Working Capital

WORKING CAPITAL MANAGEMENT
Prepared by : Nilesh M Bhitade. Roll no- 51126014 MBA in Finance. Year of Submission : 2012.
WORKING CAPITAL MANAGEMENT
A PROJECT REPORT
Under the guidance Of Mr. Navneet Goyal
Submitted by
Nilesh M Bhitade.
in partial fulfillment of the requirement for the award of the degree Of MBA
IN Finance
December 2012
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ACKNOWLEDGEMENT
The satisfaction and euphoria that accompanies the successful completion of any task would be incomplete without mentioning the names of the people who made it possible, whose constant guidance and encouragement crown all the efforts with success. Im deeply indebted to all people who have guided, inspired and helped me in the successful completion of this project. I owe a debt of gratitude to all of them, who were so generous with their time and expertise. I would like to thank Mr. Navneet Goyal for his continuous guidance and support. Last but not the least, I thank everybody, who helped directly or indirectly in completing the project that will go a long way in my career, the project is really knowledgeable & memorable one.
Nilesh M Bhitade.
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Bonafide Certificate:
BONAFIDE CERTIFICATE
Certified that this project report titled Working capital Management is the bonafide work of Nilesh M Bhitade who carried out the project work under my supervision.
Signature of the Guide. Mr. Navneet Goyal. Vice President, Aegis Ltd (Essar Group) Essar technopark,Old Swan mill compound, LBS Marg, Mumbai- 400 070.
SIGNATURE HEAD OF THE DEPARTMENT
SIGNATURE FACULTY IN CHARGE
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Executive Summary
I am privileged to study on the topic of Working Capital Management as a project work. This report is designed to be a comprehensive report of Working Capital Components, which is like the blood moving through the veins of the human body. I have tried to cover the major aspects related to Working Capital Components in this project. This project consists of study of general nature of circulating capital, factors determining circulating capital requirements etc. I have attempted to fill in the gap by introducing examples and company info to give me a stimulus in gaining my practical knowledge. In simple language, capital is bifurcated into fixed and working capital and these two are the two sides of the same coin. From the functional point of view, capital of the company is like that of blood of human body without which human body gets perished. The report is the outcome of authors who have taken up academics after serving world; it is hope that this report will be a good blend of challenging ideas and practical tips, which can be learnt through observations. I thank the management of publications like capital magazines, finance magazine and Business today whose reading materials are included in this project. The choice of topic for this individual project was really interesting and more knowledgeable which would help me in my practical life. It has really been a pleasure and challenging experience to study this topic. All that remains is from me to wish you a HAPPY READING.
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Table of Contents
1. ACKNOWLEDGEMENT..................................................................................................3 2. CERTIFICATE...................................................................................................................4 3. EXECUTIVE SUMMARY.................................................................................................5 4. INTRODUCTION...............................................................................................................9 Meaning of Working Capital.......................................................................................9 Purpose of Working Capital......................................................................................11 Definition of Working Capital...................................................................................12 Objective of Working Capital....................................................................................13 5. CONCEPT OF WORKING CAPITAL..........................................................................13 Constituents of Current Assets..................................................................................14 Constituents of Current Liabilities.............................................................................15 6. CLASSIFICATION OF WORKING CAPITAL...........................................................15 Permanent or Fixed Working Capital........................................................................16 Temporary or Variable Working Capital...................................................................17 Consequences of under assessment of Working Capital...........................................17 Consequences of over assessment of Working Capital.............................................17 Inventory Management..............................................................................................18 Receivables Management..........................................................................................19 Cash Management.....................................................................................................20 Cash Budget...............................................................................................................20 Cash Inflows....................................................................................................21 Cash Outflows.................................................................................................22 Adequacy of Working Capital...................................................................................22 Uses of adequate Working Capital............................................................................23 Evils of inadequate Working Capital.........................................................................24 Evils or redundant or excessive Working Capital.....................................................25 7. WORKING CAPITAL MANAGEMENT......................................................................26 Importance of good circulating Capital Management...............................................26 Approaches to Working Capital Management..........................................................27 Factors determining Working Capital requirement.......................................... 28 39
8. WORKING CAPITAL FINANCING............................................................................32

Trade Credit :- Features, Advantages & Cost...........................................................32 Bank Credit :- Forms of Credit & Mode of Security.................................................33 Promoters Fund........................................................................................................46 9. FACTORING....................................................................................................................37 Definition & Mechanism...........................................................................................37 Function of Factor......................................................................................................37 Making more efficient use of Working Capital.........................................................38 Factors that reduce Working Capital levels...............................................................40 Assessment of Working Capital requirement in Seasonal Industry..........................40 10. METHODS OF ESTIMATING WORKING CAPITAL REQUIREMENTS..........42 Operating Cycle Method............................................................................................42 Traditional or Usual Method.....................................................................................45 Method using Tandon/Chore Committee Norms......................................................47 Percentage of Sales Method.......................................................................................48 Regression Analysis Method.....................................................................................48 11. WORKING CAPITAL REPORT..................................................................................48 Inventory Report........................................................................................................49 Cash Report...............................................................................................................50 Receivables Report....................................................................................................50 12. FINANCIAL RATIO ANALYSIS.................................................................................52 Efficiency Ratio.........................................................................................................52 Liquidity Ratio...........................................................................................................54 Structural Health Ratio..............................................................................................55 13. WORKING CAPITLA LEVERAGE............................................................................57 14. ZERO WORKING CAPITAL.......................................................................................59 15. OVERTRADING............................................................................................................60 16. RESEARCH MEHTODOLOGY...................................................................................63 17. ANALYSIS OF FINANCIAL STATEMENTS............................................................63 18. INDUSTRY PROFILE...................................................................................................66 Sponge Iron Industry.................................................................................................66
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19. DATA ANALYSIS & INTERPRETATION.................................................................72 Current Ratio.............................................................................................................73 Quick Ratio................................................................................................................74 Absolute Liquid Ratio................................................................................................75 Inventory Turnover Ratio..........................................................................................76 Inventory Conversion Period.....................................................................................77 Debtors Turnover Ratio.............................................................................................78 Average Collection Period.........................................................................................79 Working Capital Turnover Ratio...............................................................................80 20. CONCLUSION................................................................................................................81 21. BIBLIOGRAPHY...........................................................................................................82
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INTRODUCTION MEANING OF WORKING CAPITAL

Capital required for a business can be classified under two main categories via, 1) 2) Fixed Capital Working Capital
Every business needs investment to procure fixed assets, which remain in use for a longer period. Money invested in these assets is called Long term Funds or Fixed Capital. Long terms funds are required to create production facilities through purchase of fixed assets such as Plant & Machinery, Land, Building, Furniture, etc. Investments in these assets represent that part of firms capital which is blocked on permanent or fixed basis and is called Fixed Capital. Business also needs funds for short-term purposes to finance current operations. Investment in short term assets like Cash, Inventories, Marketable Securities, Debtors etc., is called Short-term Funds or Working Capital. Funds, thus, invested in current assets keep revolving fast and are being constantly converted in to cash and these cash flows out again in exchange for other current assets. Hence, it is also known as Revolving or Circulating Capital or Short-term Capital. The Working Capital can be categorised, as funds needed for carrying out day-to-day operations of the business smoothly. The management of the working capital is equally important as the management of long-term financial investment. Every running business needs working capital. Even a business which is fully equipped with all types of fixed assets required is bound to collapse without (i) adequate supply of raw materials for processing; (ii) cash to pay for wages, power and other costs; (iii) creating a stock of finished goods to feed the market demand regularly; and, (iv) the ability to grant credit to its customers. All these require working capital. Working capital is thus like the lifeblood of a business. The business will not be able to carry on day-to-day activities without the availability of adequate working capital.
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Working capital cycle involves conversions and rotation of various constituents components of the working capital. Initially cash is converted into raw materials. Subsequently, with the usage of fixed assets resulting in value additions, the raw materials get converted into work in process and then into finished goods. When sold on credit, the finished goods assume the form of debtors who give the business cash on due date. Thus cash assumes its original form again at the end of one such working capital cycle but in the course it passes through various other forms of current assets too. This is how various components of current assets keep on changing their forms due to value addition.
Cash
Creditors
Debtors
Raw Material
Working Expenses
Finished Goods
Work in process
Figure .1. WORKING CAPITAL CYCLE.

As a result, they rotate and business operations continue. Thus, the working capital cycle involves rotation of various constituents of the working capital. While managing the working capital, two characteristics of current assets should be kept in mind viz. (i) short life span, and (ii) swift transformation into other form of current asset. Each constituent of current asset has comparatively very short life span. Investment remains in a particular form of current asset for a short period. The life span of current assets depends upon the time 39
required in the activities of procurement; production, sales and collection and degree of synchronisation among them. A very short life span of current assets results into swift transformation into other form of current assets for a running business.
These characteristics have certain implications: Decision regarding management of the working capital has to be taken frequently and on a repeat basis. The various components of the working capital are closely related and mismanagement of any one component adversely affects the other components too. The difference between the present value and the book value of profit is not significant.
PURPOSE OF WORKING CAPITAL To meet the cost of inventories, raw materials purchases, work-in-process, finished goods, etc. To pay wages and salaries. To meet overhead cost, factory cost, office and administration cost, taxes, etc. To meet selling and distribution expenses, advertising, packing etc. DEFINITION OF WORKING CAPITAL The gross working capital concept focuses attention on two aspects of current asset management:
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(a) Optimum investment in current asset; and (b) Financing of current assets. Following definition of working capital defines gross working capital Mead, Malott and Field. Working capital means current assets. Bonneville. Any acquisition of funds which increases the current asset increases working capital, for they are one and the same. J.S.Mill. The sum of the current assets is the working capital of business. Prof. K.V.Smith. Working capital management is concerned with problems that arise in attempting to manage the current assets, the current liabilities and the interrelationship that exist between them. Weston and Brigham. Working capital management refers to all aspects of the administration of both current assets and current liabilities. OBJECTIVES OF WORKING CAPITAL To decide upon the optimum level of investment in various current assets i.e. determining the size of working capital. By optimizing the investment in current assets and by reducing the level of current liabilities, the company can reduce the locking up of funds in working capital thereby; it can improve the return on capital employed in the business. To decide upon the optimum mix of short-term funds in relation to long-term capital.
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The company should always be in a position to meet its current obligations which should properly be supported by the current assets available with the firm. By maintaining excess funds in working capital means locking of funds without return. To locate appropriate sources of short term financing. Maintaining working capital at appropriate level. The firm should manage its current assets in such a way that marginal return on investment in current assets is not less than the cost of capital employed to finance the current assets. Availability of sufficient funds at the times of need. CONCEPT OF WORKING CAPITAL There are two concepts of working capital: 1. 2. Gross Working Capital Net Working Capital
The gross working capital is the capital invested in the total current assets of the enterprises. Current assets are those assets which can convert in to cash within a short period normally one accounting year.
CONSTITUENTS OF CURRENT ASSETS Cash in hand and cash at bank Bills receivables Sundry debtors Short term loans and advances Inventories of stock as:
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Raw material Work in process Stores and spares Finished goods Temporary investment of surplus funds. Prepaid expenses Accrued incomes Marketable securities In a narrow sense, the term working capital refers to the net working. Net working capital is the excess of current assets over current liability, or, say: NET WORKING CAPITAL = CURRENT ASSETS CURRENT LIABILITIES Net working capital can be positive or negative. When the current assets exceeds the current liabilities. Current liabilities are those liabilities, which are intended to be paid in the ordinary course of business within a short period of time, normally one accounting year out of the current assets or the income from business. CONSTITUENTS OF CURRENT LIABILITIES Accrued or outstanding expenses Short term loans, advances and deposits Dividends payable Bank overdraft Provision for taxation Bills payable Sundry creditors
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The gross working capital concept is financial or going concern concept whereas net working capital is an accounting concept of working capital. Both the concepts have their own merits. The gross concept is sometimes preferred to the concept of net working capital for the following reasons: It enables the enterprise to provide correct amount of working capital at correct time. Every management is more interested in total current assets with which it has to operate than the source from where it is made available. It take into consideration of the fact every increase in the funds of the enterprise would increase its working capital. This concept is also useful in determining the rate of return on investments in working capital. The net working capital concept, however, is also important for following reasons: It is qualitative concept, which indicates the firms ability to meet to its operating expenses and short-term liabilities. It indicates the margin of protection available to the short term creditors. It is an indicator of the financial soundness of enterprises. It suggests the need of financing a part of working capital requirement out of the permanent sources of funds.
CLASSIFICATION OF WORKING CAPITAL Working capital may be classified in to two ways: On the basis of concept. Gross Working Capital
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Net Working Capital On the basis of time. Permanent or Fixed Working Capital Regular Working Capital Reserve Margin or Cushion Working Capital Temporary or Variable Working Capital Seasonal Variable Working Capital Special Variable Working Capital
PERMANENT OR FIXED WORKING CAPITAL Permanent or fixed working capital is minimum amount which is required to ensure effective utilization of fixed facilities and for maintaining the circulation of current assets. Every firm has to maintain a minimum level of raw material, work- in-process, finished goods and cash balance. This minimum level of current assts is called permanent or fixed working capital as this part of working capital is permanently blocked in current assets. As the business grow the requirements of working capital also increases due to increase in current assets. Regular Working Capital. It is the minimum amount of liquid capital required to keep up the circulation of the capital from cash to inventories; to receivable and again to cash. This includes sufficient minimum cash balance to discount all bills and to maintain adequate supply of raw materials etc.
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Reserve Margin or Cushion Working Capital. It is the excess capital over the needs of regular working capital that should be kept in reserve for contingencies that may arise at any time. These contingencies include rising prices, business depression, strikes, special operations such as experiments with new products etc.
TEMPORARY OR VARIABLE WORKING CAPITAL Temporary or variable working capital is the amount of working capital which is required to meet the seasonal demands and some special exigencies. Variable working capital can further be classified as seasonal working capital and special working capital. The capital required to meet the seasonal need of the enterprise is called seasonal working capital. Special working capital is that part of working capital which is required to meet special exigencies such as launching of extensive marketing for conducting research, etc. Temporary working capital differs from permanent working capital in the sense that is required for short periods and cannot be permanently employed gainfully in the business. Seasonal variable working capital. The working capital required to meet the seasonal liquidity of the business is seasonal variable working capital. Special variable working capital. It is that part of the variable working capital which is required for financing special operation such as extensive marketing campaigns, experiments with products or methods of production, carrying of special jobs etc. Consequences of under assessment of Working Capital
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Growth may be stunted. It may become difficult for the enterprise to undertake profitable projects due to non-availability of working capital. Implementation of operating plans may become difficult and consequently the profit goals may not be achieved. Cash crisis may emerge due to paucity of working funds. Optimum capacity utilisation of fixed assets may not be achieved due to nonavailability of the working capital. The business may fail to honour its commitment in time, thereby adversely affecting its credibility. This situation may lead to business closure. The business may be compelled to buy raw materials on credit and sell finished goods on cash. In the process it may end up with increasing cost of purchases and reducing selling prices by offering discounts. Both these situations would affect profitability adversely. Non-availability of stocks due to non-availability of funds may result in production stoppage. While underassessment of working capital has disastrous implications on business, over assessment of working capital also has its own dangers. Consequences of over assessment of Working Capital Excess of working capital may result in unnecessary accumulation of inventories. It may lead to offer too liberal credit terms to buyers and very poor recovery system and cash management.
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It may make management complacent leading to its inefficiency. Over-investment in working capital makes capital less productive and may reduce return on investment. Working capital is very essential for success of a business and, therefore, needs efficient management and control. Each of the components of the working capital needs proper management to optimise profit.
INVENTORY MANAGEMENT Inventory includes all types of stocks. For effective working capital management, inventory needs to be managed effectively. The level of inventory should be such that the total cost of ordering and holding inventory is the least. Simultaneously, stock out costs should also be minimised. Business, therefore, should fix the minimum safety stock level, re-order level and ordering quantity so that the inventory cost is reduced and its management becomes efficient. RECEIVABLES MANAGEMENT Given a choice, every business would prefer selling its produce on cash basis. However, due to factors like trade policies, prevailing marketing conditions, etc., businesses are compelled to sell their goods on credit. In certain circumstances, a business may deliberately extend credit as a strategy of increasing sales. Extending credit means creating a current asset in the form of Debtors or Accounts Receivable. Investment in this type of current assets needs proper and effective management as it gives rise to costs such as: Cost of carrying receivable (payment of interest etc.) Cost of bad debt losses
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Thus the objective of any management policy pertaining to accounts receivables would be to ensure that the benefits arising due to the receivables are more than the cost incurred for receivables and the gap between benefit and cost increases resulting in increased profits. An effective control of receivables helps a great deal in properly managing it. Each business should, therefore, try to find out average credit extended to its client using the below given formula: Average Credit = Extended (in days) Total amount of receivables -----------------------------------Average credit sales per day
Each business should project expected sales and expected investment in receivables based on various factors, which influence the working capital requirement. From this it would be possible to find out the average credit days using the above given formula. A business should continuously try to monitor the credit days and see that the average credit offered to clients is not crossing the budgeted period. Otherwise, the requirement of investment in the working capital would increase and, as a result, activities may get squeezed. This may lead to cash crisis. CASH MANAGEMENT Cash is the most liquid current asset. It is of vital importance to the daily operations of business. While the proportion of assets held in the form of cash is very small, its efficient management is crucial to the solvency of the business. Therefore, planning cash and controlling its use are very important tasks. Cash budgeting is a useful device for this purpose. CASH BUDGET Cash budget basically incorporates estimates of future inflows and outflows of cash over a projected short period of time which may usually be a year, a half or a quarter year. Effective cash management is facilitated if the cash budget is further broken down into month, week or even on daily basis. A suggestive format for Cash Budget is given below: Particulars Months
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Jan Estimated Cash inflows -------------I. Total Cash inflows Estimated Cash outflows -------------II. Total Cash outflows III. Operating Cash balance IV. Add/Deduct Surplus/Deficit during the month (I-II) V. Closing Cash balance VI. Minimum level of Cash balance VII. Estimated excesses or shortfall of Cash (V-VI) There are two components of Cash Budget & its main sources: CASH INFLOWS Cash Sales Cash received from Debtors Cash received from Loans, Deposits, etc. Cash receipt of other Revenue Income Cash received from sale of Investments or Assets CASH OUTFLOWS Cash purchases Cash payment to creditors Cash payment for other revenue expenditure Cash payment for assets creation Cash payment for withdrawals, taxes Repayment of loans, etc. ADEQUACY OF WORKING CAPITAL
Feb
March
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Working capital or investment in current assets is a must for meeting the day-to-day expenditure on salaries, wages, rents, advertising etc., and for maintaining the fixed assets. Large scale capital in fixed is often determined by a relatively small amount of current assets. The heart of industry, working capital, if weak, the business cannot prosper and survive, although there may be a large investment of fixed assets. Inadequate as well as redundant working capital is dangerous for the health of industry. Inadequate working capital is disastrous; whereas redundant working capital is a criminal waste. Both situations are unwarranted in a sound organization. Adequacy of working capital is the lifeblood and controlling nerve center of a business.
USES OF ADEQUATE WORKING CAPITAL CASH DISCOUNT by adequate working capital the business can avail the
advantages of cash discount by paying cash for the purchase of raw materials and merchandise. If proper cash balance is maintained, this will reduce the cost of production. SENSE OF SECURITY AND CONFIDENCE adequate working capital creates a sense of security, confidence and loyalty throughout the business and also among its customers, creditors and business associates. The proprietor, officials or management of a concern are carefree, if they have proper capital arrangements because they need not worry for the payment of business expenditure or creditors. SOLVENCY AND CONTINUOUS PRODUCTION in order to maintain the solvency of the business, it is essential that sufficient amount of funds are available to make all the payments in time as and when they are due. In the absence of working capital, production will suffer, era of cut throat competition. A business can never flourish in the absence of adequate working capital. SOUND GOODWILL AND INCREASE DEBT CAPACITY promptness of payment in business creates goodwill and increases the debt capacity of the business. If investors and borrowers are confident that they will get their due interest and 39
payment of principal in time, a firm can raise funds from the market, purchase goods on credit and borrow short term funds from banks etc. EASY LOANS FROM THE BANKS an adequate working capital helps the company to borrow unsecured loans from the bank because the excess provides a good security to the unsecured loans. If the business has a good credit standing and trade reputation, banks favour in granting seasonal loans. DISTRIBUTION OF DIVIDEND short of working capital a company cannot distribute dividend to its shareholders in spite of sufficient profits. To make up for the deficiency of working capital profits are to be retained in the business. On the other hand, ample dividend can be declared and distributed to the market value of shares and increase by sufficient working capital. EXPLOITATION OF GOOD OPPORTUNITIES good opportunities can be exploited through adequacy of capital in a concern, for example, a company may make off seasons purchases resulting in substantial savings or it can fetch big supply orders resulting in good profits. MEETING UNSEEN CONTINGENCIES as stockpiling of finished goods becomes necessary depression shoots up the working demand of capital. If a company maintains adequate working capital unseen contingencies such as financial crises due to heavy losses, business oscillations etc. can easily be overcome. INCREASE IN EFFICIENCY OF FIXED ASSETS proper maintenance and adequate working capital increases the efficiency of the fixed assets of the business. It has been rightly said, The fate of large scale investment in fixed capital is often determined by a relatively small amount of current assets. HIGH MORAL the provision of adequate working capital improves the morale of the executive as they get an environment of certainty, security and confidence which
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is a great psychological factor in improving the overall efficiency of the business and of the person who is at the helm of affairs in the company.
INCREASE PRODUCTION EFFICIENCY a continuous supply of raw materials, research programs, innovation and technical developments and expansion programs are successfully carried out if adequate capital is maintained in the business. It increases production capacity which increases the efficiency and morale of the employees. EVILS OF INADEQUATE WORKING CAPITAL LOSS OF CREDIT WORTHINESS AND GOODWILL a firm looses its credit worthiness and goodwill if it fails to honour its current liabilities. It finds it difficult to procure the requisite funds for its business operations on easy terms. This leads to reduce profitability as well as production interruptions. NO BENEFIT FROM FAVOURABLE OPPORTUNITIES with inadequate working capital a firm fails to undertake profitable projects. It prevents the firm from availing the benefits for available opportunities and stagnates its growth. FAILURE TO AVAIL CREDIT OPPORTUNITIES due to inadequate working capital a firm fails to avail the attractive credit opportunities. OPERATING INEFFICIENCIES inadequate working capital leads to operating inefficiencies as day-to-day commitments cannot be met. LOW RATE OF RETURN ON FIXED ASSETS inadequate working capital results in lowering down the rate of return on fixed assets as these cannot be efficiently utilized or maintain due to inadequacy of working capital.
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INCREASE IN BUSINESS RISKS inadequate working capital increases the business risk of the firm. Unable to discharge its current liabilities it is liable to be declared as insolvent. Thus inadequate working capital poses a serious threat to the survival of the firm.
CANNOT ACHIEVE PROFIT TARGET due to inadequate working capital the firm cannot achieve its profit target as it cannot implement its operating plans due to shortage of working capital. LOW MORALE OF BUSINESS EXECUTIVES inadequate working capital adversely lowers the morale of the firms executives as they do not have an environment of certainty, security and confidence, which is a necessary psychological factor in improving the overall efficiency of the business. WEAKENING OF FINANCIAL CAPACITY inadequate working capital weakens the shock-absorbing capacity of the firm as it cannot meet the contingencies arising from business oscillations, financial losses, etc. EVILS OR REDUNDANT OR EXCESSIVE WORKING CAPITAL IDLE FUNDS excessive and redundant working capital implies the presence of idle funds which earn no profit for the firm. A firm with excessive working capital cannot earn proper rate of return on its total investments, as profits are distributed on the whole of its capital. This brings down the rate of return to the shareholders. Lower dividend reduces the market value of shares and causes capital losses to the shareholders. DECLINE IN OPERATING EFFICIENCY companies often adopt some objectionable devices to inflate profits to maintain or increase the rate of dividend. Sometimes, unearned dividends are paid out of companies capital to keep the show of prosperity by window dressing of accounts. In order to make up the deficiency of
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reduced earnings, certain provisions, such as provision for depreciation, repairs and renewals are not made. This leads to decline in operating efficiency and fall in profits. LOSS OF CONFIDENCE AND GOODWILL excessive working capital leads to lower rate of return on the companys total investments. Lower dividend leads to reduction of the market value of the companys shares much less than the book value. The shareholder loose confidence in the company and the goodwill or credit of the company suffers a serious setback. Thus the financial stability of the company is jeopardized. MISAPPLICATION OF FUNDS companies with excessive working capital do not utilize the resources prudently. Excessive inventories and fixed assets are purchased by the company which do not add to its profitability and increase its maintenance cost and losses due to theft, waste and mishandling. EVILS OF OVER CAPITALISATION excessive working capital leads to over capitalization, which is disastrous to the smooth survival of the company and affects the interest of those associated with the company. INEFFICIENT MANAGEMENT excessive working capital indicates that the management is not interested in expanding the business, otherwise the excessive working capital might have been utilised for this purpose. DESTRUCTION OF TURNOVER RATIO redundant working capital destroys the control of turnover ratio, which is commonly used in a conduct of an efficient business. It eradicates all other guides and sign post commonly employed in conducting and operating a business. Thus a company must have working capital adequate to its requirements neither excessive nor inadequate. While inadequate working capital adversely affects the business operations and profitability, excessive working capital keeps idle and earns no profit. It has been rightly 39
said, inadequate working capital is disasters; whereas redundant; working capital is a criminal waste. WORKING CAPITAL MANAGEMENT IMPORTANCE OF GOOD CIRCULATING CAPITAL MANAGEMENT
Working capital constitutes part of the Crown's investment in a department. Associated with this is an opportunity cost to the Crown. (Money invested in one area may "cost" opportunities for investment in other areas.) If a department is operating with more working capital than is necessary, this over-investment represents an unnecessary cost to the Crown. From a department's point of view, excess working capital means operating inefficiencies. In addition, unnecessary working capital increases the amount of the capital charge which departments are required to meet from 1st July, 1991. According to Husband and Dockery, the prime object of management is to make a profit, whether or not this is accomplished, as most business depends largely on the manner in which the working capital is administered. The primary objective of working capital management is to manage the firms current assets and current liabilities in such a way that a satisfactorily level of working capital is maintained. The firm may become insolvent if it cannot maintain a satisfactory level of working capital. Working Capital assists in increasing the profitability of the concern. The working capital position decides the various policies in the business with receipt to general operations viz., importance of management of working capital. POSITIVE CORRELATION BETWEEN SALE AND CURRENT ASSETS . There is a positive correlation between the sale of the product of the firm and its current assets. Increase in the sale of the product requires a corresponding increase in current assets. Therefore, the current assets must be managed properly. INVESTMENT IN CURRENT ASSETS. Generally more than half of the total capital of the firm is invested in current assets. Thus less than half of the capital is 39
blocked in fixed assets. Therefore management of working capital attracts the attention of the management. NO ALTERNATIVE FOR CURRENT ASSETS. While fixed capital can be acquired on lease in emergency there is no alternative for current assets. Investment in current assets cannot be avoided without substantial loss. FINANCED THROUGH OUTSIDE SOURCES. Working capital needs is often financed through outside sources. Hence, it is necessary to utilize them in the best possible way. IMPORTANT FOR SMALL UNITS. The management of working capital is more important for small units because they do not rely on the long term capital market and has easy access to short term financial sources such as trade credit, short term bank loan etc. APPROACHES TO WORKING CAPITAL MANAGEMENT The objective of working capital management is to maintain the optimum balance of each of the working capital components. This includes making sure that funds are held as cash in bank deposits for as long as and in the largest amounts possible, thereby maximizing the interest earned. However, such cash may more appropriately be "Invested" in other assets or in reducing other liabilities. Working capital management takes place on two levels: Ratio analysis can be used to monitor overall trends in working capital and to identify areas requiring closer management. The individual components of working capital can be effectively managed by using various techniques and strategies.
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When considering these techniques and strategies, departments need to recognize that each department has a unique mix of working capital components. The emphasis that needs to be placed on each component varies according to department. For example, some departments have significant inventory levels; others have little if any inventory. Furthermore, working capital management is not an end in itself. It is an integral part of the department's overall management. The needs of efficient working capital management must be considered in relation to other aspects of the department's financial and non-financial performance. FACTORS DETERMINING WORKING CAPITAL REQUIREMENT NATURE OF BUSINESS The amount of working capital is related to the nature of the business. In concerns, where the cost of the raw materials used in manufacture of a product is very large in production to its total cost of manufacture, the requirement of the working capital will be very large. For instance, a cotton or sugar mill requires a large amount of working capital on the contrary; a concern having large investments in fixed assets requires less amount of working capital. Public utility concerns such as railway or electricity services require a lesser amount of working capital as compared to trading or manufacturing concerns partly because of cash nature of their business and partly because they are selling a service instead of a commodity and there is no need of maintaining inventories. SIZE OF BUSINESS UNIT The general principal in this regard is that the bigger the size of business the larger will be the amount of working capital required because the larger business units are required to maintain big inventories for the flow of the business and to spend more in carrying out the business operations smoothly. SEASONAL VARIATIONS
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Strong seasonal variations create special problems of working capital in controlling the internal financial swings many companies such as sugar mills, oil mills or woolen mill etc. they require larger amount of working capital in the season to purchase the raw materials in large quantities and utilize them throughout the year they adjust their production schedule and maintain a steady rate of production during off season periods. Thus they require larger amount of working capital during season. TIME CONSUMED IN MANUFACTURE The average time taken in the process of manufacture is also an important factor in determining the amount of working capital. The longer the period of manufacture, the larger the inventory required. Though capital goods industries managed to minimize their investment in inventories or working capital by asking advances from the customers as work proceeds in their orders. TURNOVER OF CIRCULATING CAPITAL Turnover means the ratio of annual gross sales to average working assets. It means the speed with circulating capital completes its rounds or the number of times the amount invested in working assets has been converted into cash by sale of the finished goods and reinvested in working assets during a year. The faster the sales, the larger the turnover. Conversely, the greater the turnover, the larger the volume of business is to be done with given working capital. It will require lesser amount of working capital in spite of larger sales because of greater turnover. LABOUR INTENSIVE v/s CAPITAL INTENSIVE INDUSTRIES In labour intensive industries, larger working capital is required because of regular payment of heavy wage bills and more time taken in completing the manufacturing process. Conversely the capital intensive industries require lesser amount of working capital due to the heavy investment in fixed assets and shorter period in many acquiring processes.
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NEED TO STOCKPILE RAW MATERIAL AND FINISHED GOODS The industry, where it is necessary to stockpile the raw materials and finished goods increased the amount of working capital is tied up in stocks and stores. In some lines of business where the materials are bulky and best purchased in large quantities such as cements, stockpiling of raw material is very usual and used. In companies where, labour strike is frequent such as public utilities concerns, stockpiling of raw material is advisable. In certain industries such as seasonal industries or retail stores finished goods stock have to be large in quantities which requires larger working capital. TERMS OF PURCHASE AND SALES Cash or credit terms of purchase and sales also affect the amount of working capital. If a company purchases all goods in cash and sales its finished products on credit, it will require large amount of working capital. On the contrary, a concern having credit facilities and allowing no credit to its customers will require less amount of working capital. Terms and conditions of purchase and sales are generally governed by prevailing trade practices and by changing economic conditions.
CONVERSION OF CURRENT ASSETS INTO CASH The need of having cash in hand to meet the day-to-day requirements e.g. Payment of wages and salaries, rents rate etc., has an important bearing in deciding the adequate amount of working capital. The greater the cash requirements, the higher will be the need of working capital. A company has ample stock of liquid current assets will require lesser amount of working capital because it can encash its assets immediately in the open market. GROWTH AND EXTENSION OF BUSINESS Growing concerns require more working capital then those that are static. It is logical to expect larger amount of working capital in a going concern to meet its growing needs of 39
funds for its expansion programs though it varies with economic conditions and corporate practices. CLOSE CO-ORDINATION BETWEEN PRODUCTIONS & DISTRIBUTION POLICY This will reduce the demand of working capital. AN ABSENCE OF SPECIALISATION IN THE DISTRIBUTION OF PRODUCTS This will require more working capital as such concern will have to maintain its own marketing organization. IF THE MEANS OF TRANSPORTING AND COMMUNICATIONS ARE LESS DEVELOPED More working capital required in such areas to store the materials and finished goods. The hazards and contingencies are inherent in a particular type of business. These also decide the magnitude of working capital. The basis for assigning value to each component is given below:
Component of Working Capital 1. 2. 3. 4. 5. Stock of raw material Stock of work in process Stock of finished goods Debtors Cash
Basis of Valuation Purchase cost of raw materials At cost or market value, whichever is lower Cost of production Cost of sales or sales value Working expenses
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Each constituent of the working capital is valued on the basis of valuation enumerated above for the holding period estimated. The total of all such valuation becomes the total estimated working capital requirement. The assessment of the working capital should be accurate even in the case of small and micro enterprises where business operation is not very large. We know that working capital has a very close relationship with day-to-day operations of a business. Negligence in proper assessment of the working capital, therefore, can affect the day-to-day operations severely. It may lead to cash crisis and ultimately to liquidation. An inaccurate assessment of the working capital may cause either under-assessment or over-assessment of the working capital and both of them are dangerous. WORKING CAPITAL FINANCING Now let us understand the means to finance the working capital. Working capital or current assets are those assets, which unlike fixed assets change their forms rapidly. Due to this nature, they need to be financed through short-term funds. Short-term funds are also called current liabilities. The following are the major sources of raising short-term funds:
1] TRADE CREDIT FEATURES: Trade credit refers to the credit extended by the supplier of goods and services in the normal course of transaction/business/sale of the firm. According to trade practices, cash is not paid immediately for purchase but after an agreed period of time. There is however, no formal/ specific negotiation for trade credit. It is an informal arrangement between the buyer and the seller. There is no legal instrument of acknowledgment of debt, which is granted on an open account basis. Thus, without having an outflow of cash the business is in a position to use raw material and continue the activities. The credit given by the suppliers of raw materials is for a short period and is considered current liabilities. These funds should be used for 39
creating current assets like stock of raw material, work in process, finished goods, etc. ADVANTAGES: Trade credit, as a source of short term as working capital finance has certain advantages. It is easily, almost automatically available. Moreover it is flexible and spontaneous source of finance. The availability and magnitude of trade credits related to the size of operations of the firm in terms of sales/purchases. If the credit purchases of goods decline, the availability of trade credit will correspondingly decline. Trade credit is also informal, spontaneous source of finance. Not requiring negotiation and formal agreement, trade credit is free from the restriction associated with formal/negotiated source of finance/credit. COST: Trade credit does not involve any explicit interest charged. However there is an implicit cost of trade credit. It depends on credit terms offered by the supplier of goods. The small the difference between the payment day and the end of the discount period, the larger is the annual interest/cost of trade credit. 2] BANK CREDIT Bank credit is the primary institutional source of working capital finance in India; in fact, it represents the most important source of financing of current assets. Forms of Credit Working capital finance is provided by banks in five ways: CASH CREDIT/OVERDRAFTS: under cash credits, the bank specifies a predetermined borrowing/ credit limit. The borrowers can draw/borrow up to the stipulated credit/overdraft limit. Similarly repayments can be made whenever desired during the period. The interest is determined on the basis of the running balance/amount actually utilized by the borrower and not on the sanctioned limit.
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LOANS: under the arrangement the entire amount of borrowing is credited to the current account of the borrower or released in cash. The borrower has to pay interest on the total amount. BILLS PURCHASED/DISCOUNTED: the amount made available under this arrangement is covert by the cash credit and overdraft limit. Before discounting the bill, the bank satisfied itself about the credit-worthiness of the drawer and the genuineness of the bill. To popularize the scheme, the discounting banker asks the drawer of the bill (i.e. seller of goods) to have his bill accepted by the drawee (buyers) bank before discounting is latter grants acceptance against the cash credit limit, earlier fixed by it on the basis of the borrowing value of stocks therefore, the buyer who byes goods on credit cannot use the same goods as source of obtaining additional bank credit. TERM LOANS FOR WORKING CAPITAL: under this arrangement, banks advance loans for 3-7 years repayable in yearly or half yearly installments. LETTER OF CREDIT: while the other forms of bank credit are direct forms of financing in which banks provide funds as well as bear risk, letter of credit is an indirect form of working capital financing and banks assume only the risk, the credit being provided by the supplier himself.
MODE OF SECURITY Banks provide credit on the basis of the following modes of security: HYPOTHECATION: Under this mode of security, the banks provide credit to borrowers against the security of movable property, usually inventory of goods.
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PLEDGE: pledge, as mode of security is different from hypothecation in that in the former, unlike in the latter the goods, which are offered as security, are transferred to the physical possession of the lender. LIEN: the term lien refers to the right of the party to retain goods belonging to another party until a debt due to him is paid. MORTGAGE: it is the transfer of the legal stock equitable interest in specific immovable property for securing the payment of debts. CHARGE: where immovable property of one person is, by the act of parties or by the operation of law, made security for the payment of money to another and the transaction does not amount to mortgage, the later person is paid to have a charge on the property and all the provisions of simple mortgage will apply to such a charge. COMMERCIAL PAPERS ADVANTAGES: A CP has several advantages for both the issuer and investors. It is a simple instrument and hardly involves any documentation. It is additionally flexible in terms of maturities which can be tailored to march the cash flow of the issuer. Companies which are able to raise funds through CPs have better financial standing. The CPs are unsecured and there are no limitations on the end use of funds raised to them. Effective Cost / Interest Yield As the CPs are issued at discount and redeemed at it face value, their effective pretax cost/interest yield Face value in net amount realized -------------------------------------------------Net amount realized = 360 -----------------maturity period
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Where net amount realised = face value discount - issuing and paying agent (IPA) charges, that is, stamp duty, rating charges, dealing bank fee and fee for stand by facility. A Corporate would be eligible to issue CP provided it satisfies the following requirements: 1. Tangible net worth of the company, as per the latest audited Balance Sheet, is not less than Rs. 4 Cores. 2. Working Capital (fund based) limits of the company, sanctioned by bank/s or all-India Financial Institution/s, is not less than Rs. 4 Cores. 3. The company should obtain the specified credit rating from an agency approved by RBI, for the purpose, from time to time. 4. The borrower account of the company is classified as a Standard Asset by the by the financing bank/s/ institution/s.
3] PROMOTERS FUND It is advisable to finance a portion of current assets from the promoters funds. They are long-term funds and, therefore do not require immediate repayment. These funds increase the liquidity of the business.
FACTORING Factoring provides resources to finance receivables as well as facilitates the collection of receivables. Although such services constitute a critical segment of the financial services scenario in the developed countries, they appeared in the Indian financial scene only in early nineties as a result of RBI initiatives. There are two bank sponsored organizations which provide such services: (i) SBI factors and commercial services ltd., and (ii) Can bank factors. 39
The first private sector factoring company, foremost factors ltd. Started operations since the beginning of 1997. DEFINITION: Factoring can broadly be defined as an agreement in which receivables arising out of sale of goods/services are sold by a firm (client) to the factors (a financial intermediary) as a result of which the title of the goods/services represented by the said receivables passes on the factor. Hence forth, the factor becomes responsible for all credit control, sales accounting and debt collection from the buyers. MECHANISM: credit sales generate the factoring business in the ordinary course of business dealing. Realisation of credit sales is the main function of factoring services. Once the sales transaction is completed, the factors steps into realize the sales. Thus the factor works between the seller and the buyer and sometimes with the sellers banks together.
FUNCTION OF A FACTOR Depending on the type/form of factoring, the main functions of a factor, in general terms can be classified into 5 categories: Financing facility/trade debts, Maintenance/administration of sales ledger, Collection facility/of accounts receivables, Assumptions of credit risk/credit control and credit restriction; and next provision of advisory services COST OF SERVICES The factors provide various services at a charge. The charge for collection and sales ledger administration is in the form of a commission expressed as value of debt purchase. It is
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collected up-front/in advance. The commission for short term financing as advance partpayment is in the form of interest charged for the period between the date of advance payment and the date of collection guaranteed payment date. It is also known as discount charge. MAKING MORE EFFICIENT USE OF WORKING CAPITAL The table below lists items, which influence Working Capital levels favourably and adversely
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Items that reduce Working Capital levels for Items that increase Working Capital levels for publishers - Increased profit margins Customers who publishers - Lower profit margins promptly - Long print runs except where all the books are required on publication e.g. School and
pay
- Advance payments by customers
university textbooks - Inventory which is sold and paid for quickly - Slow authors who deliver late and whose by customers after publication manuscripts and require the substantial savings are editing large - Lower Inventory levels by reducing print - Holding paper stock unless market conditions quantities and working with printers who will demand economically titles - Successful promotion that speeds up the rate - Making of sale - Licensing (but problematic in young economies) - Paying suppliers on completion with credit - Authors who deliver manuscripts on disk ready for computer make-up - Incentives to staff, authors, suppliers, customers, sales staff and agents to speed up the rate of sale and of developing new books, delivering manuscripts on schedule deliver quickly and produce low print runs - Slow schedules for the development of new advance payments to printers
- Seasonal sales except where the publishers prints only for the season
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FACTORS THAT REDUCE WORKING CAPITAL LEVELS From the table above we can infer the following checklist of reducing Working Capital level in developed countries Small numbers of titles Need to buy rather than want to buy titles with unique information Use of standard formats for paper printing and binding Direct marketing Closer involvement in market distribution Publishing for clearly identifiable markets e.g. schools, doctors, accountants, lawyers Short run printing Book packaging Titles where printing costs are a low % of the selling price
Whether the same list will apply to young economies will depend on average wages levels and other economic data such as the percentage of urban population to rural population. In developed countries profitability for such publishers is linked to their ability to charge a premium price for need-to-buy books. Computer books are a typical example: a typical PC will cost in excess of US$1,000. Thus the selling price of a book that assists the user to make better use of the computer and its software is linked to the benefit. In many young economies that may not yet be the case.
ASSESSMENT OF WORKING CAPITAL REQUIREMENT IN SEASONAL INDUSTRY In the seasonal industries the level of working capital requirement will not be similar all the year. In times of off-season, the working capital requirement and therefore, the level of investment in current assets and liabilities are very low. But, during season, the firm requirement of working capital is at peak level. Let us look at the sugar industry. The crushing season in the year will remain for 5 to 6 months time. During the season the plant 39
is expected to work at full capacity with triple shift working and the requirement of stocks is very high and resultant increase in stock of sugar. The requirement for payment of labour, expenses and maintenance is also higher. There will not be immediate sales of sugar and finished stock inventory would be much higher. After the completion of the crushing season, the plant will be close and only upkeep and maintenance of plant will be incurred and the level of current assets and current liabilities comes down and the working capital requirement would be very low. For efficient management of working capital, the finance manager should be able to properly estimate the season and off-season requirements of working capital. For this the following precautions are taken: Preparation of projected cash flow statement showing the cash flow for peak season, normal season and off-season requirements. Make proper arrangements with the banks and other sources of finance to meet the short-term need of season. Make proper arrangement for meeting the contingencies of higher-level requirement than the projected levels of requirement. Proper and careful assessment of working capital requirements for the season and off-season requirement. Care to be taken to reduce the level of investments in current assets after the season is completed.
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METHODS OF ESTIMATING WORKING CAPITAL REQUIREMENTS Funds required to carry the required levels of current assets, to enable the Company to carry on its operations at the expected levels uninterruptedly, are the Working Capital requirements. Therefore Working Capital requirement (WCR) is proportional to: The volume of activity (i.e. level of operation ) The type of business carried on viz. manufacturing process, production program. Though there are various methods for assessing the quantum of Working Capital requirement for an industry, the following three are commonly known and used. Operating Cycle Method (for W/C limits upto Rs.25000) Usual or Traditional Method (for W/C limit upto Rs.10 lacs) Using Tandon & Chore Committee Norms (for W/C limit above Rs.10 lacs)
OPERATING CYCLE METHOD: Operating cycle is the period that a business enterprise takes in converting cash back into cash. It has the following four stages: The raw material and stores inventory stage The semi-finished goods or work in progress stage; The finished goods inventory stage; and The accounts receivable and book debt stage.
Each of the above stage is expressed in terms of number of days of relevant activity. Each requires a level of investment to support it. The sum of these stage wise investments will be total amount of working capital of the firm.
The following formulae will be used to express the framework of the operating cycle:
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T = (S * C) + W + F + B Where, T = stands for the total period of operating cycle in number of days; S = the number of days of raw material and stores consumption requirements held in raw materials and stores inventory; C = the number of days of purchases in trade creditors; W = the number of days of cost of production held in work in progress F = the number of days of cost of sales held in finished goods inventory and B = the number of days of sales in book debt The computation may be made as under Average inventory of raw material and stores S = -------------------------------------------------------------------------Average per day of consumption of raw material and stores Average trade creditors C = ------------------------------------------Average credit purchases per day Average work in progress W= ----------------------------------------------Average cost of production per day Average inventory of finished goods F= -----------------------------------------------Average cost of sales per day Average book debts
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B=
----------------------------Average sales per day
The average inventory, trade creditors, work in progress, finished goods and book debts can be computed by adding the opening and closing balances at the end of the year in the respective accounts and dividing the concerned annual figures by 365 or the number of days in the given period. The operational cycle method of determining working capital requirements gives only an average figure. In this method the fluctuations in the intervening period due to seasonal or other factors and their impact on the working capital requirements cannot be judged. Continuous short run detailed forecasting and budgeting exercises are necessary to identify these impacts. A new concept that is gaining more and more importance in recent years is the operating cycle concept of working capital. The operating cycle refers to the average time elapsed between the acquisition of raw materials and the final cash realization. Cash is used to buy the raw materials and other stores, so cash is converted into raw materials and stores inventories. Then the raw materials and stores are issued to the production department. Wages are paid and other expenses are incurred in the process and work in process comes into existence. Work in process becomes finished goods. Finished goods are sold to customers on credit. In the course of time, these customers pay cash for the goods purchased by them. Cash is retrieved and the cycle is completed. Thus operating cycle consists of four stages: The raw material and stores inventory stage The work in process stage The finished goods inventory stage The receivable stage
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The Operating Cycle of working capital is shown below CASH
PURCHASE OF RAW MATERIAL INVENTORY ACCOUNTS RECEIVABLES WORK IN PROCESS FINISHED GOODS TRADITIONAL OR USUAL METHOD: The operating cycle concept serves to identify the areas requiring improvement for the purpose of control and performance review. But bankers require a more detailed analysis to assess the various components of Working Capital requirement viz. Finance for stocks, Bills, etc. Hence usual method is different. Bankers provide working capital finance for holding an acceptable level of Current Assets, viz. Raw Material, Work In Progress, Finished Goods, and Sundry Debtors for achieving a pre-determined level of production and sales. Quantification of these funds, required to be blocked, in each of these items of Current Assets at any time is as follows:
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Raw Material requirement is generally expressed as so many months requirement (consumption). Work In Progress a rough & ready formula for computing the requirement of funds is to find the Cost of Production for the period of processing. via (RM consumed / month + Expenses / month) * period of processing in months. Finished Goods the requirement of funds against finished goods is expressed as so many months cost of production. Sundry Debtors Working Capital requirement against Sundry Debtors will be computed on the basis of Cost of Production (where as the Permissible Bank Finance will be on the basis of the sale value)
Working Capital requirement is normally expressed as so many months of Cost of Production (COP). Working Capital of any industry can thus be summerised as: RM WIP FG SDrs Expenses Months Requirement Weeks (COP) Months (COP) to be stocked Months (COP) outstanding Credit One Month Rs. A Rs. B Rs. C Rs. D Rs. E Rs. F Rs. G
Less: Credit received on purchases Less: Advance payment on received WCR (Rs. H) = (A+B+C+D+E)-(F+G)
The purpose of assessing the Working Capital Requirement of the company is to determine how the total requirement of funds will be met. 39
The two resources are:
1) Long term Borrowing and Capital 2) Short term Bank Borrowing.
METHOD USING TANDON / CHORE COMMITTEE NORMS: The Reserve Bank of India constituted study groups in 1974 and 1979 viz. Tandon Committee and Chore Committee to frame suitable guidelines for Working Capital Finance. The recommendations of Tandon / Chore Committee relate to: Norms for Inventory and Receivables Approach to Lending Follow-up, Supervision & Control of Advances The Tandon Committee prescribed definitive norms as to the reasonable level of inventory and the receivables the unit should carry and the extent to which the total Current Assets are supported by long-term funds. The lending norms comprise of three methods as under: 1st method: The quantum of the banks short-term advances will be restricted to 75% of the Working Capital gap; remaining 25% is to be met from NWC. 2nd method: NWC should be at least being equal to 25% of the total value of acceptable current assets. The remaining 75% should first be financed by other Current Liabilities and then the banker may finance the balance of the requirement. 3rd method: Borrower should provide for entire core Current Assets and 25% of the Current Assets over the core Current Assets. RBI has not implemented this method.
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All the units with Fund Based Working Capital limits of Rs.50 lacs and over should be straightaway placed under 2nd method of lending.
PERCENTAGE OF SALES METHOD: It assumes that certain balance sheet items vary directly with sales. Thus the ratio of the given balance sheet item to sales remains constant. The firms need in terms of percentage of annual sales envisaged in each individual balance sheet items are expressed in the following 3 ways: As number of days of sales; As turnover; and As percentage of sales
REGRESSION ANALYSIS METHOD: This is very useful statistical technique of working capital forecasting which helps in making projection after establishing the average relationship in the past years between sales and working capital (current assets) and its various components. This analysis may be carried out through the graphic portrayals (scattered diagrams) or through mathematical formula. The relationship between the sales and the working capital of various components may be simple and direct indicating linearly between the two. It may be complex involving simpler linear regressions or simple curvilinear regression and multiple regression situations. This method is particularly suitable for long term forecasting. WORKING CAPITAL REPORT MEANING OF WORKING CAPITAL REPORT
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A prudent financial manager is always vigilant for avoiding the financial embarrassment likely to be caused to the concern due to the inadequacy of working capital. He takes utmost care so as to keep himself well informed of the working capital position, its present aspects and the future prospects. Working capital reports vary according to the nature of the requirements of the individual concern and circumstances, etc.
TYPES OF WORKING CAPITAL REPORT INVENTORY REPORT: It gives in detail a comparative analysis of the composition of closing stores of raw material and finished products. It may be prepared weekly, monthly or quarterly. It brings into light the fact whether working capital is unnecessarily blocked up in the inventory. Following is an example of monthly inventory report: Monthly Inventory Report
Sr. No.
Item
Code No.
Max Stock Limit
Min Stock Limit
Order Size
Opening Balance
Received month
Issued the month
Balance
During the during
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1. 2. 3. 4. 5. 6.
CASH REPORT: It reflects the net liquid position of the concern. It is prepared on daily basis. It shows the summary of daily cash receipts, cash disbursements and the cash balance. Following is the cash Performa of the cash report.
Weekly Cash Report Particulars A. REVENUE X Y Z B. CAPITAL 39 Current A/c Letter of Fixed deposit A/c Cash in Total chest Previous week
credit A/c
X Y Z
TOTAL
RECEIVABLES REPORTS: These help in studying up efficiency of the collection policies and the desirability of credit policies. Detailed reports may be made to depict the reserve for bad and doubtful debts position. Some companies prepare ageing reports in respect of debtors and receivables. A Performa of receivables report is given below.
Receivable Report Monthly statement of Sundry Debtors Balance at the beginning Supplies made Realisation made during Back recoveri es Sr. No . Part y Mor e than 1 year Six mont hs Less than six month s Bill realise d Bills not realised Mor e than 1 year More months Below month s than six six Balanc e
during the month
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FINANCIAL RATIO ANALYSIS Financial ratio analysis calculates and compares various ratios of amounts and balances taken from the financial statements. The main purposes of working capital ratio analysis are: To indicate working capital management performance; and To assist in identifying areas requiring closer management. Three key points need to be taken into account when analyzing financial ratios: The results are based on highly summarised information. Consequently, situations which require control might not be apparent, or situations which do not warrant significant effort might be unnecessarily highlighted;
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Different departments face very different situations. Comparisons between them, or with global "ideal" ratio values, can be misleading; Ratio analysis is somewhat one-sided; favourable results mean little, whereas unfavourable results are usually significant. However, financial ratio analysis is valuable because it raises questions and indicates directions for more detailed investigation.
WORKING CAPITAL RATIOS Working capital ratios indicate the ability of business concern in meeting its current obligations as well its efficiency in managing its current assets in generation of sales. These ratios are applied to evaluate efficiency with the firm manages and utilizes its current assets. The following three categories of ratios are used for efficient management of working capital: Efficiency Ratios Liquidity Ratios Structural Health Ratios EFFICIENCY RATIOS: Sales
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Working Capital to Sales Ratio
----------------------Working Capital
This ratio is computed by dividing working capital by sales. This ratio helps to measure the efficiency of the utilization of networking capital. It signifies for an amount of sales a relative amount of working capital is needed. If any increase in sales is contemplated, working capital should be adequate and thus, this ratios management to maintain the adequate level of working capital. Sales Inventory Turnover Ratio = ------------Inventory This ratio indicates the effectiveness and efficiency of the inventory management. The ratio shows how speedily the inventory is turned into accounts receivables through sales. The lower the inventory of sales ratio, the more efficiently the inventory is said to be managed vis-a-versa. Sales Current Assets Turnover Ratio = -------------------Current Assets This ratio indicated the efficiency with which current assets turn into sales. The lower current assets to sales ratio implies by enlarge a more efficient use of funds. Thus, a high turnover rate indicates reduced lock up of funds in current assets. An analysis of this ratio over a period of time reflects working capital management of a firm. LIQUIDITY RATIOS: Current Assets, Loans & advances Current Ratio = ---------------------------------------------Current Liabilities and Provisions 39
This ratio indicates the extent of the soundness of the current financial position of an undertaking and the degree of safety provided to the creditors. The higher the current ratio the large amount of rupee available per rupee for current liability, the more the firms ability to meet current obligations and the greater safety of funds of short term creditors. Current assets are those assets, which can be converted into cash within a year. Current liabilities and provisions are those liabilities that are payable within a year. A current ratio of 2:1 indicates a highly solvent position. Banks consider a current ratio of 1.3:1 as minimum acceptable level for proving working capital finance. The constituents of the current assets are as important as the current assets themselves for evaluation of companys solvency position. Current Assets, Loads and Advances Inventories Quick Ratio = ----------------------------------------------------------------Current Liabilities and Provisions Bank Overdraft Quick ratio is a more refined tool to measure the liquidity of an organization. It is better taste of financial strength then the current ratio, because it excludes very slow moving inventories and the items of current assets, which cannot be converted into cash easily. This ratio shows the extent of cushion of protection provided from the quick assets to the current creditors. A quick ratio of 1:1 is usually considered satisfactory though it is again a rule of thumb only.
STRUCTURAL HEALTH RATIOS: Net Assets Current Assets to Total Net Assets = -------------------Current Assets This ratio explains the relationship between current assets and total investment in current assets. A business enterprise should use its current assets effectively and economically because it is out of the management of these assets that profits accrue. A business will end up in losses if there is any lacuna in managing assets to the advantage of business. 39
Investment in fixed assets being in elastic in nature, there is no elbowroom to make an amends in this sphere and its impact on profitability remains minimal. Composition of Current Assets An analysis of current assets component enables one to examine in which component the working capital funds are locked up. Large tie up of funds in inventories effects profitability of the business adversely owing to carry over costs. In addition losses are likely to occur by way of depreciation, decay, obsolescence, evaporation and so on. Receivables constituting another component of current assets. If the major portion of current assets is made up of cash alone, the profitability will be decreased because cash is a non-earning asset. If the portion of cash balance is excessive, then it can be said that management is not efficient to employee the surplus cash.
Sales Debtors Turnover Ratio = ----------Debtors This ratio shows the extent of trade credit granted and the efficiency in the collection of debts thus; it is an indicative of efficiency of trade credit management. The lower the debtors to sales ratio, the better the trade credit management and better the quality (liquidity) of debtors. The lower debtors mean prompt payment by customers. An excessively long collection period, on another hand, indicates a very liberal, ineffective and inefficient credit and collection policy. Debtors Average Collection period (in days) = ----------- X 365 Sales 39
Average collection period, which measures how long it takes to collect amounts from debtors. The actual collection period can be compared with the stated credit terms of the company. If it is longer than those terms, then this indicates some in sufficiency in the procedures for collecting debts. Bad Debts Bad Debts to Sales = -------------Sales This ratio indicates efficiency of the control procedures of the company. The actual ration is compared with the target or norm to decide whether or not it is acceptable. Creditors Creditors Turnover period (in days) = --------------Purchases The measurement of the creditor turnover period shows the average time taken to pay for goods and services by the company. In general the longer the credit period achieved the better, because delays in payment mean that the operation of the company are being financed interest free by suppliers funds. But there will be a point beyond which if they are operating in a sellers market, may harm the company. If too long a period is taken to pay creditors, the credit rating of the company may suffer, thereby making it more difficult to obtain supplier in the future.
WORKING CAPITAL LEVERAGE One of the important objectives of working capital management is by maintaining the optimum levels of investment sin current assets and by reducing the levels of current liabilities, the company an minimize the investment in working capital thereby improvement in return on capital employed is achieved. The term working capital leverage refers to the impact of level of working capital on companys profitability. The working capital management should improve the productivity of investments in current assets and ultimately it will increase the return on capital employed. Higher levels of investments in current assets 39
than is actually required mean increase in the cost of interest charges on the short-term loans and working capital finance raised from banks etc. and will result on lower return on capital employed and vis-e-versa. Working capital leverage measures the responsiveness of ROCE for changes in current assets. It is measured by applying the following formula. C.A. Working Capital Leverage = -----------------T.A. - C.A. Where, C.A. = Current Assets T.A. = Total Assets (Net Fixed Assets + Current Assets) = Change in Current Assets
IMPACT OF INFLATION ON WORKING CAPITAL REQUIREMENT When the inflation rate is high, it will have its direct impact on the requirement of working capital as explained below. Inflation will cause to show the turnover figure at higher level even if there is no increase in the quantity of sales. The higher the sale means the higher levels of balances in receivables. Inflation will result in increase of raw material prices and hike in payment for expenses and as a result increase in balance s of trade creditors and creditors for expenses.
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Increase in valuation of closing stocks result in showing higher profits but without its realization into cash causing the firm to pay higher tax dividend and bonus. This will lead the firm in serious problems of funds shortage and firm may enable to meets its short term and long-term obligations. Increase in investments is current assets means the increase in requirements of working capital without corresponding increase in sales or profitability of the firm. Keeping in view of the above, the finance manager should be very careful about the impact of inflation in assessment of working capital requirements and its management.
IMPACT
OF
DOUBLE
SHIFT
WORKING
ON
WORKING
CAPITAL
REQUIREMENT If the firm which is presently running in single shift plans to go for working in double shift the following factors should be considered while assessing the working capital requirements of the firm. Working in double shift means requirement of raw materials will be doubled and other variable expenses will also increase drastically. With the increase in raw materials requirement and expenses, the raw material inventory and work in Progress will increase simultaneously the creditors for goods and creditors for expenses balances will also increase. Increase in production to meet the increased demand which will also increase the stock of finished goods. The increase in sales means increase in debtors balances. Increase in production will result in increased requirement of working capital. 39
The fixed expenses will increase with the working on double shift bases. The finance manager should reassess the working capital requirements if the change is contemplated from single shift operation to double shift. ZERO WORKING CAPITAL This is one of the latest trends in working capital management. The idea is to have zero working capital. For e.g. at all times the current assets shall equal the current liabilities. Excess investment in current assets is avoided and firm meets its current liabilities out of the matching current assets. As current ratio is 1 and the quick ratio below 1, there may be apprehensions about the liquidity, but if all current assets are performing and are accounted at their realizable values, these fears are misplaced. The firm saves opportunity cost on excess investments in current assets and as bank cash credit limits are linked to the inventory levels, interest cost is also sold. There would be a self-imposed financial discipline on the firm to manage their activities within their current liabilities and current assets and there may not be attendance to over borrow or divert funds. Zero working capital also ensures a smooth and uninterrupted working capital cycle, and it would pressure the finance manager to improve the quality of current assets at all times, to keep them 100 % realizable. There would also be constant displacements in the current liabilities and the possibility of having overdue may diminish. The tendency to postpone current liability payments has to be curbed and working capital always maintained at zero. Zero working capital would call for a fine balancing act in financial management, and the success in this endeavor would get reflected in healthier bottom lines. OVERTRADING
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Overtrading arises when a business expands beyond the level of funds available overtrade means and attempt to finance a certain volume of production and sales with inadequate working capital. If the company does not have enough funds of its own to finance stock and debtors it is forced, if it wishes it expand to borrow from creditors and the bank on overdraft sooner or later such expansion, financed completely by the funds of others, will lead to a chronic imbalance in the working capital ratio. Expansion is advantageous so long as the business has the funds available to finance the stocks and debtors involved. Overtrading begins at the point where the business relies on extra trade credit and increased turnover are financed by taking longer periods of credit from suppliers and/or negotiating an extension of overdraft limits with the bank. Over dependence on outside finance is a sign of weakness, unless the expansion is curtailed, suppliers may refuse credit beyond certain limits, and the bank may call for a reduction of the overdraft. If this happens, the business may be insolvent in that it does not have sufficient liquid resources (Cash) to pay for current operations or to repay current liabilities until customers pay for sales made on credit terms, or unless stock is sold at a loss for immediate cash payment.
The following ratios will analysis the situation properly: Working Capital = Current Assets : Current Liabilities Acid Test = Quick Assets : Current Liabilities Stock Turnover = Stock : Cost of Sales Debtors Turnover = Debtors : Credit Purchases The object of using these ratios is to detect a deterioration of the liquidity position of the business end an increasing reliance upon trade creditors and overdraft facilities OVERCAPITALISATION OF WORKING CAPITAL
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If there are excessive stocks, debtors and cash and very few creditors, there will be an over investment in current assets. The inefficiency in managing working capital will cause this excessive working capital resulting in lower return on capital employed and long term funds will be unnecessarily tied up when they could be invested as well to earn profit.
SYMPTOMS OF POOR WORKING CAPITAL MANAGEMENT In general, the following causes are seen inefficient management of working capital: Excessive carriage of inventory over the normal levels required for the business will result in more balance in trade creditors accounts. More creditors balances will cause strain on the management in management of cash. Working capital problems will arise when there is a show down in collection of debtors. Sometimes capital gods will be purchased from the funds available for working capital. This will result in storage of working capital and its impact is on operations of the company. Unplanned production schedules will cause excessive stocks of finished gods or failure in meeting dispatch schedules. More funds kept in the form of cash will not generate any profit for the business. In efficiency in using potential trade credit require more funds for financing working capital. Overtrading will cause shortage of working capital and its ultimate effect is on the operations of the company.
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Dependence in short term sources of finance for financing permanent working capital causes lesser profitability and will increase strain on the management in managing working capital.
Inefficiency in cash management causes embezzlement of cash.
Inability to get working capital limits will cause serious concern to the company and sometime may turn out to be sick. UNDER CAPITALIZATION Under capitalisation is a situation where a company does not have funds sufficient to run its normal operations smoothly. This may happen due to insufficient working capital or diversion of working capital funds to finance capital items. If the company faces the situation of undercapitalisation, it will face difficulties in current obligations, procurement of raw material in stores items; meeting day-to-day running expenses etc. its impact will ultimately be the reduced turnover and reduced profitability. The finance manager should take immediate and proper steps to overcome the situation of unde15r capitalization by making arrangement for the sufficient working capital. For this purpose he should prepare the realistic cash flow and funds flow statement of the company.
RESEARCH METHODOLOGY The methodology, we have to adopt for our study are the various tools, which basically analyse critically financial position of the organization: COMMON-SIZE P/L A/C COMMON-SIZE BALANCE SHEET COMPARTIVE P/L A/C COMPARTIVE BALANCE SHEET
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TREND ANALYSIS RATIO ANALYSIS The above parameters are used for critical analysis of financial position. With the evaluation of each component, the financial position from different angles is tried to be presented in well and systematic manner. By critical analysis with the help of different tools, it becomes clear how the financial manager handles the finance matters in profitable manner in the critical challenging atmosphere, the recommendation are made which would suggest the organization in formulation of a healthy and strong position financially with proper management system. Through the evaluation of various percentage, ratios and comparative analysis, the organization would be able to conquer its in efficiencies and makes the desired changes. ANALYSIS OF FINANCIAL STATEMENTS FINANCIAL STATEMENTS: Financial statement is a collection of data organized according to logical and consistent accounting procedure to convey an under-standing of some financial aspects of a business firm. It may show position at a moment in time, as in the case of balance sheet or may reveal a series of activities over a given period of time, as in the case of an income statement. Thus, the term Financial Statements generally refers to the two statements. (1) The Position Statement or Balance Sheet. (2) The Income Statement or Profit and Loss Account. OBJECTIVES OF FINANCIAL STATEMENTS: According to Accounting Principal Board of America (APB) states, The following objectives of financial statements:
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To provide reliable financial information about economic resources and obligation of a business firm. To provide other needed information about charges in such economic resources and obligation. To provide reliable information about change in net resources (recourses less obligations) missing out of business activities. To provide financial information that assets in estimating the learning potential of the business. LIMITATIONS OF FINANCIAL STATEMENTS: Though financial statements are relevant and useful for a concern, still they do not present a final picture a final picture of a concern. The utility of these statements is dependent upon a number of factors. The analysis and interpretation of these statements must be done carefully otherwise misleading conclusion may be drawn. Financial statements suffer from the following limitations: Financial statements do not given a final picture of the concern. The data given in these statements is only approximate. The actual value can only be determined when the business is sold or liquidated. Financial statements have been prepared for different accounting periods, generally one year, during the life of a concern. The costs and incomes are apportioned to different periods with a view to determine profits etc. The allocation of expenses and income depends upon the personal judgment of the accountant. The existence of contingent assets and liabilities also make the statements imprecise. So, financial statements are at the most interim reports rather than the final picture of the firm.
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The financial statements are expressed in monetary value, so they appear to give final and accurate position. The value of fixed assets in the balance sheet neither represent the value for which fixed assets can be sold nor the amount which will be required to replace these assets. The balance sheet is prepared on the presumption of a going concern. The concern is expected to continue in future. So, fixed assets are shown at cost less accumulated depreciation. Moreover, there are certain assets in the balance sheet which will realize nothing at the time of liquidation but they are shown in the balance sheets. The financial statements are prepared on the basis of historical costs or original costs. The value of assets decreases with the passage of time current price changes are not taken into account. The statement are not prepared with the keeping in view the economic conditions. The balance sheet loses the significance of being an index of current economic realities. Similarly, the profitability shown by the income statements may be represents the earning capacity of the concern. There are certain factors which have a bearing on the financial position and operating result of the business but they do not become a part of these statements because they cannot be measured in monetary terms. The basic limitation of the traditional financial statements comprising the balance sheet, profit & loss A/c is that they do not give all the information regarding the financial operation of the firm. Nevertheless, they provide some extremely useful information to the extent the balance sheet mirrors the financial position on a particular data in lines of the structure of assets, liabilities etc. and the profit & loss A/c shows the result of operation during a certain period in terms revenue obtained and cost incurred during the year.
INDUSTRY PROFILE
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SPONGE IRON INDUSTRY The story of Sponge Iron also known as Direct Reduce Iron (DRI) industry is very interesting as for as India goes. The three-decade old, this industry came into existence all on sudden when mini steel plants were looking out for raw materials randomly. Since, India has adequate coal deposits; its utilization for steel plant was considered of prime importance. Production of coal based sponge iron in the beginning was taken as vital option. Sponge iron industry grew at slow speed till the mid of 1980 due to government restrictive licensing. The year 1985 proved as a historical for the industry in general and the steel industry in particular. In this year the DRI production was de-licensed and since then the industry started growing rapidly to reach todays level. DRI is a high quality metallic product obtained from iron-ore, pellets etc. as a feed stock in the Electric Arc Furnaces (EAF), Blast Furnaces (BF) as well as other iron and steel making process. INDUSTRY GROWTH:
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Since 1980, the Sponge Iron industry took a U turn and the players of the industry were very reluctant to contribute significantly for steel making looking at bright prospects of the steel industry in India and neighboring countries. Keeping the growth momentum in the Iron and Steel sector, India has emerged as the largest producer of sponge iron. Sponge Iron India Ltd was outcome of players enthusiasm who accepted the challenge for DRI production. This was the first sponge iron plant in the country which was setup at Palvancha in Andhra Pradesh with a capacity of 0.039 MTPA in 1980. Between 1980 and 1988, there was only three plants setup namely Orissa Sponge Iron Ltd, capacity of 0.1 MTPA, Sunflag Iron Steel Ltd, capacity of 0.09 MTPA and Ipitata Sponge Iron Ltd, capacity of 0.09 MTPA. In 1989, the first merchant Sponge Iron plant is Bihar Sponge Iron Ltd with a capacity of 0.15 MTPA was setup. In the late eighties, domestic producers were enthused by the discovery of large reserves of Natural Gas, started setting up gas based Sponge Iron plants. The first one was set up by Essar Steel Ltd at Hazira in Gujarat in 1990. Jindal Steel and Power Ltd is the largest producer of coal based Sponge Iron in Asia and second largest in the world. QUANTUM: It is hard to reach a particular figure which indicates the total number on sponge iron units exists in India because 60% of the sponge iron units are coming from small scale industries. Many of them are from unorganized sector too. There are certain unreported fly by night companies, hence, it is quite impossible to ascertain the total number. OUTPUT: The installed production capacity of Sponge Iron in India has increased from 1.52 MTPA in 1990-91 to over 7 MTPA in 2003-03. The country produced 9.37 million tone of Sponge Iron in 2004 as compared with 7 million tons in 2003. Venezuela produced 8.09 million tone Mexico produced 6.65 million tone 39
Iran produced 6.4 million tone Thus industry grew approximately at the rate of 30 percent. All these point out to the substantial growth in the demand of sponge iron in the country. RAW MATERIALS: The major raw materials required for production of Sponge Iron are oxides of iron in the form of Lump Iron, Pellets, Non-Coking Coal and Fluxes (lime stone and dolomite). Some precaution is necessary in selecting the iron reliability for easy reduction. Use of high purity of lump are, pellets with low phosphorus at and economic price helps in the cost effective production of sponge iron. As far as chemical composition for sponge iron goes for maximum yield, the metallic iron content Sulphur and Phosphorus as low as possible. The gauge content should preferably be with 2 percent and silica less than 3% to ensure lower slag volume, less power consumption and for achieving higher productivity.
LAND MARKS: India became the largest producer in the world in 2002; a performance repeated two tears in succession with an output of 6.53 MTPA. According to an expert of industry, a few new steel ventures in the secondary sector are coming up with combined installed capacities of about 6 MTPA. The indigenous demand for Sponge Iron has been estimated to reach the level of 17.77 MTPA. India has once again emerged as the largest producer of Sponge Iron in the world for the year 2003 with a record production of 77 million tones, showing a significant growth of 17.5%. The world production of sponge iron too has risen from 45.10 million tons to 49.45 tons. INCONVENIENCE FACED BY THE INDUSTRY: The Sponge Iron industry in India is facing tremendous problems or which mounting cost of basic inputs, high cost of capital are of primary importance. The demand was in recession in the immediate past years, however it has recovered now and the industry is enjoying healthy 39
demand for the last few months. But the industry is afraid of continuing the scenario in future as steel scrap imports is increasing voluminously. High quality iron ore are supplied to them. Premium grade iron ore which has more than 60% of iron content is preferably exported. High prices of Natural Gas in India as compared to the global market are increasing the cost of production of the gas based producers.
POWER GENERATION: Power generation through waste gases at very low cost is one of the biggest advantages, the sponge iron industry is enjoying with. This provides power at the low cost per unit which helps the unit to generate more profit than the sale of sponge iron in real sense. That means electrical power could become prime product with sponge iron. And as tariff for power to nearby high, these units can sell the power to nearby small industries at lower rates and can earn revenue from power. Although globally iron ore is the major feedstock for blast finance, steel making through which is an early process currently producing 57% of the world crude steel. The steel technologist found sponge iron as a suitable charging material for the EAFs.
ON THE GLOBAL FRONT: The steel industry globally using about 25% of the alternative iron sources like DRI/HRI, merchant pig iron and hot metal to produce high quality steels in the EAFs the global supply of sponge iron is expected to reach 55 MTPA at present liquid hot metal and solid pig iron would also be used to a large extent. At the same time, the quality scrap is not like to show any major improvement in future. The developing countries lead the race with Mexico, Venezuela, India and Iran together produce over 50% of the total production of DRI in the
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world. India was the third largest producer of sponge iron in the world in 1998 went one step ahead to grab the second position in 1999, slipped to third position again in 2000, but left all countries behind to reach the top in 2001. FUTURE: Sponge Iron and steel making industries go hand in hand, hence, its quite difficult to assume the future of sponge iron industry without steel and vis-e-versa. Therefore, the future of sponge iron depends on steel demand coupled with the availability of substitute i.e., Steel scrap producing this material saves a lot of revenue loss in the form of high foreign currency demand and long gestation period to obtain subsequently. Hence, these producers are lobbying from liabilities and overheads. NON-COMPLAINCE WITH POLLUTION CONTROL NORMS: Kiran Kumar, Assistant Environmental Officer of the Karnataka State Pollution Control Board (KSPCB) based at the office of the District Pollution Control Board (DPCB) in Bellary, explains that around a year and a half ago, none of the sponge iron units had any pollution control equipment like Electrostatic Precipitating Devices (ESP). These are highly efficient filtration devices that remove fire particulate matter like dust from the air stream. Persuasion by the board resulted in just four units operating within the hospet road area to regularly run ESPs. Kumar says, I have been trying to convince the KPSCB to compel the units to install an interlocking system between the power supply and the kiln. This mechanism will ensure the regular use of pollution control equipment it automatically disconnects power supply if ESP is off. According to pollution control norms, Sponge Iron units are supposed to carry out ambient air quality checks every month, for 24 hours and forward the data to the Pollution Control Board via testing centers. But there are always delays in submitting reports, which when they finally reach the office, are outdated. To avoid delays in monitoring, the DPCB came up with a facility allowing online reporting of air quality. But even this does not appear to be working, thanks to conventional mindset to the industry. There is simply no interest being displayed by the sponge iron units to try and help control pollution. 39
First of all they do not submit reports, even if they do; the actual concentration of suspended particulate matter is never brought out in the reports submitted. says a senior official. He adds We all know the concentration level is very high, anyone can feel it. But the reports show that everything is fine with air quality. The only testing lab in the area is in Dharwad, where the ambient air quality standard data is sent.
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DATA ANALYSIS AND INTERPRETATION
Current Assets 1. Current Ratio = ---------------------Current Liabilities
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Year 2009 2010 2011
Current Assets 397,664,869 426,208,269 497,664,869
Current Liabilities 69,145,258 58,300,605 79,145,258
Current Ratio 5.75 7.31 6.29
CURRENT RATIO 8 7 6 5 4 3 2 1 0 2009 2010 2011
Current Ratio
Interpretation: As we know that ideal Current Ratio for any firm is 2:1. If we see the current ratio of the company for last three years it has increased from 2009 to 2010 and decreased in 2011. The current ratio of company is more than the ideal ratio. This depicts that companys liquidity position is sound. Its Current Assets are more than its Current Liabilities.
Quick Assets 2. Quick Ratio = ---------------------Current Liabilities Year 2009 2010 2011 Quick Assets 136,616,734 103,210,166 129,547,271 Current Liabilities 69,145,258 58,300,605 79,145,258 Quick Ratio 1.98 1.77 1.64 39
QUICK RATIO
2 1.5 1 0.5 0
Quick Ratio
2009
2010
2011
Interpretation: A Quick Ratio is an indication that the firm is liquid and has the ability to meet its current liabilities in time. The ideal Quick Ratio is 1:1. Companys quick ratio is more than ideal ratio in the year 2009 this shows company has no liquidity problem. But it decreased from the year 2010.
Absolute Liquid Assets 3. Absolute Liquid Ratio = ----------------------------Current Liabilities Year 2009 2010 2011 Absolute Liquid Assets 94,827,967 78,120,345 91,876,142 Current Liabilities 69,145,258 58,300,605 79,145,258 Absolute Liquid Ratio 1.371 1.340 1.161
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ABSOLUTE LIQUID RATIO 1.4 1.35 1.3 1.25 1.2 1.15 1.1 1.05 2009 2010 2011 Absolute Liquid Ratio
Interpretation: These ratio shows that company carries a small amount of cash. But there is nothing to be worried about the lack of cash because company has reserve, borrowing power & long term investment. In India, firms have credit limits sanctioned from banks and can easily draw cash. Here absolute liquid ratio is decreased constantly from the year 2009.
Cost of goods sold 4. Inventory Turnover Ratio = ----------------------Average Stock Year 2009 2010 2011 Cost of goods sold 137,188,885 374,073,409 311,040,021 Average Stock 27,710,405 59,373,439 57,817,825 Inventory Turnover Ratio 4.951 6.300 5.380
INVENTORY TURNOVER RATIO 39
7 6 5 4 3 2 1 0 2009 2010 2011 Inventory Turnover Ratio
Interpretation: This ratio shows how rapidly the inventory is turning into receivable through sales. In 2010 the company has high inventory turnover ratio but in 2011 it has reduced. This shows that the companys inventory management technique is less efficient as compare to last year.
No of working days 5. Inventory Conversion Period = ------------------------------Inventory Turnover Ratio Year 2009 2010 2011 No of working days 365 365 365 Inventory Turnover Ratio Inventory 4.951 6.300 5.380 period 73.725 57.933 67.848 conversion
INVENTORY CONVERSION PERIOD
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80 70 60 50 40 30 20 10 0 Inventory Conversion Period
2009
2010
2011
Interpretation: Inventory conversion period shows that how many days inventories take to convert from raw material to finished goods. In the company inventory conversion period is very good. This shows the efficiency of management to convert the inventory into cash. Sales 6. Debtors Turnover Ratio = -------------Debtors Year 2009 2010 2011 Sales 313,423,033 356,411,987 418,943,765 Debtors 7,279,286 6,832,776 5,799,362 Debtors Turnover Ratio 43.057 52.162 72.240
DEBTORS TURNOVER RATIO
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80 70 60 50 40 30 20 10 0 2009 2010 2011 Debtors Turnover Ratio
Interpretation: This ratio indicates the speed with which debtors are being converted or turnover into sales. The higher the values the higher is the turnover into sales. The higher the values of debtors turnover, the more efficient is the management of credit. In the company the debtor turnover ratio is increasing year to year. This shows that company is utilizing its debtors efficiently. Now their credit policy becomes liberal as compare to previous year.
No of working days 7. Average Collection Period = ----------------------------Debtors Turnover Ratio
Year 2009 2010 2011
No of working days 365 365 365
Debtors Ratio 43.057 52.162 72.240
Turnover Average period 8 days 7 days 5 days
collection
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AVERAGE COLLECTION PERIOD 8 7 6 5 4 3 2 1 0 2009 2010 2011 Average Collection Period
Interpretation: The Average Collection Period measures the quality of debtors and it helps in analyzing the efficiency of collection efforts. It also helps to analysis the credit policy adopted by company. In the firm average collection period is increasing year to year. It shows that the firm has Liberal Credit policy. These changes in policy are due to competitors credit policy.
Cost of goods sold 8. Working Capital Turnover Ratio = -----------------------Net working capital
Year 2009 2010 2011
Cost of goods sold 137,188,885 374,073,409 311,040,021
Net working capital 259,374,353 251,908,564 269,316,787
Working Turnover Ratio 1.199 1.485 1.372
Capital
WORKING CAPITAL TURNOVER RATIO
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1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 2009 2010 2011 Working Capital Turnover Ratio
Interpretation: This ratio indicates low much net working capital requires for sales. This ratio is fluctuating throughout from year to year. This ratio is helpful to forecast the working capital requirement on the basis of sale and cost of goods sold. Conclusion Working Capital is the lifeline of every industry, irrespective of whether its a manufacturing industry, services industry. Working Capital is the prime and most important requirement for carrying out the day to day operations of the business. Working Capital gives the muchneeded liquidity to the business. Working Capital Finance reduces the overall fund requirement, required to build up the Current Assets, which in turn help you improve your Turnover Ratio. We have discussed in this project, various ways in which Working Capital requirements can be financed. There are different instruments and facilities available, which can be used cost effectively in a given situation, by different businesses. For this, one should have sound knowledge of these instruments and facilities.
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BIBLIOGRAPHY REFERENCE BOOKS
1] FINANCIAL MANAGEMENT 2] FINANCIAL MANAGEMENT 3] FINANCIAL MANAGEMENT 39 P. CHAUDHARY I. M. PANDAY
4] FINANCIAL MANAGEMENT 5] PRINCIPALS OF CORPORATE FINANCE INTERNET SITES-: 1] WWW.GOOGLE.COM 2] WWW.INDIATIMES.COM 3] WWW.BHARATPETROLEUM.COM 4] WWW.RBI.ORG.IN 5] WWW.STATEBANKOFINDIA.COM
S. M. D. MAHESWARI
PRASANNA CHANDRA
BRAILLY & MAYERS
39

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WORKING CAPITAL MANAGEMENT

WORKING CAPITAL MANAGEMENT

Under the guidance Of Mr. Navneet Goyal

SIGNATURE HEAD OF THE DEPARTMENT

SIGNATURE FACULTY IN CHARGE

8. WORKING CAPITAL FINANCING............................................................................32

INTRODUCTION MEANING OF WORKING CAPITAL

Figure .1. WORKING CAPITAL CYCLE.

- Advance payments by customers

----------------------------Average sales per day

The Operating Cycle of working capital is shown below CASH

The two resources are:

1) Long term Borrowing and Capital 2) Short term Bank Borrowing.

Max Stock Limit

Min Stock Limit

Issued the month

During the during

during the month

Working Capital to Sales Ratio

Inefficiency in cash management causes embezzlement of cash.

DATA ANALYSIS AND INTERPRETATION

Current Assets 1. Current Ratio = ---------------------Current Liabilities

Year 2009 2010 2011

Current Assets 397,664,869 426,208,269 497,664,869

Current Liabilities 69,145,258 58,300,605 79,145,258

Current Ratio 5.75 7.31 6.29

CURRENT RATIO 8 7 6 5 4 3 2 1 0 2009 2010 2011

INVENTORY TURNOVER RATIO 39

7 6 5 4 3 2 1 0 2009 2010 2011 Inventory Turnover Ratio

INVENTORY CONVERSION PERIOD

80 70 60 50 40 30 20 10 0 Inventory Conversion Period

DEBTORS TURNOVER RATIO

80 70 60 50 40 30 20 10 0 2009 2010 2011 Debtors Turnover Ratio

No of working days 7. Average Collection Period = ----------------------------Debtors Turnover Ratio

Year 2009 2010 2011

No of working days 365 365 365

Debtors Ratio 43.057 52.162 72.240

Turnover Average period 8 days 7 days 5 days

AVERAGE COLLECTION PERIOD 8 7 6 5 4 3 2 1 0 2009 2010 2011 Average Collection Period

Year 2009 2010 2011

Cost of goods sold 137,188,885 374,073,409 311,040,021

Net working capital 259,374,353 251,908,564 269,316,787

Working Turnover Ratio 1.199 1.485 1.372

WORKING CAPITAL TURNOVER RATIO

BIBLIOGRAPHY REFERENCE BOOKS

1] FINANCIAL MANAGEMENT 2] FINANCIAL MANAGEMENT 3] FINANCIAL MANAGEMENT 39 P. CHAUDHARY I. M. PANDAY

BRAILLY & MAYERS

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