Atal Bihari Vajpayee 

Indian Institute of Information Technology &

Management, Gwalior

Financial Management
ASSIGNMENT - 2

(IPG-MBA, SEMESTER VIII)

Submitted To:
Dr. Vishal Vyas
BHEL BACKGROUND PROFILE

Bharat Heavy Electricals Limited (BHEL) is India's largest engineering and manufacturing
company, with over 42000 employees working in the energy sector. It has a national and
international presence in the heavy electrical equipment industry, having been established in
1956. BHEL is amongst Indian public sector companies one of Navaratnas (literally nine gems).
Its vision is "a global company which is committed to increasing the value of stakeholders." Its
mission is: "to be an Indian multinational engineering company that provides full business
solutions in the areas of energy, industry, transport, infrastructures, and other potential areas
through quality products, systems and services."

BHEL is a large-scale enterprise that manufactures more than 180 products categorised into 30
main product groups, catering to the core power and transmission sectors, to industry, transport
and telecommunications. It consists of 14 production units, four regional power sector centres,
over 100 project sites, eight service centres and 18 regional offices. It develops technology from
abroad and in its research and development centres develops its own technology. BHEL's
operations are organised into three power, industry and businesses abroad. In addition to the
departments of the business sector, corporate engineering and R&D, human resources, finance,
and corporate planning and development departments are available.

Case insight

● The case is all about the financial fluctuations faced by BHEL (Bharat Heavy Electricals
Limited) with reference to its operating and strategic context which included the work
attitude towards Nature of Business, Research and Development, Corporate Mission,
objectives and Systems.
● Liquidity crises faced by the company in 1981-1983, how did the management respond
to it, and its impact
● The case highlights the financial and economic scenario and steps taken by the firm in
the year 1981-1985. The case also defines the Future Corporation Policy and Financial
Goals.

Business sectors Operates by BHEL

● Power Sector: BHEL was equipped with 23,902 MW or 56 percent of the installed
capacity in the country in 1985. Power area added to around 60% of BHEL's business. It
assumed a significant part in India's force area by contributing and providing gear and
building foundation to produce, communicate and supply power climate hydro, warm or
atomic. BHEL was equipped with 23,902 MW or 56 percent of the installed capacity in
the country in 1985.
● Industry Sector: The organization has made huge commitment to different ventures like
force, concrete, manure and so on. The largest transformer to Ramagundam Fertilizer
 Project and largest DC motor to Rourkela Steel Plant proved the technological ability of
BHEL. The range of equipment provided by it included oil field equipment, control gears,
large turbo sets, pumps and heat exchangers etc.
● Transportation Sector: Electric traction equipment for a variety of diesel locomotives,
electric multiple units for suburban trains, complete traction equipment and many more
such equipment were designed, manufactured and supplied by BHEL.
● Non-conventional Energy and Pollution Control: To serve remote rural areas, pumps
that are driven by solar energy are manufactured. Several hydro and thermal sets,
boilers, compressors and turbo generators are produced. Apart from this about 2 percent
of its turnover is spent on Research and Development. This not only helps BHEL to
explore more product opportunities but also contributes towards the innovation sector of
the country.

Company Objectives
● Growth: To guarantee consistent development in business as to satisfy public
assumptions and grow global activities.
● Profitability: to ensure a reasonability, efficiency increase in capacity, use and
productivity and an adequate return on the capital used.
● Image: to build customer trust through the preservation of international quality,
performance and service standards.
● Congruity: To put resources into HR improvement, supporting innovative work, make
progress toward greatness in administration and other long reach exercises to guarantee
an initiative status for BHEL.

BHEL’s Financial Goals

● Earn a minimum of 12%return on net worth.

● Pay 10% dividend on paid-up capital to the Indian government.
● Sale to reach Rs 30,000 million by end of 1989-90.
● Achieve inventory level of 90 days and book debts of 60 days.
● Achieve debtor’s turnover of 45 day
1. Explain BHEL’s financial performance with reference to its operating and
strategic context.

BHEL’s nature of business was stretched majorly in three sectors namely - power, industry,
transportation and others including non-conventional energy and pollution control in the ratio
3:1:1.

Operating profit decreased significantly between 1984 and 1985. The profit is down more than
net sales, which means that the company could not reduce its cost of goods sold and control its
operating expenses. Sundry debtors have shown higher growth and other assets and buildings.
During the period the company increased its sales by more than three times, with PBIT nearly
doubling. PAT has shown fluctuations however, which remained nearly the same in the 1980-83
fiscal year. Since 1977, dividends have been paid regularly by the firm.

I made use of the financial ratios to evaluate both short-term and long-term BHEL liquidity,
solvency, efficiency, stability and profitability. Overall, liquid or current ratios, debt/equity
ratios, interest coverage ratios, inventory turnover ratios, capital ratios are of major use to
determine performance of financial and management activities. Below are the financial
indicators:

● Profitability : In order to determine sustainable growth and income earned by an

organisation, we assess profitability in both short and long terms. An organization's
degree of profitability is highly dependent on the revenue statement reporting the
company's results. Return on Equity (ROE) also provides an insight into how the
management uses equity finance to develop the company. The decline of ROE from 5%
in 1980 to 3.5% in 1982 means that management makes poor choices about reinvesting
capital in unproductive assets. In contrast, 1985 showcased a sustainable increased
ROE because of the modification in capital structure and well-thought investments that
enhance productivity and profits. ROE is also a function of financial leverage.

● Solvency: the capacity of an organisation, by assessing its balance sheet, to pay off its
responsibilities or obligations in the long run to third parties or creditors. Table 1, shows
 that BHEL is aggressive in financing its debt growth, according to a high debt-to-equity
ratio. The additional interest costs can lead to volatile earnings. However, with the
implementation of its corporate plan and strategic moves, it has been able to reduce its
debt and grow its own equity from 1.66 to 0.91. The Interest coverage ratio determines
how easily BHEL can pay outstanding debt interest. If the interest coverage ratio is
lower, it is questionable whether it is able to cover interest expenses and suggests that
the company does not generate enough revenue to satisfy interest expenditures. In
1982-83, the company's debt burden and the highest chance of bankruptcies or defaults
showed a very low value of 1.61 compared to other years. The rate coverage is
important to shareholders because it gives a clear overview of a business' short-term
financial health. The interest coverage ratio should serve as a security measure for bond
holders.

● Liquidity:The ability of a company to meet immediate commitments, maintain positive

cash flows and most likely are based on the company balance sheet depicting the
organization's financial condition. As can be seen in the current ratio value, a value
greater than 1 as in this case is satisfactory but a decreasing trend can be seen from
1980 to 1985 indicating less liquid assets and improper fund management.
The company bore a very low inventory-turnover ratio of less than 1.5 indicating that
the management team wasn’t doing its job properly in managing inventories. It also
implies poor sales and excess inventory. The ratio significantly improved to 2.1 in 1985
implying effective inventory management in the new policy.

● Stability: Ability or organisation, for a longer period of time, to remain in business without
substantial losses while conducting the business. We are using the balance sheet,
revenue and non-financial and financial indicators to calculate stability ratios.

2. Describe the reasons for BHEL’s liquidity crisis, particularly during

1981–83.

BHEL had a major liquidity problem, especially in the early 1980s, despite its strong revenue
and profit results. At the end of 1980–81, it had a cash deficit of 1,170 million, which grew to
1,810 million in 1981–82 and 2,400 million in 1982–83. BHEL’s cash shortage increased by
almost 50% each year from 1980 to 1983.

The following are the noteworthy reasons -

● Super high working capital because of its compulsion to complete projects of
government departments, SEBs and PSUs which had chronic cash problems. This also
 led to delay in dispatches and a very high inventory holding against quick dispatches
once ready.

NWC = Accounts Receivable + Inventory – Accounts Payable

● Steep rise in number of debts and debtors - The company's own finances were
inadequate to cover its working capital requirements. As a result, it had to rely heavily on
bank loans.
● BHEL was into a multi-product range and produced majorly custom-built products
assigned on a short notice period instead of general bulk orders with sufficient notice
period. This led to longer production cycles and redundant working days for personnel
and unnecessary expenditure of working capital to fulfil those orders.
● Poor capital structure and liquidity position - BHEL incurred high capital on
upgrading its infrastructure, extending its ability to satisfy rising demand for its goods,
and branching out into new fields including the oil industry.
● BHEL was binded to purchase steel and copper as its raw materials from government
owned companies like SAIL and MMTC. The raw materials were a subject of
availability and led to longer lead times to restock the inventory, thus accounting for
an increasing number of inventory days and escalated costs.
● It also faced infrastructure issues such as a lack of carts, port congestion, erratic
delivery of indigenous raw materials, and customers' failure to list goods ready for
handover.
● No help from Reserve Bank of India (RBI) and Ministry of Finance for interest-free
budgetary support. The government instead of extending the time period to repay
loans, reduced the time limit for repayment to just 7 days.
● Outstanding book debts as high as 3 years due to inherited customers who took longer
in paying bills, and clearing their dues. It was also because of improper management of
the commercial departments and bill monitoring teams.

3. Discuss the process of BHEL liquidity management.

Decision 1 - BHEL adjusted its accounting practices to save money.

Manufacturing and erection units were strictly ordered to take sale value on goods that were
shipped and billed. Management was now aware of the true sales figures. As a result, the
inventory levels of the finished goods decreased significantly and it pressurized the units to ship
items as early as possible to meet their sales targets.

Decision 2 - Prioritization of production budget

Three categories (A, B, C) were introduced to label the production budget for all customers
based on their cash availability, lesser fund restrictions and turnaround time to recover the
purchase amount. Category “A” customers included NTPC, ONGC, NALCO. Category”B”
customers were obliged to supply but were uncertain of cash payment just after the delivery. .
Off-the-shelf supply components like metres and insulators, as well as items that could be
produced for power use were included in the ‘C-category' production budgets.

Decision 3 - Close tracking and management of inventory

Right from purchase commitment to forming a material management group who directly
reported to the Director of Finance in weekly meetings, BHEL managed to balance appropriate
amount of material availability, planning and production control. A monthly appraisal of total
inventory by senior executives was also called for. This meant the employees became cost
conscious and BHEL was able to bring down its inventory levels.

Decision 4 - Strengthen its compilation and control of book debts

BHEL asked the managers to keep a close eye on client obligations and distribution dates, and
avoided sending out non-sequential shipments. The people were supposed to maintain constant
communication between industry associations, manufacturing units, and the Planning
Commission to ensure proper plan funding allocation, availability and site readiness. BHEL also
pushed to expedite bill despatch/verification, reconciliation of outstandings with consumers,
resolution of pending disputes/withheld numbers, timely bill payment once funds are available
with customers with a strict review and warning to customers with unpaid debts by the Planning
Commision.

Decision 5 - Develop a cash management system to keep track of the cash flows
Senior level managers were asked to prepare daily cash reports, cash delegated to divisions,
and their cash inflows. Annual and monthly cash plans were also generated by the company.
Periodic discussions for cash positions also took place in the management committee.

Decision 6 - Implement a centralised cash management scheme

Collections made by the company's bank units' branch offices were combined to the corporate
office's consolidated cash credit account to maintain smooth workflows and integrity of the data
and avoid inconsistency.

Decision 7 - Restructure its loan portfolio

BHEL decided to reduce its dependence on cash credits from the bank since it cost the
company millions of interest expenses. The company identified low cost sources to fund its
working capital, sold debentures to banks, attached 3-year public deposits to raise money. The
company also borrowed funds from cheap sources such as euro-currency markets and saved
an interest differential of around 5-6%. This significantly reduced the company’s heavy interest
burden and enhanced profitability.

4. Critically review BHEL proposed strategic changes and financial

objectives. Are they consistent?

BHEL’s financial objectives as mentioned in the case study were:

➔ Objective 1 - Earn a minimum of 12% return on net worth.
➔ Objective 2 - Pay 10% dividend on paid up capital to the government.
➔ Objective 3 - Raise annual sales figure to Rs.30,000 million by the end of 1989-90.
➔ Objective 4 - Reduce inventory holding level to 90 days and book debts to 60 days.
➔ Objective 5 - Achieve debtor’s turnover of 45 days.

In terms of revenue and earnings, the corporation has performed admirably. Increased earnings,
after taxes and dividends, have continued to increase the company's reserve position. The
company's net revenue nearly doubled and the profit before tax rose by 32 percent annually.
For bank loans and intercorporate loans, long and medium-term debentures have been
replaced. The proportion of public loans also fell. The restructuring of capital structure has
shown positive effects in line with financial goal 1.

Bank borrowings and inter-corporate lending have been replaced by long and medium-term
loans in the form of debentures and other instruments. The percentage of government loans has
also decreased. This led to decrease in interest expenses and reduced burden. This attitude
had a major implication: the firm must finance its working capital and acquisitions mostly with
internally raised funds.This move was also in line with the objective 2.

In major product areas, BHEL has increased sales and earnings despite strong competition
from both domestic and foreign rivals. Corporate also felt the need to prepare themselves to
ensure growth and diversification in economically favourable regions.The aim of BHEL's
investment strategy during this period was to increase capacity for the development of power
equipment and to build third-generation plants to free up space in existing plants for the
production of high-tech and sophisticated components. This is consistent with objective 3.
BHEL's management also defined the roles of product manager, sales manager. They saw the
value of defining products as benefit centres under the oversight and guidance of product
managers in terms of development with viability and liquidity. The sales manager's job was to
optimise profits and cash flow. The management's determination to preserve financial stability
was a final result of the liquidity crisis. Management does not want to be in a cash-shortage
situation. Inventory management, debtors management, and cash management were
determined as the top priorities at all the organizational levels. The success of these efforts is
already visible in improved cash collection, vacation of provisions, increased conversion of
contract assets into collectibles and closure of long pending cases. BHEL managed to balance
appropriate amounts of material availability, planning and production control. A monthly
appraisal of total inventory by senior executives was also called for. This meant the employees
became cost conscious and BHEL was able to bring down its inventory levels. This is consistent
with financial objectives 4 and 5.

5. Prepare a 5-year financial plan of BHEL. Justify your assumptions.

BHEL's cash surplus in 1984 was RS 1,830 million at the end of 1985, and in the coming years
it was expected to generate even bigger cash surplus. At the beginning of 1985-86, the
company considered its long-term finance plan, discussed its profitability consolidation and
liquidity policy and used its improved financial position to help diversify and enhance the
competitiveness of the company's investment. The management's main objective was to identify
the diversification business area and design a financial policy in accordance with its business
plan.

● Diversification and Growth Plan

Diversification, the management considers, is more important in reducing risks and
improving profitability and liquidity. Despite its diversification, management believes
however that the power sector remains an important business line, and that financially
strong foreign producers are facing significant competition. BHEL should intend to
reduce its dependence on the power sector to around 40% by implementing its
proposed long-term diversification policy.The company could not receive enough
contracts over the past few years to fill up its capacity in the electricity sector. With
increasing competition from abroad, BHEL would not be able to match the resources of
these global suppliers with relatively cheap project packages. Therefore the expansion
of the power sector business, which currently comprises around two thirds of its total
business, will not be of advantage for BHEL. Electronics, AC locos, gas turbines and
protection are possible major areas. Most foreign companies like General Electric have
major defence contracts and a large proportion of their funds come from defence
companies. By starting defence production, BHEL can improve its performance and
liquidity because the government has no shortage of In particular, the field of electronics
and telecommunications is a potential sector of growth. Some BHEL senior managers
are convinced that BHEL should enter into the production of amusement electronics in
 order to improve the profitability, position and image of the company. But it does not
have any experience in very competitive markets for consumer goods. The provision of
services and savings is another field of business that can receive further attention from
BHEL in future. In the case of services and supplies, the problem of long-term funds still
outstanding may not arise because they can be supplied in cash. The margin of this
company is also high.

● Consolidation of existing business areas

In the medium term, BHEL's investment policy will be focusing on consolidating and
diversifying its existing business areas and prioritising areas such as electronics,
large-scale urban transportation systems, etc. in the next five years from 1985 to 86 to
1989 to 1990. The aim will be achieved by better use of existing installations and
marginal investments in the production of new products and improving productivity by
removing debottles and replacing and adding CNC/NC machines. Product quality
improvement investments will also be made.

● Investments in product quality improvement - In the next five years, total capital
expenditure is expected to reach Rs. 3,000-4,000 million.
● Majority raw material supply on internal sources
In the next few years, BHEL's financing policy should be focussed on providing internal
resources for operations and growth. BHEL should not receive government budget
support, they will need to generate retained income to support their working capital and
investments. It could invest 80% of its employed capital in the form of equities at the end
of 1989–90. They can use a debt/equity ratio of 1:1 as a company in the public sector,
but prefer low levers, because they have highly competitive product lines and because
interest is costly. They should also develop a financial policy that gives us flexibility to
implement our long-term diversification plans.

● High growth and achieve all financial goals

The profit objective of BHEL is to earn a return on net value of at least 12 percent. The
management believes that BHEL should safeguard the interests of their employees,
customers and society as a public sector company; hence, a 12% net surplus is an
appropriate compensation for the owners of the company, that is to say the Government
of India. They also want to pay the government a 10 percent dividend on the capital
paid-up. By the end of 1989-90, BHEL expects its sales at Rs. 30.000 million to grow
faster and then to slow down slightly for the first two years. As a long-term desirable
goal, it would also like to achieve a 90-day inventory and 60-day book debts. BHEL's
management is well aware that its goal of faster receipt is difficult to achieve.