this
factor and although the project may not be profitable yet the investment has to be made.
5. Availability of Funds.
As the capital expenditure generally requires large funds, the availability of funds is an
important factor that influences the capital budgeting decisions. A project, how so ever
profitable, may not be taken for want of funds and a project with a lesser profitability may be
some times preferred due to lesser pay-back period for want of liquidity.
6. Future Earnings
A project may not be profitable as compared to another today but it may promise better
future earnings. In such cases it may be preferred to increase earnings.
7. Obsolescence.
There are certain projects, which have greater risk of obsolescence than others. In case of
projects with high rate of obsolescence, the project with a lesser payback period may be
preferred other than one this may have higher profitability but still longer pay-back period.
8. Research and Development Projects.
It is necessary for the long-term survival of the business to invest in research and
development project though it may not look to be profitable investment.
9. Cost Consideration.
Cost of the capital project, cost of production, opportunity cost of capital, etc. Are other
considerations involved in the capital budgeting decisions?
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RISK AND UNCERTANITY IN CAPITAL BUDGETING
All the techniques of capital budgeting require the estimation of future cash inflows and cash
outflows. The future cash inflows are estimated based on the following factors.
1. Expected economic life of the project.
2. Salvage value of the assets at the end of economic life.
3. Capacity of the project.
4. Selling price of the product.
5. Production cost.
6. Depreciation rate.
7. Rate of Taxation
8. Future demand of product, etc.
But due to the uncertainties about the future, the estimates of demand, production, sales,
selling prices, etc. cannot be exact. For example, a product may become obsolete much
earlier than anticipated due to unexpected technological developments. All these
elements of uncertainty have to be take in to account in the form of forcible risk while
taking on investment decision. But some allowances for the elements of the risk have to
provide.
The following methods are suggested for accounting for risk in capital Budgeting.
1. Risk-Adjusted cut off rate or method of varying discount rate:
The simple method of accounting for risk in capital Budgeting is to increase the cut-
off rate or the discount factor by certain percentage on account of risk. The projects
which are more risky and which have greater variability in expected returns should be
discounted at a higher rate as compared to the projects which are less risky and are
expected to have lesser variability in returns.
The greatest drawback of this method is that it is not possible to determine the
premium rate appropriately and more over it is the future cash flow, which is
uncertain and requires adjustment and not the discount rate.
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Method
2. Certainty Equivalent Method:
Another simple method of accounting for risk in capital budgeting is to reduce
expected cash flows by certain amounts. It can be employed by multiplying the expected
cash in flows certain cash outflows.
3. Sensitivity Technique:
Where cash inflows are very sensitive under different circumstances, more than one
forecast of the future cash inflows may be made. These inflows may be regards as
“Optimistic”, “Most Likely”, and “Pessimistic”. Further cash inflows may be discounted to
find out the Net present values under these three different situations. If the net present values
under the three situations differ widely it implies that there is a great risk in the project and
the investor’s decision to accept or reject a project will depend upon his risk bearing abilities.
4. Probability Technique:
A probability is the relative frequency with which an event may occur in the future. When
future estimates of cash inflows have different probabilities the expected monetary values
may be computed by multiplying cash inflow with the probability assigned. The monetary
values of the inflows may further be discounted to find out the present vales. The project that
gives higher net present value may be accepted.
5. Standard Deviation Method:
If two projects have same cost and there net present values are also the same, standard
deviations of the expected cash inflows of the two projects may be calculated to judge the
comparative risk of the projects. The project having a higher standard deviation is set to be
more risky has compared to the other.
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6. Coefficient of variation Method:
Coefficient of variation is a relative measure of dispersion. If the projects have the same cost
but different net present values, relative measure, I,e. coefficient of variation should be
computed to judge the relative position of risk involved. It can be calculated as follows.
Coefficient of Variation = Standard Deviation X100
Mean
7. Decision Tree Analysis:
In modern business there are complex investment decisions which involve a sequence of
decisions over time. Such sequential decisions can be handled by plotting decisions trees. A
decision tree is a graphic representation of the relationship between a present decision and
future events, future decisions and their consequences. The sequences of event are mapped
out over time in a format resembling branches of a tree and hence the analysis is known as
decision tree analysis. The various steps involved in a decision tree analysis are
1 Identification of the problem
2 Finding out the alternatives;
3 Exhibiting the decision tree indicating the decision points, chance events, and other
relevant date;
4 Specification of probabilities and monetary values for cash inflows;
5 Analysis of the alternatives.
Limitations of Capital Budgeting
Capital Budgeting Techniques Suffer From the Following Limitations.
1 All the techniques of capital budgeting presume the various investment proposals
under consideration are mutually exclusive which may not practically be true in some
particular circumstances.
2. The techniques of capital budgeting require estimation of future cash inflows and
outflows. The future is always uncertain and the data collected for future may not be
exact. Obviously the results based upon wrong data may not be good.
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3. There are certain factors like morale of the employees, goodwill of the firm, etc.,
which cannot be correctly quantified but which otherwise substantially influence the
capital decision.
4. Urgency is another limitation in the evaluation of capital investment decisions.
5. Uncertainty and risk pose the biggest limitation to the techniques of capital
budgeting.
STEPS INVOLVED IN THE CAPITAL EXPENDITURE
The various steps involved in the control of capital expenditure.
1. Preparation of capital expenditure.
2. Proper authorization of capital expenditure.
3. Recording and control of expenditure.
4. Evaluation of performance of the project.
OBJECTIVES OF CONTROL OF CAPITAL EXPENDITURE
In the following all the main objectives are on control of capital expenditure: To make an
estimate of capital expenditure and to see that the total cash outlay is with in the financial
resources of the enterprise.
1. To ensure timely cash inflows for the projects so that non-availability of cash may not
be a problem in the implementation of the project.
2. To ensure all the capital expenditure is properly sanctioned.
3. To properly co-ordinate the projects of various departments.
Data collection:
Primary data: - The primary data is the data which is collected, by interviewing directly
with the organizations concerned executives. This is the direct information gathered from the
organization.
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\
Secondary data: - The secondary data is the data which is gathered from publications
and websites.
CAPITAL BUDGETING:
A capital expenditure is an outlay of cash for a project that is expected to
produce a cash inflow over a period of time exceeding one year. Examples of projects
include investments in property, plant, and equipment, research and development projects,
large advertising campaigns, or any other project that requires a capital expenditure and
generates a future cash flow.
Because capital expenditures can be very large and have a significant impact on the financial
performance of the firm, great importance is placed on project selection. This process is
called capital budgeting.
KINDS OF CB DECISIONS:
Capital Budgeting refers to the total process of generating, evaluating, selecting and
following up on capital expenditure alternatives basically; the firm may be confronted with
three types of capital budgeting decisions
Accept reject decisions
This is a fundamental decision in capital budgeting. If the project is accepted, the firm
invests in it; if the proposal is rejected, the firm does not invest in it. In general, all those
proposals, which yield rate of return greater than a certain required rate of return or cost
of capital, are accreted and rest are rejected. By applying this criterion, all independent
projects all accepted. Independent projects are the projects which do not compete with
one another in such a way that the acceptance of one project under the possibility of
acceptance of another. Under the accept-reject decision, the entire independent project
that satisfies the minimum investment criterion should be implemented.
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Mutually exclusive project decision
Mutually exclusive projects are projects which compete with other projects in such a way
that the acceptance of one which exclude the acceptance of other projects. The alternatives
are mutually exclusive and only one may be chosen.
Capital Rationing Decision Capital rationing is a situation where a firm has more investment proposals than it can
finance. It may be defined as a situation where a constraint in placed on the total size of
capital investment during a particular period. In such a event the firm has to select
combination of investment proposals which provides the highest net present value subject to
the budget constraint for the period. Selecting or rejecting the projects for this purpose will
require the taking of the following steps:
1) Ranking of projects according to profitability index (PI) or Initial rate of return (IRR).
2) Selecting of rejects depends upon the profitability subject to the budget limitations
keeping in view the objectives of maximizing the value of firms.
NATURE OF INVESTMENT DECISSIONS
The investment decisions of a firm are generally known as the capital budgeting, or capital
expenditure decisions. A capital budgeting decision may be defined as the firm’s decision to
invest its current funds most efficiently in the long term assets in anticipation of an expected
flow of benefits over a series of years. The long term assets are those that affect the firms
operations beyond the one year period. The firm’s investment decisions would generally
include expansion, acquisition, modernization and replacement of the long-term assets.
Sale of a division or business (divestment) is also as an investment decision. Decisions like
the change in the methods of sales distribution, or an advertisement campaign or a research
and development programme have long-term implications for the firm’s expenditures and
benefits, and therefore, they should also be evaluated as investment decisions. It is important
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to note that investment in the long-term assets invariably requires large funds to be tied up in
the current assets such as inventories and receivables. As such, investment in the fixed and
current assets is one single activity.
Features of Investment Decisions:- The following are the features of investment decisions:
The exchange of current funds for future benefits.
The funds are invested in long-term assets.
The future benefits will occur to the firm over a series of year.
Importance of Investment Decisions:-
Investment decisions require special attention because of the following reasons.
They influence the firms growth in the long run
They affect the risk of the firm
They involve commitment of large amount of funds
They are irreversible, or reversible at substantial loss
They are among the most difficult decisions to make.
Growth
The effects of investment decisions extend in to the future and have to be
endured for a long period than the consequences of the current operating expenditure. A
firm’s decision to invest in long-term assets has a decisive influence on the rate and direction
of its growth. A wrong decision can prove disastrous for the continued survival of the firm;
unwanted or unprofitable expansion of assets will result in heavy operating costs of the firm.
On the other hand, inadequate investment in assets would make it difficult for the firm to
complete successfully and maintain its market share.
Risk
A long-term commitment of funds may also change the risk complexity of the firm.
If the adoption of an investment increases average gain but causes frequent fluctuations in its
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earnings, the firm will become more risky. Thus, investment decisions shape the basic
character of a firm.
Funding
Investment decisions generally involve large amount of funds, which make it
imperative for the firm to plan its investment programmers very carefully and make an
advance arrangements for procuring finances internally or externally.
Irreversibility
Most investment decisions are irreversible. It is difficult to find a market for such
capital items once they have been acquired. The firm will incur heavy losses if such assets
are scrapped.
Complexity
Investment decisions are among the firm’s most difficult decisions. They are
an assessment of future events, which are difficult to predict. It is really a complex problem
to Economic, political, social and technological forces cause the uncertainty in cash flow
estimation.
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METHODOLOGY
Methodology is a systematic process of collecting information in order to analyze and
verifies a phenomenon. The collection of data is two principle sources. They are discussed as
I. Primary data
II. Secondary data
PRIMARY DATA
The primary data needed for the study is gathered through interview with concerned officers
and staff, either individually or collectively, sum of the information has been verified or
supplemented with personal observation conducting personal interviews with concerned
officers of finance department of “K.C.P.Sugar and Industries Corporation Limited”.
SECONDARY DATA
The secondary data needed for the study was collected from published sources such as,
pamphlets of annual reports, returns and internal records, reference from text books and
journal management.
Further data needed for the study was collected from:-
Collection of required data from annual records of the company.
Reference from text books and journals relating to financial management.
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Diagrammatic Representation of Research Methodology:
DATASOURCES
PrimarySources
SecondarySources
Management RespondentsInside theCompany
Outside theCompany
AnnualReports
Text booksJournals
PersonalObservance
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SCOPE OF THE STUDY
The efficient allocation of capital is the most important financial function in the modern
times. It involves decision to commit the firm’s, since they stand the long- term assets
such decision are of considerable importance to the firm since they send to determine its
value and size by influencing its growth, probability and growth.
The scope of the study is limited to collecting the financial data K.C.P.Sugar and
Industries Corporation Limited”. for four years and budgeted figures of each year.
NEED AND IMPORTANCE:
Capital Budgeting means planning for capital assets. Capital Budgeting decisions are
vital to an organization as to include the decision as to:
Whether or not funds should be invested in long term projects such as settings of an
industry, purchase of plant and machinery etc.,
Analyze the proposals for expansion or creating additions capacities.
To decide the replacement of permanent assets such as building and equipments.
To make financial analysis of various proposals regarding capital investment so as to
choose the best out of many alternative proposals.
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LIMITATIONS OF THE STUDY
At each point of time a business firm has a number of proposals regarding various projects
in which, it can invest funds. But the funds available with the firm are always limited and are
not possible to invest trend in the entire proposal at a time. Hence it is very essential to select
from amongst the various competing proposals, those that gives the highest benefits. The
crux of capital budgeting is the allocation of available resources to various proposals. There
are many considerations, economic as well as non-economic, which influence the capital
budgeting decision in the profitability of the prospective investment.
Yet the right involved in the proposals cannot be ignored, profitability and risk are directly
related, i.e. higher profitability the greater the risk and vice versa there are several methods
for evaluating and ranking the capital investment proposals.
.The study is limited to K.C.P.Sugar and Industries Corporation Limited”. only.
1. The study is limited to certain projects of K.C.P.Sugar and Industries Corporation
Limited”..
2. Period of the study is restricted to five years only.
3. The present study cannot be used for inter firm comparison.
4. Limited span of time is a major limitation for this project.
5. The act and figures of the study is limited to the period of FIVE years i.e. 2008-2012.
6. The data used in reports are taken from the annual reports, published at the end of the
years.
7. The result does not reflect the day-to-day transactions.
8. It is also impossible to the study of day-to-day transactions in cash management.
9. The analysis of the capital is taken FIVE years.
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OBJECTIVES OF THE STUDY
To present theoretical framework relating to capital budgeting.
To provide support to accomplish the overall goal of the capital budgeting system of
“K.C.P.Sugar and Industries Corporation Limited”.
To study the financial aspects for future expansion of “K.C.P.Sugar and Industries
Corporation Limited”.
To discuss the process of project evolution followed by “K.C.P.Sugar and Industries
Corporation Limited”.
To evaluate the elements consider by “K.C.P.Sugar and Industries Corporation
Limited”.
To summaries and offer suggestions for the better investment proposals in
“K.C.P.Sugar and Industries Corporation Limited”.
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PLAN OF THE STUDY
The study is presented in 5 chapters in the following sequence.
Chapter – I First chapter deals with theoretical back ground of a capital budgeting.
Chapter – II Chapter two presents review of literature and objectives and methodology of
the study.
Chapter – III Chapter three deals with the analysis of Industry and company.
Chapter – IV Chapter four deals with analysis in the capital budgeting in K.C.P.Sugar and
Industries Corporation Limited.
Chapter – V Chapter five deals with summarizes findings and suggestions of the study.
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INDUSTRY PROFILE
INTRODUCTION
Indian is considered to the country of origin of sugarcane, symbolically referred to as
"Sweet Grass" Sugarcane existed in ancient India. North-eastern India is regarded as the
center of the origin and from where Sugarcane was believed to have been carried to China
and other places by early travelers and nomads, sometime between 1800B.C. and 1700B.C.
Later, it spread to Philippines, Java and other places including Caribbean Islands by
explorers. The Sugar Industry in India has a long history. Reference to sugar is found even in
early medic literature. The story goes that Sugarcane was one of the luxuries provided by
Vishwamitra to Trishanku in the special Heaven created for him. In 600AD the Chinese
emperor, Tsai Heng sent agents to higher on record of the technical commission,
investigating the manufacturing processing to a foreign country. Alexander the great emperor
and his soldiers took back along with the Sugarcane, Which they called the 'Honey Read'.
There are also many other reasons for believing that India was the original home of
sugarcane.
It has been established beyond doubt that for the first time the Sugarcane was
cultivated in Bengal and the credit of becoming the first to manufacture sugar goes to the
state of Bihar.
The name of the product of sugarcane in early days was "Shirker". During those days
and for a long time thereafter, India had the monopoly of producing “Shakara" and supplying
kit to different parts of the world. Therefore, it is not surprising that the world "Sharkara" is
found in many languages of the world.
Even during the ancient periods, India used to export sugar to different parts of the
world. It exported sugar to Geneva, Venice and many other parts of Europe. It was also
exported to several countries in Africa and Asia. The Indian Sugar was exported through
caravan routs of Chiba and Bolan in Northwest India to Europe etc.
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But by the Middle of the 15th century, the Turks captured Constantinople and, by their
policy of heavy extortion from traders, almost stopped the supply of Sugarcane through this
route. The second Jolt which proved perhaps more fatal and which lad to the rise of serious
competitor to India sugar was the Navel blocked of France by Great Briton Which forced
Napoleon t order the scientists of his country to find out some alternative, sources to produce
sugar, The blockage had completely stopped the entry of
Indian sugar to France. Napoleon's efforts resulted in the production of sugar from the
sugar beets.
Although the modem process of manufacturing sugar began for the first time in
Europe as early as in 1853, it came to Indian as late as in about 1903. When the first sugar
factory having vacuum pan process and modern milling method was commissioned in Bihar
Morhowrah in 1904. Indigenous sugarcane has been extensively grown in Indian from
ancient times. There was, however, a revolution in the method in the method of cane
cultivation during the last decade of the 19 th century. It was only in 1912 that India
established her first Sugarcane breeding station of Coimbatore.
In the early part of century, there were a few sugar mills in the country, mostly in
Utter Pradesh and Bihar where sugarcane was being grown traditionally. The production of
sugar was not sufficient to meet the demand of the domestic consumption and so sugar was
being imported from Java and other countries. The Indian sugar factories were unable to
meet the competition of imported Javanese sugar, which had commanding the Indian market.
The government of India then granted protection to the indigenous sugar industry under the
sugar industry Protection Act passed in 1932. This Act was followed by another legislation
enabling the provincial Governments to enforce the minimum price to be paid by sugar
factories to cane growers in respect by sugar factories to cane growers in respect of cane
supplied by them as per Sugarcane Act of 1934. These two legislation gave significant
impetus and encouragement to entrepreneurs to set up new sugar factories in various parts of
the country.
After independence, with the introduction the five-year plan for the national
development, the sugar industry too received considerable amount of support. The
development and regulation of the sugar industry was brought under the control of the
Government India from May 1952.
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The Sugar industry in India made a rapid development after protection was granted to
this industry in 1932. Accordingly, the import of sugar was almost stopped after 1936-38".
The sugar Industry was granted this protection till 1950. Since independence there has been
and over all tread of sugar in India. Like other agro-industries, this industry has been subject
to wide and sometimes violent fluctuations. The main reason is that the raw material of this
industry i.e.,
Sugarcane comes from agricultural sector, which is highly insatiable in India.
Sometimes, it suffers from drought, floods and heavy rains. Other factors like Government
policies, Prices, market conditions etc., are also responsible for the fluctuations in production
in this country.
As against a mere 29 sugar mills in 1930-31, this number has gone up to 408 in 1994-
95 with 222 in the co-operative sector, 75 in the Public Sector and the rest in the Private
Sector. The total production of sugar during 1991-92 seasons was 132.73 lakh tones with
76.83 lakh tones in the co-operative sector 11.35 lakh tones in the public sector and 44.59
lakh tones in private sector. In 1994-95 the total sugar production has increased to 146.43
lakh tones.
The industry has surpassed the targets set for it in the various plan periods and 160
lakh tones per annum has been targeted for the year 2000. In the year 2012 production of
sugar has been increased to 1840 lakh tones.
Sugar industry in India was initially concentrated in the sub-tropical states of Utter
Pradesh and Bihar, but since the second Five year plan, it spread to the Deccan area and the
Southern states. About 35 millions farmers constituting 7% of the total rural population
portion of the cane crop and provide the farmer with resources to meet his commitments.
Each sugar factory deals with thousand of cane growers.
STATE- WISE SPREAD OF SUGAR INDUSTRY IN INDIA
Sugarcane is grown widely in India In 17 out of 25 states and 2 Union Territories
grown sugarcane. Nine states account for 96% of the production and 94% of the total area.
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These states are : Uttar Pradesh, Maharashtra, Karnataka, Tamilnadu, Andhra Pradesh, Bihar,
Haryana, Gujarat and Punjab. Uttar Pradesh ranks first in area and in production during
1990-91, U.P. accounted for 50% of area and 43% of production of sugarcane in India.
Maharashtra which occupies second place has about 1/3 of the area and its production of
Sugarcane is almost half that of the production of U.P; Maharashtra exceeds U.P in terms of
recovery of Sugar.
Gujarat, which has only 1.15 lakh hectares under Sugarcane cultivation, has the
highest percentage of sugar recovery (11.65). Tamilnadu, which has produced 352.36 lakh
tones of Sugarcane, has a mere 8.68% of sugar recovery. This clearly shows that recovery of
sugar is based on the fertility of the soil of India fixed the target for production at 15.50 MT
and the target for installed capacity at 16.00 MT.
The number of factories in the plan periods has also increased rapidly. They increased
from 139 in 1959-60 to 408 in 1994-95 with 237in the co-operative sector 75 in the public
sector and the rest in the private sector. The sugar production has also been gradually
increased in view of the rising demand for sugar in the country. At present, there are 422
installed sugar factories in the country with an annual sugar production capacity of 11.1
million tones and about a 100 new sugar factories are under various stages of construction.
The sugar industry is the most advanced processing industry in the agricultural sector in
India, located in rural massed and serves as the nerve center for rural development.
SUGAR INDUSTRY IN ANDHRA PRADESH
Sugarcane is on the important commercial crops in Andhra Pradesh, greatly
contributing to the agricultural prosperity of the state. Andhra Pradesh is situated in the
tropical Zone considered highly suitable for the production of good sugarcane. The average
rainfall in the state from June to September in a year is 602mm. Sugarcane is an irrigated
crop throughout the state frequency of irrigation varying widely with facilities available.
Sugarcane cultivation in the State was known for centuries in the Coastal belt. The rank of
Andhra Pradesh in sugarcane acreage and production is finished between 5 th and 7th and
between 4th and 5th respectively, at the national level.
In the past, white sugar was obtained by refining polymer jugglery by the Guru
refinery at Samarklakot. Direct manufacture of Sugar started in the year 1934 at Bobbili
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followed by factories at Thummapala and Etikoppaka in 1935, Vuyyuru in 1936 and Bodhan
in 1938. At present in Andhra Pradesh, the total number of sugar factories is 35. These have
been established in various viz., Co-operative, public and private sector. Recently, the
Government of Andhra Pradesh gave permission to establish 13 more Sugar factories
throughout the state under the private sector. There are 18 factories in the co-operative sector,
8 in the public Sector and 10 in the private sector with a crushing capacity expect in the year
1989-90. There are about 120 licensed Khandasari units in the state and these units crush
about 16,797 tons per day. The normal crushing season is spread over a period of 130 days.
Out of the total production of sugar 40% is levy sugar and the remaining 60% is for free sale
by the Sugar factories. Different varieties of Sugarcane seed are introduced for higher yield
and recovery of Sugar, year after year.
EMERGENCE OF CO-OPERATIVE SUGAR FACTORIES
While in all in other sectors in the country co-operative has either failed or made
negligible progress. The successes achieved by the co-operative sugar mills have two
positive advantages in their favor. First of all, they get the maximum supply of sugarcane as
all most all the sugarcane farmers are members of the co-operative sugar mills. Secondly,
profits of the co-operative are distributed among the farmers instead of going into the hands
of a few sugar barons. All the sugar factories were setup in the privet sector till 1950. The
factories that came up subsequently were mostly in the co-operative sugar factories
accounted for only 15% of the total sugar production in the country, they claimed 60.6& in
1992-93.
The sugar and allied by-product using industries, particularly, in the cooperative
sector have contributed significantly to the increase in employment opportunities and
development off the infrastructure like educational institutions, medical facilities and
recreational facilities for the entire community at large. The Government has now issued
licenses for establishment of more factories in cooperative sector.
In the context of new economic policy, based on market responses the Government is
planning to provide more freedom to the cooperative sector. This will go a long way in
achieving a vibrant economic structure. Co-operative sugar factories are certain to play in
even more important role.
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THE SUGAR POLICY OF THE GOVERNMENT OF INDIA
The union Government announces every year a uniform sugarcane price (statutory
Minimum Price) on the basis of the Recommendation of the commissions Agricultural Cost
and Price (CACP). The Government announced the SMP, which is linked to the sugar
recovery of 8.5% fixed as minimum level to be achieved by the sugar units. The actual price
paid to Sugarcane farmers is than fixed on the basis of the state advised price (SAP)
announced by the State Government which are usually higher than the SMP. The SMP and
the SAP guide the sugarcane prices in the market.
Under the dual pricing system levy sugar and free sale sugar priced differently. The
levy price which is defined by the Essential Commodities Act is equal to or lowers than the
cost of production. The cost of production is determined by the Bureau of industrial costs and
prices. Levy prices are fixed by the Government of India on the advice of the BICP.
At percent, the quota is fixed at a ratio of 40:60 for levy and free sugar which means
that 40% of the production will be procured from the sugar factories at a fixed levy price and
factory will be free 0 sell 60% at the free market price. The sugar factories are expected to
earn sufficient profits by selling the free sale quota at the market price and to compensate the
loss that they have incurred on the levy quota. However, the Ventral Government indirectly
controls the free sale sugar prices through sugar releases each month. The price of sugar in
the market has always been a sensitive political issue. Whenever sugar is in short supply, the
Government of India imposed conditions on sugar units to protect the interests of the
common man. Profitability in the sugar industry is dependent on the sugarcane price paid by
the companies and sugar prices under the state imposed dual pricing system.
The government's sugar policy was announced in November 1991, retained the
minimum economic capacity of 2500 tons of cane crushed per day for issued of fresh
licenses. The Government has no intention of nationalizing the sugar factories. Priority
would be given to proposals for new units form the co-operatives and the public sector. The
Government has permitted the existing mills to raise their capacity.
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EXPORT OF SUGAR
India first started exporting of sugar form the year 1957, since 1970-71 the quantity
that was exported steadily rise from 18,000 tons to 9.5 Lakh tones. Whenever there has been
a higher sugar production, efforts were made by the industry to get more export quota
sanctioned from the International sugar organization.
The Government policy is to encourage exports from agro-based industries and the
time has come to fix a minimum export quota for sugar every year, so that permanent buyer -
seller relations could be established and also better prices realized. Industry sources feel that,
at least a minimum quota of one million tons for the export of sugar could be released in the
beginning of every season, so that export commitment would be entered into at an
appropriate time.
According to food industry sources, at present the two major buyers in the
International market are Pakistan which needs 3 lakh tones and Bangladesh which needs 1
lakh tone. As India now cannot fulfill its contracts Thailand and Brazil will grab the
opportunity. As the industry made contracts based on the Government's decision, India has
become a laughing stock among the International community because of its apathetic attitude
towards exports.
In August, 1995 the Government permitted the export of 5 lakh tones of sugar. And
of theses 5,00,000 tones were exported in August with 1.5 lakh tones and 3 lakh tones being
exported in September and October, respectively. As the country still has a huge stock pile of
disposable sugar, the Government decided to create a buffer stock of 5 lakh tones and permit
further exports of 5 lakh tones in January, 1996. Meanwhile, sugar industry continues to face
a serious liquidity crisis because of this delay.
Majority of the sugar factories in India are not willing to export the sugar as the price of
sugar is very low in the world market. If there are little prospects for any price increase in the
world market, the major producers are keen to sell more in view of a foreign exchange
constraint, and the exports will become more profitable. The convertibility of the Indian
rupee will ensure higher benefits to the exporters.
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Problems of the sugar Industry
Sugar industry is controlled by the Government like all the industries in the country.
The central Government regulates all the activities of the sugar industry from the purchase of
raw material, to the sale of finished products. The importance of sugar industry in the
national economic cannot be over emphasized, as on its prosperity depends on the livelihood
of millions of cane growers, workers in the factories and other working in the ancillary
industry. It therefore requires careful nursing, but unfortunately it is subjected to great
vicissitudes of prosperity and depression.
This industry has a large number of problems-inadequate supplies of cane, under
utilization of capacity low recovery, old and obsolete machinery, transport difficulties and
the pricing policy of the Government. The low level of productivity is crippling the industry.
Secondly the output of cane is influenced to a greater extent by the Government's main raw
material is dependent upon the prices of competitive food crops on the one hand and the
prices of sugarcane fixed by the Government on the other.
Since the sucrose content of sugarcane begins to deteriorate soon after the stalks have
been cut, it is essential that a unit be located in close proximity to the sources of raw material.
Then, there is a vast gap between the technology developed by the Research Institutions and
the cane growers. Another problem regarding cane supply to the factories is diversion. The
sugar factories and Guru and Khandasari units are competitors for sugarcane supply.
According to D.C.A Agate, "Guru and Khandasari producers have a leeway over the sugar
factories in the matter of procuring sugarcane diverted from sugar factories owing to absence
of controls over them and also fiscal advantages they enjoy"
Next problem facing the industry is that of transport, in our country the transport
system is not up to the requirements, which affect the recovery from sugarcane Utilization of
by products. By the fuller utilization of by-products the sugar industry can hope to reduce the
cost of production.
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SUGAR INDUSTRIES IN ANDHARA PRADESH
In Andhra Pradesh there are 34 industries of which 16 are under the cooperative
sector, 8 are Under Government management and another 9 are under private sector.
Khandasari Mills, the counter part of sugar mills have been estimated at a number of 120.
The mill at Bodhan in Nizamabad district is the biggest in Asia. Average cane yield.
Per acre in India is 20 tonnes and in Andhra Pradesh. It is 30 tonnes. The crushing capacity
of all mills in Andhra Pradesh is 57 lakh tonnes. Private Mills could utilize 70% of the
crushing capacity. Whereas the other mills could just manage.
PRIVATE SECTOR IN SUGAR FACTORIES :
SL.NO INDUSTRY PLACE DISTRICT
1.K.C.P Sugar and Industries Corporation Limited., Vuyyuru Krishna
2.K.C.P Sugar and Industries Corporation Limited.,
Lakshmipuram Krishna
3. The Andhra Sugars Ltd., Tanuku West Godavari
4. The Jeypore Sugars Company Ltd., Chagallu East Godavari
5. Sri Saravarya Sugar Mills Limited Chelluru East Godavari
