A Project Report on:

Analysis of
Financing Business operations-
Working capital Finance
&
Its implications in JBM

Submitted By

Ms. Rubina
MBA (First Year)
Department of Management Studies
D.A.V. Institute of Management

A report submitted in partial fulfillment of

The requirement of
MBA program of
MDU, Rohtak (Haryana)

Company Guide:
Mr. Naresh Kumar Goel
Ms. Shubhra Sahay
Ms. Baljeet ka

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 Acknowledgement:

This project has given me a perfect opportunity to see and know how the
concepts of finance are applied in the Industry. The project has been a big
learning experience for me and I would like to express my gratitude towards
all the people who have guided me throughout, and without whose guidance
and support this project would not have been completed successfully

First of all, I express my deep sense of gratitude to this esteemed

organization, D.A.V. Institute of Management for enriching me with such
a courage and knowledge to undertake this project. Further, I also want to
thank JBM Auto Limited for providing me an opportunity to learn and
attain first corporate experience.

In particular, I want to express my gratitude to Mr. Naresh Goel (CFO) for

providing me consistent guidance and valuable critical counsel for the
completion of this project and all the people in JBM Auto Limited, without
whom this project won’t have achieved its completion. Their valuable
insight made the entire training an extremely learning experience. .

And I want to give my special thanks to Ms. Shubra Sahay (Manager-

HR) and Ms. Baljeet Kaur for their cooperation.

Thanking all for their support

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 PREFACE

The study aims at analyzing the working capital practices and policies of
JBM Ltd. The project has been a very learning experience in practically
evaluating the working capital situation of a company and other related
areas.

The project work comprises the analytical and inferential study of various
aspects related to the current assets and current liabilities of the JBM Ltd
which gives objective criteria to study the operational performance. It also
throws light on the liquidity and profitability of the company which is
closely connected to the efficient management of working capital. Moreover
brief estimation of the working capital requirement for the current year is
also made under this project.

This project also consist of various sources of Working Capital i.e. Fund
based, Non-fund based and structured sources. And its implications in the
JBM ltd.

The project work is enriched by the previous projects on working capital

which provided a base to the project and data to compare the performance
over a number of years.

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 Table of Contents:

Particulars Page n.
Company Profile

4
COMPANY
PROFILE

5
 Introduction:

The journey of excellence began in 1983, when the JBM Group entered the
realm of engineering with the inception of Gurera Gas Cylinders Limited.

JBM ventured into the auto components industry in 1985 with the
establishment of Isuki Auto India. And Jay Bharat Maruti, a joint venture
between JBM and Maruti Udyog Limited, was born in 1987; today, it is the
Group’s Flagship Company.

JBM created a new meaning for excellence in the manufacturing of sheet

metal parts and welding assemblies. The group has embraced international
systems and processes, implementing them in all levels, in every unit, and
across all parameters. This has invited prestigious certifications from global
institutions. The Groups companies have consistently met and surpassed
world-class standards, while accumulating a wealth of knowledge and
expertise in the industry. The equipment and machines in all its plants are
state-of-the-art, manned by a highly skilled, professional work force,
ensuring only the best in quality. Their talents are finely honed, with each
member of team JBM being trained regularly on the latest methods and
techniques the world offers. They are kept fully conversant with all the
global safety norms, reflecting JBM’s deep care for its human resource. A
third eye is always on the lookout for the environment, to ensure a green and
clean planet for our children. All these factors combine and complement
each other, translating to zero-defect products and services.
JBM ensures a faster time-to market and greater cost competitiveness,
resulting in customer delight.

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JBM is committed towards meeting the aspiration and requirements of
clients in India and overseas, providing tailor-made solutions. With several
awards to its credit and the support of its partners, the company stands
poised atop a launch pad to the future…fully geared to meet new challenges,
destined to touch newer heights in excellence.

VISION STATEMENT

Expanding leadership in business

Through people,
Keeping pace with
Market trends and technology

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 Corporation Information:

Board of Directors Mr. S.K. Arya, Chairman

Mr. Ashok Kumar Agarwal, Director
Mr. M.K. Aggarwal, Director
Mr. H.R. Saini, Executive Director
Ms. Esha Arya, Executive Director

Chief Financial Officer &

Company Secretary Mr. Naresh kumar Goel

Bankers ABN Amro Bank

Standard Chartered Bank
Canara Bank
ICICI Bank Ltd.
HDFC Bank Ltd.
Citi Bank N.A.
Bank of Baroda
Yes Bank Ltd.

Statutory Auditors Mehra Goel & Co., Chartered

Accountants

Share Transfer Agent MCS Limited

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MISSION STATEMENTS

BUSINESS
• Lead the Industry rate of growth
• No. 1 in profit in Industry
• Global Thrust

CUSTOMER
• Trusted Partner
• Reliable & Cost effective Solutions/ services
• Customer acquisition/expansion

EMPLOYEES
• Top 3 preferred employer
• Learning Organization
• Digital way

TECHNOLOGY
• Technology Excellence
• Introduction of new Solutions/Services
• World Class Products

PROCESSES
• Best in Class Organization
• Business & Service /Product delivery
Excellence
• Quality Leadership

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 Values:
We believe in simplicity by keeping a low profile and having clear,
frank and effective communication in the organization.

• We believe in teamwork with well-defined responsibilities and

accountability.

• We believe in relationships of trust amongst people through well-

defined responsibility and authority.

• We believe in top priority to customer focus through prompt and

appropriate response.

• We believe in respect and care for all those associated with us by

meeting commitments.

GROUP HISTORY
 Started TEXTILES & TRANSPORT business before
independence in Calcutta.

 Name JAY BHARAT conceived from Victory for INDIA.

 Expanded business to Mumbai, Surat and Ahemdabad.

 Registered Trade Mark - JAY BHARAT MILLS – JBM

 Diversified in engineering activities during eighties.

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GROUP COMPANIES

• JBM Auto Limited

• Jay Bharat Maruti Limited
• Jay Bharat Exhaust Systems Limited
• ThyssenKrupp JBM Private Limited
• JBM Industries Limited
• Neel Industries Private Limited
• Neel Metal Products Limited
• Thai Summit Neel Auto Pvt. Ltd.
• Neel Engineering Solutions
• Jaico Steel Fasteners Limited
• ANS Private Limited
• JBM MA Automotive
• JBM Ogihara Automotive India Limited.

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LOCATIONS

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CUSTOMERS

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Segment Wise Customers

Car’s

1. General Motor India Limited

2. Hml-Lancer
3. Honda Siel Cars India Limited
4. Jai Bharat Maruti Limited
5. Subros Limited
6. Delphi Air Conditioning Systems

HCVs /LCVs

1. Ashok Leylend Limited

2. Eicher Motors Limited
3. Mahindre And Mahindra (Zahirabad)
4. Mahindra And Mahindra (Nasik)
5. Volvo India Limited

Two Wheelers

1. Honda M/ccle & Scoters

2. Yamaha Motors India Limited

Tractors

1. Escorts Limited
2. Sonalika
3. Eicher Tractors
4. New Holland Limited
5. Tafe Dana India

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 Some Plants of JBM:

Faridabad Plant:

Faridabad SPV:

Greater Noida:

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Corporate Governance:

The Company’s philosophy of corporate governance is based on integrity, respect for the
laws & compliance thereof and transparency & accountability in all facets of its
operation. The Company believes that good governance brings sustained corporate
growth and enhances returns to all its stakeholders’ viz. customers, suppliers,
shareholders, employees and government agencies including society of which the
Company is an integral part.

Steel metals & assemblies:

Our press shops are suitable for manufacturing components for car, tractor and truck
industry. Current product range includes BIW parts and sub-assemblies for cars, skin
panels and axles for tractors & body components, bumpers, axles and suspension
components for trucks. Components are being also exported to various truck
manufacturers in Europe.

In the year 2003, keeping in view the growth opportunities for domestic auto components
industry and exports, JBMA decided to go for expansion by putting up a green field
project at Greater Noida (U.P.) and expansion of its existing facilities at Faridabad by
adding sophisticated machinery and equipments, which brings in latest technologies.

In the year 2006 the Company again decided to go for expansion by putting up a new
manufacturing unit at Nashik.

JBM Group spanned over 28 plants in 11 locations is spreading its wings further to new
areas and new locations to touch new heights.....

The journey to excellence began in 1983, when the JBM Group entered the realm of

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engineering with the manufacturing of LPG cylinders. JBM ventured into the auto
component industry in 1985 and is constantly on move....

LPG Cylinders 1983

Sheet Metal Parts 1985
Welded Assemblies 1989
Dies, Moulds, Fixtures Manufacturing 1990
Large Sheet Metal Panels 1994
Skin Panels 1996
Exhaust Systems 1997
Integrated Welded Modules 1998
High Tensile Steel Fasteners 2000
BIW Parts Design/Development 2002
Fuel Neck Filler with differential zinc Plating 2003
Motor Cycle Wheel Assembly 2004
Four Wheeler Axle 2004
ERW Steel Tubes 2005
Special Purpose Vehicles 2006
Tailor Welded Blanks 2007
Environment and Waste Management 2007
Large Skin Panels or Full Body Panels 2008

JBM created a new meaning for excellence in manufacturing of Sheet Metal Parts and
Welded Assemblies, Exhaust Systems, Axles, High Tensile Fasteners, ERW Tubes and
Special Purpose Vehicles. The Group has embraced international systems and processes,
implementing them at all levels, in every unit and across all parameters. This has resulted
in prestigious certifications from global institutions. The Group companies have
consistently met and surpassed world-class standards, while accumulating a wealth of
knowledge and expertise in the industry. All the plants have state-of-the-art machinery,
manned by a highly skilled and professional workforce, ensuring only the best in quality.
Their talents are finely honed, with each member of Team JBM being trained regularly

17
on the latest methods and techniques in the world. All these factors combine to
complement each other, translating into zero-defect product and services resulting into
group turnover of Rs. 2700 crores ($ 540 Millon) in 2008-09.

WORLDWIDE PARTNERS

Aims and Objectives

The study aims at the following:
• Brief discussion of JBM Ltd company profile
• Studying the impact of working capital policies of JBM ltd on its overall
performance
• Pattern of working capital financing of JBM ltd.

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Research Methodology

"Research: Diligent and systematic inquiry or investigation into a subject in order

to discover facts or principles." American College Dictionary, 1964 .Thus research
methodology are the strategies applied to systematically carrying out the investigation
and reporting the findings

RESEARCH DESIGN

It is the conceptual framework or the blueprint of the research. Research design contains
the purpose of study, the sample design, the method of data collection, tools for analysis
and interpretation of data and the format of reporting the findings.
The study was carried out at Raymond Ltd, Thane to analyse the working capital policies
of the company and analyse the pattern of financing the day to day operations.
The study is based on descriptive research design.

Descriptive research is used to obtain information concerning the current status of the
phenomena to describe "what exists" with respect to variables or conditions in a situation.
The methods involved range from the survey which describes the status quo, the
correlation study which investigates the relationship between variables, to developmental
studies which seek to determine changes over time.

METHODS OF DATA COLLECTION

The data is secondary in nature and is derived from the published Balance sheets of the
company. Some facts and figures are collected through direct oral questioning.

Importance of topic

Working capital management is s concerned with the problems that arise in attempting to
manage current assets, the current liabilities & the interrelationship that exists between
them. Working capital management or short-term financial management is a significant
facet of financial management. It is important due to 2 reasons:

• Investment in current assets represents a substantial portion of total investment

• Investment in current assets and the level of current liabilities have to be geared
quickly to changes in sales.

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Working capital involves activities such as arranging short-term finance, negotiating
favorable credit terms, controlling the movement of cash, administrating accounts
receivables, and monitoring the investment in inventories also take a great deal of time.

Before we come to Working Capital Finance, we should know the meaning of

Working capital for the better understanding of the concept.

WORKING CAPITAL:

Meaning:

Capital required for a business can be classified under two main categories via,

1) Fixed Capital

2) Working Capital

Every business needs funds for two purposes for its establishment and to carry out
its day- to-day operations. 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 firm’s capital which is blocked on
permanent or fixed basis and is called fixed capital. Funds are also needed for short-term
purposes for the purchase of raw material, payment of wages and other day – to- day
expenses etc.

These funds are known as working capital. In simple words, working capital
refers to that part of the firm’s capital which is required for financing short- term or
current assets such as cash, marketable securities, debtors & inventories. Funds, thus,
invested in current assts keep revolving fast and are being constantly converted in to cash

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and this cash flows out again in exchange for other current assets. Hence, it is also known
as revolving or circulating capital or short term capital.

CONCEPT OF WORKING CAPITAL:

There are two concepts of working capital:

• 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:

1) Cash in hand and cash at bank

2) Bills receivables

3) Sundry debtors

4) Short term loans and advances.

5) Inventories of stock as:

a. Raw material

b. Work in process

c. Stores and spares

d. Finished goods

6. Temporary investment of surplus funds.

7. Prepaid expenses

8. Accrued incomes.

9. Marketable securities.

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 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 are more than the current assets. Current liabilities
are those liabilities, which are intended to be paid in the ordinary course of
business within a short period of normally one accounting year out of the
current assts or the income business.

Constituents of Current Liabilities:

1. Accrued or outstanding expenses.

2. Short term loans, advances and deposits.

3. Dividends payable.

4. Bank overdraft.

5. Provision for taxation, if it does not amt. to appropriation of profit.

6. Bills payable.

7. Sundry creditors.

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 working capital
for the following reasons:

1. It enables the enterprise to provide correct amount of working capital at

correct time.

2. Every management is more interested in total current assets with which it

has to operate then the source from where it is made available.

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 3. It take into consideration of the fact every increase in the funds of the
enterprise would increase its working capital.

4. 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 quantitative concept, which indicates the firm’s 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.

Working Capital Operating Cycle:

The operating cycle of a firm, begins from the procurement of raw material (or payment
of advance for the same) and ends with conversion of receivables (or sometimes finished
goods) into cash.

Operating cycle analysis has been of immense benefit in determining the duration of the
period that a single operating cycle to complete. This gives us the idea about the length of
time each component of working capital, (involved in the operating cycle) will require
investment or blockage of funds therein. That is, if the operating cycle will be of a longer
duration more funds will be required to finance the components which in turn will
involve higher cost in the form of inventory carrying costs and interest outgo or
opportunity costs. The reverse will be the position if the operating cycle period will be
shorter. Therefore, “shorter the operating cycle period the better but it also depends on
the business”. As faster will be the transformation of current assets into cash.
Investment in working capital is influenced by four key events in the production and sales
cycle of the firm.
 Purchase of raw material

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 Payment of raw material
 Sale of finished goods
 Collection of cash for sales

These activities create funds flows that are both unsynchronized and uncertain. They are
unsynchronized because cash disbursements usually take place before cash receipts. They
are uncertain because future sales and costs which generate the respective receipt and
disbursements cannot be forecasted with complete accuracy.

This can be represented as under:

O=R+W+F+D+C

O= Operating Cycle
R= Raw material storage period
W= Duration of work in progress
F= Finished goods storage period
D= Debtor collection period
C= Creditors payment period

The figure below depicts these events on the cash flow lines. The firm begins with the
purchase of raw materials which are paid for after a delay which represents the accounts
payable period. The firm converts the raw materials into finished goods and then sells the
same. The time lag between purchase of raw materials and sale of finished goods is the
inventory period. Customers pay their bills some time after the sales. The period that
elapses between the date of sales and the date of collection of receivables is the accounts
payable period (debt period).

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The time that elapses between the purchase of raw materials and the collection of cash for
sales is referred to as the operating cycle, whereas the time length between the payment
for raw material purchases and the collection of cash for sales is referred to as the cash
cycle.

Figure

A more comprehensive version of the operating cycle includes raw material, storage
period, conversion period, finished goods storage period and average collection period
before getting back cash along with profits. The total duration of all segments is known
as Gross operating cycle period. When the average payment of the company to its

25
suppliers is deducted from the Gross operating cycle period the resultant period is Net
operating cycle period or cash cycle.

The faster a business expands the more cash it will need for working capital and
investment. The cheapest and best sources of cash exist as working capital right within
business. Good management of working capital will generate cash will help improve
profits and reduce risks.

CASH

Raw material
Accounts Inventory
Receivable
Operating
Cycle

Work-in-progress

Finished
goods

REASONS FOR PROLONGED OPERATING CYCLE

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Purchase of materials in excess/short of requirements
• Buying inferior, defective materials
• Failure to get trade discounts or cash discounts.
• Inability to purchase during seasons
• Defective inventory policy
• Lack of production planning, coordination and control
• Mismatch between production policy and demand
• Use of outdated machinery and technology
• Poor maintenance and upkeep of plant, equipment etc.
• Defective credit policy
• Inability to get credit from supplier

Utility of operating cycle:

The net operating cycle represents the net time gap between the investment of cash and
its recovery of sales revenue. The length of the operating cycle is the indicator of
operating management’s performance. It represents the time interval for which the firm
has to negotiate for working capital from its bankers. As well as it also helps to determine
accurately the amount of working capital needed for continuous operation of its activity.
It also involves monitoring of factors in the external environment such as government
policies (taxation, import restrictions), credit policies of Central Banks, price trend,
technological advancements, etc.

FACTORS DETERMINING WORKING CAPITAL REQUIREMENT

Though there is no set of universally applicable rules to ascertain working capital needs,
the following factors may be considered:

 Nature of business
The working capital requirement depends upon the nature of business carried on by
the organization. In a manufacturing firm the requirement is generally high, but it also

27
depends on the type and nature of the product. The proportion of current asset to total
assets measures the relative requirements of working capital of various industries.

 Manufacturing cycle
Time span required for the conversion of raw materials into finished goods is a block
period. The period in reality extends a little before and after the work-in-progress.
The manufacturing cycle and the fund requirements vary in direct proportion. The
funds blocked in manufacturing cycle vary from industry to industry. Further, even
within the same group of industries, the operating cycle may be different due to
technological considerations.

 Business cycle

Business fluctuations lead to cyclic and seasonal changes which, in turn, cause a shift
in working capital position particularly for working capital requirement. The
variations in business conditions may be in two directions:

(i) Upward phase when boom conditions prevail, and, (ii) downswing phase when
economic activity is marked by a decline. During the upswing of business activity,
the need for working capital is likely to grow and during the downswing phase the
working capital requirement is likely to be less. The decline in economy is associated
with a fall in the volume of sales which, in turn, leads to a fall in the level of
inventories and book debts.

 Seasonal variation
Variation apart, seasonality factor creates production or even shortage problem. This
is the reason as to why manufacturing concerns producing seasonal products purchase
their raw material throughout the year and carry on the manufacturing activity. For
example; woolen garments have a demand during winter. But the manufacturing

28
operation for the same has to be conducted during the whole year resulting in working
capital blockage during off-season.

 Production policy
While working capital requirements vary because of seasonal factors, the impact can
be minimized by suitably gearing the production schedule. There are two choices-
either the production is periodically adjusted to meet the seasonal requirements or a
steady level of production is maintained throughout, consequently allowing the
inventories to build up in the off-season.

 Scale of operations:
Operational level determines the working capital demand during a particular period.
Higher the scale, higher will be the need for working capital. However, pace of sales
turnover is another factor. Quick turnover calls for lesser investment for inventory
while low turnover rate necessitates larger investments.

 Credit policy

The credit policy influences the requirement of working capital in two ways:
(i) Through credit terms granted by the firm to its customers/buyers of goods.
(ii) credit terms available to the firm from its creditors.

 Growth and expansion

It is, of course difficult to determine precisely the relationship between the growth
and volume of business and the increase in working capital. The composition of
working capital also shifts with economic circumstances and corporate practices.
However, it is to be noted that the need for increased working capital funds does not
follow the growth in business activity but precedes it.

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  Dividend policy
The payment of dividend consumes cash resources and, thereby, effects working
capital to that extent. However, if the firm does not pay dividend but retains the
profit, working capital increases. There are wide variations in industry practices as
regards the inter relationship between working capital requirement and dividend
payment. In some cases, shortage of working capital is sometimes a powerful reason
for reducing or even skipping dividends in cash(resolved by payment of bonus
shares).

 Depreciation policy
There is an indirect effect of depreciation policy on working capital. Enhanced rates
of depreciation lower the profits and tax liability and, thus, more cash profits. Higher
depreciation means lower disposable profits and a smaller dividend payment. Thus
cash is preserved. If the current capital expenditure falls short of the depreciation
provision, the working capital position is strengthened and there may be no need for
short-term borrowing. If the current capital expenditure exceeds the depreciation
provision, either outside borrowing will have to be resorted to or a restriction on
dividend payment coupled with retention of profits will have to be adopted to prevent
working capital position from being adversely affected.

 Price level changes

Rising prices necessitate the use of more funds for maintaining an existing level of
activity. However, the implications of rising price levels on working capital position
may vary from company to company depending on the nature of its operation, its
standing in the market and other relevant considerations.

 Operating efficiency

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 The efficient utilization of resources by eliminating waste, improved coordination and
full utilization of existing resources would increase the operating efficiency.
Efficiency of operations accelerates the pace of cash cycle and improve the working
capital turnover. It releases the pressure on working capital by improving profitability
and improving the internal generation of funds.

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 given 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 sales mean 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 balances of trade creditors and creditors for
expenses.
• Increase in valuation of closing stocks result in showing higher profits but without
its realization into cash causing the firm to pay higher tax, dividends and bonus.
This will lead the firm in serious problems of funds shortage and firm may be
unable to meet its short term and long term obligations.
• Increase in investments in current assets means increase in requirement of
working capital without corresponding increase in sales of profitability of the
firm.

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Classification of Working Capital:

WORKING CAPITAL

BASIS OF BASIS OF
CONCEPT TIME

Permanent
Gross Net Temporary /
/ Fixed
Working Working Variable WC
WC
Capital Capital

Seasonal Special
WC WC

Regular Reserve
WC WC

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Working capital may be classified in to ways:

• On the basis of Concept

• On the basis of Time

On the basis of concept working capital can be classified as gross working capital and net
working capital. On the basis of time, working capital may be classified as:

 Permanent or fixed working capital.

 Temporary or 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 is permanently blocked in current assets.
As the business grow the requirements of working capital also increases due to increase
in current assets.

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

33
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.

Graph showing difference between permanent and temporary Working

Capital:

Variable Working
Capital
Amount
of
Working
Capital

Permanent Working Capital

Importance or Advantage of adequate Working Capital:

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• Solvency of the Business:

Adequate working capital helps in maintaining the solvency of the business by

providing uninterrupted of production.

• Goodwill:

Sufficient amount of working capital enables a firm to make prompt payments and
makes and maintain the goodwill.

• Easy loans:

Adequate working capital leads to high solvency and credit standing can arrange
loans from banks and other on easy and favorable terms.

• Cash Discounts:

Adequate working capital also enables a concern to avail cash discounts on the
purchases and hence reduces cost.

• Regular Supply of Raw Material:

Sufficient working capital ensures regular supply of raw material and continuous
production.

• Regular Payment of Salaries, Wages & other day to day

Commitments:

It leads to the satisfaction of the employees and raises the morale of its employees,
increases their efficiency, reduces wastage and costs and enhances production and
profits.

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 • Exploitation of favorable Market conditions:

If a firm is having adequate working capital then it can exploit the favorable market
conditions such as purchasing its requirements in bulk when the prices are lower and
holdings its inventories for higher prices

• Ability to Face Crises:

A concern can face the situation during the depression with the help of adequate
Working Capital.

• Quick And Regular Return On Investment:

Sufficient working capital enables a concern to pay quick and regular of dividends to
its investors and gains confidence of the investors and can raise more funds in future.

• High Morale:

Adequate working capital brings an environment of securities, confidence, high

morale which results in overall efficiency in a business.

Excess and inadequate Working Capital:

Every business concern should have adequate amount of working capital to run its
business operations. It should have neither redundant or excess working capital nor
inadequate nor shortages of working capital. Both excess as well as short working
capital positions are bad for any business. However, it is the inadequate working
capital which is more dangerous from the point of view of the firm.

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Disadvantages of redundant or excessive Working Capital:

• Excessive working capital means ideal funds which earn no profit for
the firm and business cannot earn the required rate of return on its
investments.
• Redundant working capital leads to unnecessary purchasing and
accumulation of inventories.
• Excessive working capital implies excessive debtors and defective
credit policy which causes higher incidence of bad debts.
• It may reduce the overall efficiency of the business.
• If a firm is having excessive working capital then the relations with
banks and other financial institution may not be maintained.
• Due to lower rate of return n investments, the values of shares may
also fall.
• The redundant working capital gives rise to speculative transactions

Disadvantage of inadequate Working Capital:

Every business needs some amounts of working capital. The need for working capital
arises due to the time gap between production and realization of cash from sales. There is
an operating cycle involved in sales and realization of cash. There are time gaps in
purchase of raw material and production; production and sales; and realization of cash.

Thus working capital is needed for the following purposes:

• For the purpose of raw material, components and spares.

• To pay wages and salaries.
• To incur day to day expenses and overload costs such as office expenses.

37
• To meet the selling costs as packing, advertising, etc.
• To provide credit facilities to customers.
• To maintain inventory of raw material, work-in-progress & finished stock.

For studying the need of working capital in a business, one has to study the business
under varying circumstances such as a new concern requires a lot of funds to meet its
initial requirements such as promotion and formation etc. These expenses are called
preliminary expenses and are capitalized. The amount needed for working capital
depends upon the size of the company and ambitions of its promoters. Greater the
size of the business unit, generally larger will be the requirements of the working
capital. The requirement of the working capital goes on increasing with the growth
and expensing of the business till it gains maturity. At maturity the amount of
working capital required is called normal working capital.

There are others factors also influence the need of working capital in a business.

For Trading Concern:

STATEMENT OF WORKING CAPITAL REQUIREMENTS

Particulars Amount

Current Assets

(a)Cash

(b)Receivables(for months salary)

(c)Stocks(For months salary)

(d)Advance Payments if any

Less: Current Liabilities

(a)Creditors (For….. Month’s Purchases)

38
(ii) Lag in payment of expenses

WORKING CAPITAL (CA – CL)

Add: Provision / Margin for Contingencies

NET WORKING CAPITAL REQUIRED

39
For Manufacturing Concern:

STATEMENT OF WORKING CAPITAL REQUIREMENTS

Particulars Amount
Current Assets
a) Stock of raw material (for months consumption)
b) Work in progress (for month consumption)
• Raw material
• Direct labor
• Overheads

c) Stock of finished goods (for month’s sales)

• Raw material
• Direct labor
• Overheads

d) Sundry debtors (for month’s sales)

• Raw material
• Direct labor
• Overheads

e) Payment in advance (if any)

f) Balance of cash of daily for expenses
g) Any other

Less: Current liabilities

a) Creditors (for month’s purchase)
b) Lag in payment of expenses
c) Any other
WORKING CAPITAL (CA-CL)
Add: Provision/ margin for contingency

NET WORKING CAPITAL

Strategies for Working Capital:

40
 Current Conservative
Assets

Moderate

aggressive

Sales level

1) CONSERVATIVE WORKING CAPITAL STRATEGY

In conservative strategy the level of current assets is more as compared to sales.

Surplus current assets absorb sudden variations in sales, production plans and

procurement time without disrupting production plans. Also higher liquidity levels

reduce the risk of insolvency. At the same time lower risk yields lower returns. Large

investments in current assets lead to higher interest and carrying costs. The

conservative policy assures continuous flow of operations thereby absorbing day-to-

day business risk. Under this strategy long term financing covers more than the total

requirement for working capital. The excess cash is invested in short-term marketable

securities which are sold in the market to meet the urgent requirement of working

capital.

41
2) AGGRESSIVE WORKING CAPITAL STRATEGY

Here the current assets just to meet the current liabilities without keeping any cushion
for the variations in the working capital needs. The core working capital is financed by
long -term sources and seasonal variations through short-term borrowings. This
strategy minimizes the investment in net working capital, thereby lowering the cost of
financing the working capital. The main drawback of this strategy is that it necessitates
frequent financing and therefore increases risk as the firm is vulnerable to sudden
variations.

Above figure show three policies in working capital management.

• In conservative policy value of current asset increases more rapidly than sales level.
Such a policy tends to reduce the risk of shortage of working capital by increasing the
safety component of current asset. The conservative policy also reduces the risk of
nonpayment to liability.
• In moderate policy value of current asset increases in proportion with sales level.
• In aggressive type of policy sales level increases more in percentage than increase
in current assets. This type of aggressive policy has many implications.
a) The risk of insolvency of the firm increases as it maintains law liquidity.
b) The firm is expose to greater risk as it may not be able to face unexpected change in
market
c) Reduced investment in current asset will result in increase in profitability of the firm.

MANAGEMENT OF WORKING CAPITAL:

Management of working capital is concerned with the problem that arises in attempting
to manage the current assets, current liabilities. The basic goal of working capital
management is to manage the current assets and current liabilities of a firm in such a way
that a satisfactory level of working capital is maintained, i.e. it is neither adequate nor
excessive as both the situations are bad for any firm. There should be no shortage of

42
funds and also no working capital should be ideal. WORKING CAPITAL
MANAGEMENT POLICES of a firm has a great on its probability, liquidity and
structural health of the organization. So working capital management is three dimensional
in nature as

1. It concerned with the formulation of policies with regard to

profitability, liquidity and risk.

2. It is concerned with the decision about the composition and level

of current assets.

3. It is concerned with the decision about the composition and level

of current liabilities.

Working Capital Analysis:

As we know working capital is the life blood and the centre of a business.
Adequate amount of working capital is very much essential for the smooth
running of the business. And the most important part is the efficient management
of working capital in right time. The liquidity position of the firm is totally
effected by the management of working capital. So, a study of changes in the uses
and sources of working capital is necessary to evaluate the efficiency with which
the working capital is employed in a business. This involves the need of working
capital analysis. The analysis of working capital can be conducted through a
number of devices, such as:

1. Ratio analysis.

2. Fund flow analysis.

3. Budgeting

43
1. Ratio Analysis:

A ratio is a simple arithmetical expression one number to another. The technique

of ratio analysis can be employed for measuring short-term liquidity or
working capital position of a firm. The following ratios can be calculated for
these purposes:

1. Current ratio.

2. Quick ratio

3. Absolute liquid ratio

4. Inventory turnover.

5. Receivables turnover.

6. Payable turnover ratio.

7. Working capital turnover ratio.

8. Working capital leverage

9. Ratio of current liabilities to tangible net worth.

2. Fund flow analysis:

Fund flow analysis is a technical device designated to the study the source
from which additional funds were derived and the use to which these sources
were put. The fund flow analysis consists of:

44
 a. Preparing schedule of changes of working capital

b. Statement of sources and application of funds.

It is an effective management tool to study the changes in financial position

(working capital) business enterprise between beginning and ending of the
financial dates.

3. Working Capital Budget:

A budget is a financial and / or quantitative expression of business plans and

polices to be pursued in the future period time. Working capital budget as a part
of the total budge ting process of a business is prepared estimating future long
term and short term working capital needs and sources to finance them, and then
comparing the budgeted figures with actual performance for calculating the
variances, if any, so that corrective actions may be taken in future. He objective
working capital budget is to ensure availability of funds as and needed, and to
ensure effective utilization of these resources. The successful implementation of
working capital budget involves the preparing of separate budget for each element
of working capital, such as, cash, inventories and receivables etc.

Analysis of short-term financial position or test of liquidity:

The short –term creditors of a company such as suppliers of goods of credit and
commercial banks short-term loans are primarily interested to know the ability of a firm
to meet its obligations in time. The short term obligations of a firm can be met in time
only when it is having sufficient liquid assets. So to with the confidence of investors,
creditors, the smooth functioning of the firm and the efficient use of fixed assets the
liquid position of the firm must be strong. But a very high degree of liquidity of the firm
being tied–up in current assets. Therefore, it is important proper balance in regard to the
liquidity of the firm. Two types of ratios can be calculated for measuring short-term
financial position or short-term solvency position of the firm.

45
A. Liquidity ratios.

B. Current assets movement ratios.

LIQUIDITY RATIOS
(1) Current ratio
The current ratio is a reflection of financial strength. The current ratio measures the
ability of the firm to meets its current liabilities- current assets get converted into cash
and provide the funds needed to pay current liabilities. A current ratio can be improved
by increasing current assets or by decreasing current liabilities.
Steps to accomplish an improvement include:
• Paying down debt.
• Acquiring a long-term loan (payable in more than 1 year's time).
• Selling a fixed asset.
• Putting profits back into the business.
A high current ratio may mean that cash is not being utilized in an optimal way. For
example, the excess cash might be better invested in equipment. Higher the current ratio,
the greater the margin of safety, the larger the amount of current assets in relation to
current liabilities, the more the firms ability to meet its current obligations It must be
noted that this ratio is a test of quantity rather than quality and therefore, too much
reliance should not be placed on it. However, it cannot be ignored at the same time as it is
a crude and quick measure of the firm’s liquidity.

CALCULATION OF CURRENT RATIO:

YEAR RATIO VALUE

2004-05 4663 =1.96
2380

46
2005-06 6091 =2.16
2822
2006-07 7750 =2.56
3025
2007-08 12082 =2.09
5769
2008-09 14830 =2.02
7353
(In Rupees)

2. Quick Ratio:

Quick ratio is a more rigorous test of liquidity than current ratio. Quick ratio
may be defined as the relationship between quick/liquid assets and current or

47
liquid liabilities. An asset is said to be liquid if it can be converted into cash
with a short period without loss of value. It measures the firms’ capacity to pay
off current obligations immediately.

Quick Ratio = Quick Assets/Current Liabilities

Where Quick Assets are:

1) Marketable Securities

2) Cash in hand and Cash at bank.

3) Debtors.

A high ratio is an indication that the firm is liquid and has the ability to meet its
current liabilities in time and on the other hand a low quick ratio represents that
the firms’ liquidity position is not good.

As a rule of thumb ratio of 1:1 is considered satisfactory. It is generally thought

that if quick assets are equal to the current liabilities then the concern may be
able to meet its short-term obligations. However, a firm having high quick ratio
may not have a satisfactory liquidity position if it has slow paying debtors. On
the other hand, a firm having a low liquidity position if it has fast moving
inventories.

48
 Calculation of Quick Ratio: (in rupees)

YEAR RATIO VALUE

2004-05 2756 =1.16
2380
2005-06 3686 =1.31
2822
2006-07 5461 =1.81
3025
2007-08 6430 =1.11
5769
2008-09 10300 =1.4
7353

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. Company’s quick ratio is more than ideal
ratio. This shows company has no liquidity problem.

49
ABSOLUTE LIQUID RATIO:

Although receivables, debtors and bills receivable are generally more liquid than
inventories, yet there may be doubts regarding their realization into cash immediately or
in time. So absolute liquid ratio should be calculated together with current ratio and acid
test ratio so as to exclude even receivables from the current assets and find out the
absolute liquid assets. Absolute Liquid Assets includes:

Absolute liquid ratio = Absolute liquid assets/Current Liabilities*100

ABSOLUTE LIQUID ASSETS = CASH & BANK BALANCES.

Calculation of Absolute Liquid Ratio: (in rupees)

YEAR RATIO VALUE

2004-05 81 =3%
2380
2005-06 194 =7%
2822
2006-07 46 =2%
3025
2007-08 78 =1%
5769
2008-09 61 =1%
7353
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.

50
 B) Current asset movement ratios:

Funds are invested in various assets in business to make sales and earn profits. The
efficiency with which assets are managed directly affects the volume of sales. The better
the management of assets, large is the amount of sales and profits. Current assets
movement ratios measure the efficiency with which a firm manages its resources. These
ratios are called turnover ratios because they indicate the speed with which assets are
converted or turned over into sales. Depending upon the purpose, a number of turnover
ratios can be calculated. These are:

1. Inventory Turnover Ratio

2. Debtors Turnover Ratio

3. Creditors Turnover Ratio

4. Working Capital Turnover Ratio

The current ratio and quick ratio give misleading results if current assets include high
amount of debtors due to slow credit collections and moreover if the assets include high
amount of slow moving inventories. As both the ratios ignore the movement of current
assets, it is important to calculate the turnover ratio.

1) Inventory turnover or stock turnover ratio:

Every firm has to maintain a certain amount of inventory of finished goods so as to meet
the requirements of the business. But the level of inventory should neither be too high nor
too low. Because it is harmful to hold more inventory as some amount of capital is
blocked in it and some cost is involved in it. It will therefore be advisable to dispose the
inventory as soon as possible.

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Inventory turnover ratio = Cost of goods sold/Average stock

Inventory turnover ratio measures the speed with which the stock is converted into sales.
Usually a high inventory ratio indicates an efficient management of inventory because
more frequently the stocks are sold; the lesser amount of money is required to finance the
inventory. Where as low inventory turnover ratio indicates the inefficient management of
inventory. Low inventory turnover implies over investment in inventories, dull business,
poor quality of goods, stock accumulations and slow moving goods and low profits as
compared to total investment.

Average Stock = (Opening stock+ Closing stock) / 2

Measures number of times inventory has been converted into sales.

=Net Sales/Average Inventory

YEAR RATIO VALUE

2004-05 9022 =5.6 times
1604
2005-06 11118 =5 times
2155.8
2006-07 14507 =6 times
2346.8
2007-08 18621 =4.7 times
3970
2008-09 21636 =4.3 times
5091

52
Interpretation:

This ratio shows how rapidly the inventory is turning into receivables through sales. In
2004-2005, company has high inventory turnover ratio but in 2008-2009 it has reduced to
4.3 times. This shows that the company’s inventory management technique is less
efficient as compare to previous years.

2. Inventory conversion period:

Inventory conversion period = 365days (net working days)/Inventory
turnover ratio

Year 2004-2005 2005-2006 2006-2007 2007-2008 2008-2009

No. of days 365 365 365 365 365
Inventory 5.6 5 6 4.7 4.3
turnover ratio
Inventory 65days 73days 61days 78days 85days
conversion
period

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
increasing. This shows the much cash is blocked in the conversion of inventory into sales.

3. Debtor Turnover Ratio:

A concern may sell its goods on cash as well as on credit to increase its sales and a liberal
credit policy may result in tying up substantial funds of a firm in the form of trade
debtors. Trade debtors are expected to be converted into cash within a short period and
are included in current assets. So liquidity position of a concern also depends upon the

53
quality of trade debtors. Two types of ratio can be calculated to evaluate the quality of
debtors.

a) Debtors Turnover Ratio

b) Average Collection Period

Debtors Turnover Ratio = Total Sales (Credit)/Average Debtors

Debtor’s velocity indicates the number of times the debtors are turned over during a year.
Generally higher the value of debtor’s turnover ratio the more efficient is the
management of debtors/sales or more liquid are the debtors. Whereas a low debtors
turnover ratio indicates poor management of debtors/sales and less liquid debtors. This
ratio should be compared with ratios of other firms doing the same business and a trend
may be found to make a better interpretation of the ratio.

Average debtors= opening debtor + closing debtor/2

YEAR RATIO VALUE

2004-05 9022 =4.51 times
1997.37
2005-06 11118 =4.66 times
2385.5
2006-07 14507 =4.37 times
3316.4
2007-08 18621 =4.64 times
4010
2008-09 21636 =3.69 times
5859

54
Interpretation:

This ratio indicates the speed with which debtors are being converted or turnover into
sales. The higher the values or turnover into sales. The higher the values of debtors
turnover, the more efficient is the management of credit. But in the company the debtor
turnover ratio is decreasing year to year. This shows that company is not utilizing its
debtor’s efficiency. Now their credit policy becomes liberal as compare to previous year.

4. Average collection period:

Average Collection Period= No. of Working Days/Debtors turnover ratio

The average collection period ratio represents the average number of days for which a
firm has to wait before its receivables are converted into cash. It measures the quality of
debtors. Generally, shorter the average collection period the better is the quality of
debtors as a short collection period implies quick payment by debtors and vice-versa.

Average Collection Period = 365 (Net Working Days)/ Debtor Turnover Ratio

Debtor collection period:

Year 2004-2005 2005-2006 2006-2007 2007-2008 2008-2009

working 365 365 365 365 365
days
Debtor 4.51 4.66 4.37 4.64 3.69
turnover
ratio
Debtor 81 days 79 days 84 days 79 days 99 days
collection
period

55
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 increasing year to year. It shows that the
firm has Liberal Credit policy. These changes in policy are due to competitor’s credit
policy

5. Working capital turnover ratio:

Working capital turnover ratio indicates the velocity of utilization of net working capital.
This ratio indicates the number of times the working capital is turned over in the course
of the year. This ratio measures the efficiency with which the working capital is used by
the firm. A higher ratio indicates efficient utilization of working capital and a low ratio
indicates otherwise. But a very high working capital turnover is not a good situation for
any firm.

Net Working Capital Turnover Ratio = Sales/Net working capital:

Working Capital Turnover = Sales/Net working capital

YEAR RATIO VALUE

2004-05 9022 =4 times
2282.6
2005-06 11118 =3.4 times
3269
2006-07 14507 =3 times
4724.8
2007-08 18621 =3 times
6312.7
2008-09 21636 =3 times
7476

56
 Working Capital Finance:

Importance of Working Capital Finance:

Three Meanings of Working Capital:

The term working capital has several meanings in business and economic development
finance. In accounting and financial statement analysis, working capital is defined as the
firm’s short-term or current assets and current liabilities. Net working capital represents
the excess of current assets over current liabilities and is an indicator of the firm’s ability
to meet its short term financial obligations. From a financing perspective, working capital
refers to the firm’s investment in two types of assets. In one instance, working capital
means a business’s investment in short-term assets needed to operate over a normal
business cycle. This meaning corresponds to the required investment in cash, accounts
receivable, inventory, and other items listed as current assets on the firm’s balance sheet.
In this context, working capital financing concerns how a firm finances its current assets.
A second broader meaning of working capital is the company’s overall non fixed asset
investments. Businesses often need to finance activities that do not involve assets
measured on the balance sheet. For example, a firm may need funds to redesign its
products or formulate a new marketing strategy, activities that require funds to hire
personnel rather than acquiring accounting assets. When the returns for these “soft costs”
investments are not immediate but rather are reaped over time through increased sales or
profits, then the company needs to finance them. Thus, working capital can represent a
broader view of a firm’s capital needs that includes both current assets and other non
fixed asset investments related to its operations. In this project, we use this last meaning
of working capital and focus on the tools and issues involved in financing these business
investments.

Business Uses of Working Capital:

Just as working capital has several meanings, firms use it in many ways. Most
fundamentally, working capital investment is the lifeblood of a company. Without it, a
firm cannot stay in business. Thus, the first, and most critical, use of working capital is

57
providing the ongoing investment in short-term assets that a company needs to operate. A
business requires a minimum cash balance to meet basic day-to-day expenses and to
provide a reserve for unexpected costs. It also needs working capital for prepaid business
costs, such as licenses, insurance policies, or security deposits. Furthermore, all
businesses invest in some amount of inventory, from a law firm’s stock of office supplies
to the large inventories needed by retail and wholesale enterprises. Without some amount
of working capital finance, businesses could not open and operate. A second purpose of
working capital is addressing seasonal or cyclical financing needs. Here, working capital
finance supports the buildup of short-term assets needed to generate revenue, but which
come before the receipt of cash. For example, a toy manufacturer must produce and ship
its products for the holiday shopping season several months before it receives cash
payment from stores. Since most businesses do not receive prepayment for goods and
services, they need to finance these purchase, production, sales, and collection costs prior
to receiving payment from customers. Figure illustrates this short-term cash flow and
financing cycle.

Another way to view this function of working capital is providing liquidity. Adequate
and appropriate working capital financing ensures that a firm has sufficient cash flow to
pay its bills as it awaits the full collection of revenue. When working capital is not
sufficiently or appropriately financed, a firm can run out of cash and face bankruptcy. A
profitable firm with competitive goods or services can still be forced into bankruptcy if it

58
has not adequately financed its working capital needs and runs out of cash. Working
capital is also needed to sustain a firm’s growth. As a business grows, it needs larger
investments in inventory, accounts receivable, personnel, and other items to realize
increased sales. New facilities and equipment are not the only assets required for growth;
firms also must finance the working capital needed to support sales growth. A final use of
working capital is to undertake activities to improve business operations and remain
competitive, such as product development, ongoing product and process improvements,
and cultivating new markets. With firms facing heightened competition, these
improvements often need to be integrated into operations on a continuous basis.
Consequently, they are more likely to be incurred as small repeated costs than as large
infrequent investments. This is especially true for small firms that cannot afford the cost
and risks of large fixed investments in research and development projects or new
facilities. Ongoing investments in product and process improvement and market
expansion, therefore, often must be addressed through working capital financing.

Permanent and Cyclical Working Capital:

Firms need both a long-term (or permanent) investment in working capital and a short
term or cyclical one. The permanent working capital investment provides an ongoing
positive net working capital position, that is, a level of current assets that exceeds current
liabilities. This allows the firm to operate with a comfortable financial margin since
short-term assets exceed short-term obligations and minimizes the risk of being unable to
pay its employees, vendors, lenders, or the government (for taxes). To have positive net
working capital, a company must finance part of its working capital on a long-term basis.
Since total assets equal total liabilities and owner’s equity, when current assets exceed
current liabilities, this excess is financed by the long-term debt or equities, Figure
demonstrates this point graphically. For current assets (area CA) to be greater than
current liability (area CL), long-term debt and equity must finance part of area CA.
Beyond this permanent working capital investment, firms need seasonal or cyclical
working capital. Few firms have steady sales and production throughout the year. Since

59
the demand for goods and services varies over the course of a year, firms need to finance
both inventories and other costs to prepare for their peak sales period and accounts
receivable until cash is collected. Cyclical working capital is best financed by short-term
debt since the seasonal buildup of assets to address seasonal demand will be reduced and
converted to cash to repay borrowed funds within a short predictable period. By matching
the term of liabilities to the term of the underlying assets, short-term financing helps a
firm manage inflation and other financial risks. Short-term financing is also preferable
since it is usually easier to obtain and priced lower than long-term debt.
Working capital financing is a key financing need and challenge for small firms. Small
businesses have less access to long term sources of capital than large businesses,
including limited access to equity capital markets and fewer sources of long-term debt.
Thus, many small firms are heavily dependent on short-term debt, much of which is tied
to working capital.1 However, limited equity and reliance on short-term debt increases
the demand on a firm’s cash flow, reduces liquidity, and increases financial leverage—all
of which heighten the financial risks of extending credit. Consequently, small firms may
have trouble raising short-term debt while at the same time facing obstacles to securing
the longer-term debt necessary to improve their financial position and liquidity, and
lessen their credit risk. Development finance has an important role in addressing this
problem, either by offering working capital loans when private loans are not available or
by providing debt terms that reduce a firm’s financial risk and help it access private
working capital financing. In particular, practitioners can help businesses finance
permanent working capital to reduce their short-term financial pressures.

60
 Current
Current Liabilities
Assets (CL)
(CA)

Long term
Long term Liabilities
Assets &Owners
funds

Share of current
assets financed
by long term
assets

There comes a time in the life of most small businesses where the amount of money out
doesn't match the amount of money coming in. You may look good on paper. You may
even be making a killing in your industry, but that doesn't mean you have the financing
you need to do basic things like pay employees or keep the power on in your office.

If you're new to the lending game, working capital loans are basically short-term loans
that are designed to help sustain a business during rapid growth and financial times of
need. You may think businesses take out loans when they're in trouble, but this simply
isn't the case. If you're waiting to get paid, you may still need to invest in additional
equipment, technological advancements, or additional workspace.

Working Capital financing to the Rescue

Working capital financing is often a superior alternative to using credit cards to pay for
immediate financial obligations. There are several different types of working capital
loans available to small businesses today. Some of the most common types of working
capital financing include lines of credit, short-term loans, factoring and equity loans.
Working capital finance generally refers to debt raised for a period of less than a year
from Term Lending Institutions, Commercial Banks and Non Banking Finance
Companies (NBFC) catering to the short-term credit needs of the business entities.

61
Investors assist clients to raise working capital for day-to-day operations as well as for
other exigencies. Working capital finance may be fund-based or through non-fund based
or documentary credit instruments.

Sources of
Working capital
finance

Fund based Non-Fund based Structured

Working capital Working capital Finance
Finance Finance

Letter of Commercial
Domestic Export
Credit Paper

Bank Corporate
Cash Credit Pre-shipment loans
Guarantee

Overdraft
Post-shipment Factoring
facility

Bill Finance Forfeiting

Documentary

Clean

62
Fund based Limits/Working Capital Finance:
Fund Base Limit is a limit in which the Co is getting money actually (Cash). In other
words, to fulfill the needs of daily requirements of funds, a firm take help of banks or
other institutes and fulfills its needs in the money terms.
These funds based limits are again divided into two parts. Following are these:
• For Domestic purpose
• For Export purpose

Cash Credit:
Cash credit is a short-term cash loan to a company. A bank provides this type of
funding, but only after the required security is given to secure the loan. Once a security
for repayment has been given, the business that receives the loan can continuously draw
from the bank up to a certain specified amount. This type of financing is similar to a line
of credit.
Sometimes bank funding is just out of the question. Unless your business has excellent
credit and a proven track record, a bank loan will be nearly impossible to obtain. Trying
to find alternative sources of funding can also seem like a daunting task since there are so
many options to choose from. A capital directory can make this process faster and easier
since it organizes the criteria of each individual funding source and allows you to find a
perfect funding match for your business. No more manually sorting through thousands of
different lenders and types of funding to guess which one might be right for you business.

Overdrafts:
Overdraft means an agreement with a bank by which a current account holder is allowed
to withdraw more than the balance to his credit up to a certain limit. The interest is
charged on daily overdrawn balances.
The main difference between cash credit and overdraft is that overdraft is allowed for a
short period and is a temporary accommodation whereas the cash credit is allowed for a
longer period.

63
Bills purchased/Discounting:

These advances are allowed against the security of bills which may be clean or
documentary. Bills are sometimes purchased from approved customers in whose favor
limits are sanctioned. Before granting a limit the banker satisfies himself as to the credit
worthiness of the drawer. Although the term “bill purchased” gives the impression that
the bank becomes the owner or purchaser of such bills, in actual practice the bank holds
the bills only as a security for advance. The bank, in addition to the rights against the
parties liable on the bills, can also exercise a pledge’s right over the goods covered by the
documents.

Bills maturing at a future date or sight are discounted by the banks for approved parties.
When a bill is discounted, the borrower is paid the present worth. The bankers, however,
collect the full amount on maturity. The difference between these two amounts represents
earning of the banker for the period. This item of income is called “Discount”.

Sometimes, overdraft or cash credit limits are allowed against the security of bills. A
suitable margin is usually maintained. Here the bill is not a primary security but only a
collateral security. The banker in the case, doesn’t become a party to the bill, but merely
collects it as an agent for the customer.

When a banker purchases or discounts a bill, he advances against the bill, he has
therefore to be very cautious and grant such facilities only to those customers who are
creditworthy and have established a steady relationship with the bank. Credit reports are
also compiled on the drawees.

For Export Purpose:

Financing of export trade by banks:

Exports play an important role in the accelerating the economic growth of a developing
country like India. Of the several factors influencing export growth, credit is a very

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important factor which enables exporters in efficiently executing their export orders. The
commercial banks provide short term export finance mainly by two ways. Following are
those ways:
a) Pre-shipment finance i.e., before shipment of goods
b) Post-shipment finance i.e., after shipment of goods

a) Pre-shipment Finance:

This generally takes the form of packing credit facility, packing credit is an advance
extended by banks to an exporter for the purpose of buying, manufacturing, processing,
packing, shipping goods to oversee buyers. Any exporter, having at hand a firm export
order placed with him by his foreign buyer or an irrevocable letter of credit opened in his
favor, can approach a bank for availing of packing credit. An advance so taken by an
exporter is required to be liquidated within 180days from the date of its commencement
by negotiation of export bills or receipt of export proceeds in an approved manner. Thus
packing credit is essentially short term finance.

Types of Packing Credit:

a) Clean packing credit:
This is an advance made available to an exporter only on production of a firm export
order or a letter of credit without exercising any charge or control over raw material or
finished goods. It is a clean type of export advance. Each proposal is weighed according
to particular requirements of the trade and credit worthiness of the exporter. A suitable
margin has to be maintained. Also, Export Credit Guarantee Corporation (ECGC) cover
should obtained by bank.

b) Packing credit against hypothecation of goods:

Export finance is made available on certain terms and conditions where exporter has
pledge able interest and the goods are hypothecated to the bank as security with stipulated
margin. At the time of utilizing the advance, the exporter is required to submit , along

65
with the firm export order or letter of credit relative stock statements and thereafter
continue submitting them every fortnight and/or whenever there is any movement in
stocks.

c) Packing credit against pledge of goods:

Export finance is made available on certain terms and conditions where the exportable
finished goods are pledged to the banks with approved clearing agents who will ship the
same from time to time as required by the exporter. The possession of the goods so
pledged lies with the bank and is kept under its lock and key.

d) E.C.G.C. guarantee:

Any loan given to an exporter for the manufacturing, processing, purchasing, or packing
of goods meant for exports against a firm order qualifies for the packing. Credit
guarantee issued by Export Credit Guarantee Corporation (ECGC).

e) Forward exchange contract:

Another requirement of packing credit facility is that if the export bill is to be drawn in a
foreign currency, the exporter should enter into a forward exchange contract with the
bank, thereby avoiding risk involved in a possible change in the rate of exchange.

Post-shipment Finance: It takes the following forms:

a) Purchase/discounting of documentary export bills:

Finance is provided to exporters by purchasing export bills drawn payable at sight or by

discounting export bills covering confirmed sales and backed by documents including
documents of the title of goods such as bill of lading, post parcel receipts or air
consignment notes.

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Documents to be obtained:
• Letter of hypothecation covering the goods
• General guarantee of directors or partners of the firm as the case may be

b) E.C.G.C. guarantee:

Post-shipment finance, given to an exporter by a bank through purchase, negotiation or

discount of an export bill against an order, qualifies for post-shipment export credit
guarantee. It is necessary, however, that exporters should obtain a shipment or contracts
risk policy of E.C.G.C. Banks insist on the exporters to take a contracts shipments
(comprehensive risks) policy covering both practical and commercial risks. The
Corporation, on acceptance of the policy, will fix credit limits for individual exporters
and corporation’s liability will be limited to the extend of the limit so fixed for the
exporter concerned irrespective to the amount of the policy.

c) Advance against export bills sent for collection:

Finance is provided by banks to exporters by way of advance against export bills

forwarded through them for collection, taking into account the creditworthiness of the
party, nature of goods exported, usage, standing of drawee, etc appropriate margin is
kept.

Documents to be obtained:
• Demand promissory note
• Letter of continuity
• Letter of hypothecation covering bills
• General guarantee of directors or partners of the firm (as the case may be)

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d) Advance against duty draw backs, cash subsidy, etc.:

To finance export losses sustained by exporters, bank advance against duty draw-back,
cash subsidy, etc. receivable by them against export performance. Such advances are of
clean nature; hence necessary precautions should be exercised.

e) Conditions:

Bank providing finance in this manner see that the relative export bills are either
negotiable or forwarded for collection through it so that it is in a position to verify the
exporter’s claim for duty draw-backs, cash subsidy, etc. An advance so availed of by an
exporter is required to be liquidated within 180 days from the date of shipment of relative
goods.

Documents to be obtained:
• Demand promissory note
• Letter of continuity
• General guarantee of directors or partners of the firm as the case may be
• Undertaking from the borrowers that they will deposit the cheques/payments
received from the appropriate authorities immediately with the bank and will not
utilize such amounts in any other way.

Non-Fund based Limits/ Working Capital Finance:

In non-fund based limits, bank make payment on behalf of co. In other words, when a
company needs funds for its working capital, it gets a guarantee or like from bank or
other institute. This means these limits are not in the monetary terms. These are non-
monetary bank limits. Following are these:

Letter of Credit:
A binding document that a buyer can request from his bank in order to guarantee that the
payment for goods will be transferred to the seller. Basically, a letter of credit gives the

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seller reassurance that he will receive the payment for the goods. In order for the payment
to occur, the seller has to present the bank with the necessary shipping documents
confirming the shipment of goods within a given time frame. It is often used in
international trade to eliminate risks such as unfamiliarity with the foreign country,
customs, or political instability. It is an open-ended loan with a borrowing limit that the
business can draw against or repay at any time during the loan period. This arrangement
allows a company flexibility to borrow funds when the need arises for the exact amount
required. Interest is paid only on the amount borrowed, typically unsecured, if no specific
collateral is pledged for repayment, or secured by specific assets such as accounts
receivable or inventory. The standard term for a line of credit is 1 year with renewal
subject to the lender’s annual review and approval. Since a line of credit is designed to
address cyclical working capital on a monthly basis. A line of credit can be either
unsecured, if no specific collateral is pledged for repayment, or secured by specific assets
such as accounts receivable or inventory. The standard term for a line of credit is 1 year
with renewal subject to the lender’s annual review and approval. Since a line of credit is
designed to address cyclical working capital needs and not to finance long-term assets,
lenders usually require full repayment of the line of credit during the annual loan period
and prior to its renewal. This repayment is sometimes referred to as the annual cleanup.
Two other costs, beyond interest payments, are associated with borrowing through a line
of credit. Lenders require a fee for providing the line of credit, based on the line’s credit
limit, which is paid whether or not the firm uses the line. This fee, usually in the range of
25 to 100 basis points, covers the bank’s costs for underwriting and setting up the loan
account in the event that a firm does not use the line and the bank earns no interest
income. A second cost is the requirement for a borrower to maintain a compensating
balance account with the bank. Under this arrangement, a borrower must have a deposit
account with a minimum balance equal to a percentage of the line of credit, perhaps 10%
to 20.

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Structured Finance:
These limits are the combination of Fund based limits and Non-Fund limits. This means
firm get help to fulfills its working capital requirements in the both forms i.e. monetary as
well as non-monetary terms. Following are some of these:
Commercial papers:

Commercial Paper (CP) is an unsecured money market instrument issued in the form of a
promissory note. It was introduced in India in 1990 with a view to enabling highly rated
corporate borrowers/ to diversify their sources of short-term borrowings and to provide
an additional instrument to investors. Subsequently, primary dealers and satellite dealers
were also permitted to issue CP to enable them to meet their short-term funding
requirements for their operations.

• They are unsecured debts of corporate and are issued in the form of promissory notes,
redeemable at par to the holder at maturity.
• Only corporate who get an investment grade rating can issue CPs, as per RBI rules.
• It is issued at a discount to face value
• Attracts issuance stamp duty in primary issue
• Has to be mandatory rated by one of the credit rating agencies
• It is issued as per RBI guidelines
• Its held in Demat form
• CP can be issued in denominations of Rs.5 lacs or multiples thereof. Amount invested
by a single investor should not be less than Rs.5 lacs (face value).
• Issued at discount to face value as may be determined by the issuer.
• Bank and FII’s are prohibited from issuance and underwriting of CP’s.
• Can be issued for a maturity for a minimum of 15 days and a maximum up to one year
from the date of issue.

Issuer: Can be issued by corporates, Primary Dealers and the all-India financial
institutions (FIs) that have been permitted to raise short-term resources under the
umbrella limit fixed by the Reserve Bank of India are eligible to issue CP.

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All eligible participants shall obtain the credit rating for issuance of Commercial Paper
either from CRISIL or ICRA or CARE or the FITCH Ratings India Pvt. Ltd. or such
other credit rating agency (CRA) as may be specified by the Reserve Bank of India from
time to time, for the purpose.
The minimum credit rating shall be P-2 of CRISIL or such equivalent rating by other
agencies.
The issuers shall ensure at the time of issuance of CP that the rating so obtained is current
and has not fallen due for review and the maturity date of the CP should not go beyond
the date up to which the credit rating of the issuer is valid.

Investment in CP: CP may be issued to and held by individuals, banking companies,

other corporate bodies registered or incorporated in India and unincorporated bodies,
Non-Resident Indians (NRIs) and Foreign Institutional Investors (FIIs). However,
investment by FIIs would be within the limits set for their investments by Securities and
Exchange Board of India (SEBI).

Types of commercial papers:

There are varying types of commercial paper such as:

• Chattel paper, which involves the distribution of goods across state and/or country
lines.
• Evidences of indebtedness from one merchant to another, commonly known as a
receivable to the seller and a payable to the buyer.
• Warehouse receipts evidencing inventory that is being stored in definable
quantities with a market price in a secure location.

Commercial paper continues to evolve as an explosion in the electronic World Wide Web
has come to play a bigger role in the supply chain.

Commercial paper is highly liquid. By its nature, it relates to transaction flows that
usually involve days, sometimes months, and very rarely, years. Because these assets are
considered very liquid, they tie very well with short-term lending programs. Ideally, a

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company who is trying to eliminate their cash flow gap will use short-term liquid assets
to deal with the cash flow gap and support and sustain the long-term viability of the
business with infrastructure related loans to land, building and equipment that are focused
on long-term objectives.

This combination of short-term versus long-term assets in securing working capital

transactions creates challenges for some businesses because lenders tend to disregard
commercial paper or highly liquid collateral as a viable asset to secure a short-term
transaction because of the perceived administrative nightmare of securing the process.

Ideally, lenders would give more emphasis on securing their working capital based loans
with liquid collateral and support the overall relationship with a particular borrower with
long-term collateral as ancillary collateral to the transaction.

Factoring:

Factoring is a financial option for the management of receivables. In simple definition it

is the conversion of credit sales into cash. In factoring, a financial institution (factor) buys
the accounts receivable of a company (Client) and pays up to 80% (rarely up to 90%) of
the amount immediately on agreement. Factoring company pays the remaining amount
(Balance 20%-finance cost-operating cost) to the client when the customer pays the debt.
Collection of debt from the customer is done either by the factor or the client depending
upon the type of factoring. We will see different types of factoring in this article. The
account receivable in factoring can either be for a product or service. Examples are
factoring against goods purchased, factoring for construction services (usually for
government contracts where the government body is capable of paying back the debt in
the stipulated period of factoring. Contractors submit invoices to get cash instantly),
factoring against medical insurance etc. Let us see how factoring is done against an
invoice of goods purchased.

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Characteristics of factoring

1. Usually the period for factoring is 90 to 150 days. Some factoring companies
allow even more than 150 days.
2. Factoring is considered to be a costly source of finance compared to other sources
of short term borrowings.
3. Factoring receivables is an ideal financial solution for new and emerging firms
without strong financials. This is because credit worthiness is evaluated based on
the financial strength of the customer (debtor). Hence these companies can
leverage on the financial strength of their customers.
4. Bad debts will not be considered for factoring.
5. Credit rating is not mandatory. But the factoring companies usually carry out
credit risk analysis before entering into the agreement.
6. Factoring is a method of off balance sheet financing.
7. Cost of factoring=finance cost + operating cost. Factoring cost vary according to
the transaction size, financial strength of the customer etc. The cost of factoring
varies from 1.5% to 3% per month depending upon the financial strength of the
client's customer.
8. Indian firms offer factoring for invoices as low as 1000Rs
9. For delayed payments beyond the approved credit period, penal charge of around
1-2% per month over and above the normal cost is charged (it varies like 1% for
the first month and 2% afterwards).

Different types of Factoring

1. Disclosed and Undisclosed

2. Recourse and Non recourse

A single factoring company may not offer all these services.

Disclosed

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In disclosed factoring client's customers are notified of the factoring agreement.
Disclosed type can either be recourse or non recourse.

Undisclosed

In undisclosed factoring, client's customers are not notified of the factoring arrangement.
Sales ledger administration and collection of debts are undertaken by the client himself.
Client has to pay the amount to the factor irrespective of whether customer has paid or
not. But in disclosed type factor may or may not be responsible for the collection of debts
depending on whether it is recourse or non recourse.

Recourse factoring

In recourse factoring, client undertakes to collect the debts from the customer. If the
customer doesn’t pay the amount on maturity, factor will recover the amount from the
client. This is the most common type of factoring. Recourse factoring is offered at a
lower interest rate since the risk by the factor is low. Balance amount is paid to client
when the customer pays the factor.

Non recourse factoring

In non recourse factoring, factor undertakes to collect the debts from the customer.
Balance amount is paid to client at the end of the credit period or when the customer pays
the factor whichever comes first. The advantage of non recourse factoring is that
continuous factoring will eliminate the need for credit and collection departments in the
organization.

Advantages of factoring:
There are many advantages to factoring, including:

• You maximize your cash flow as factoring enables you to raise up to 80% or more
on your outstanding invoices. An overdraft secured against invoices could only
raise up to 50%.

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 • Using a factor can reduce the time and money you spend on debt collection since
the factor will usually run your sales ledger for you.
• You can use the factor's credit control system to help assess the creditworthiness
of new and existing customers - this is especially useful if you do a lot of business
with companies whose turnover is lower than £1 million and who do not have to
file full returns with Companies House.
• Factoring can be an efficient way to minimize the cost and risk of doing business
overseas.

Disadvantages of factoring:

Of course, there are disadvantages to factoring and here are the most important ones to
consider. Unless carefully implemented, factoring can have a negative impact on the way
a business operates.

• The factor usually takes over the maintenance of the sales ledger. Customers may
prefer to deal with the company it is trading with rather than a factor. However, if
the factor's techniques are clearly agreed beforehand, there will usually be no
problem.
• Factoring may impose constraints on the way to do business. For non-recourse
factoring, most factors will want to pre-approve customers, which may cause
delays. The factor will apply credit limits to individual customers (though these
should be no lower than prudent credit control would suggest).
• The client company might only want the finance arrangements and yet it might
feel it is paying for collection services they do not really need.
• Ending a factoring arrangement can be difficult where the only exit route is to
repurchase the sales ledger or to switch factors and that could cause a sudden
shortfall in your working capital.

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 A Table showing the position of Fund Based and Non-fund based limits
of JBM ltd.: (in crores)

S.N. Particulars Canera Standard ABM Amro ICICI Bank

Bank Chartered
A. Non-Fund Based Limits 16.50 12.00 15.00 25.00
B.
Fund based Limits
CC Limits 10.00 1.00 5.50 3.50
Bill Discounting
WCDL 11.00 9.50
WCDL(FCNR)

Total of Fund Based 10.00 12.00 15.00 3.50

Limits
Grand total (A+B) 26.50 24.00 15.00 28.50

S.N. Particulars HDFC Yes Bank Indusind Citi Bank

Bank
A. Non-Fund Based Limits - 10.00 10.00 -
B.
Fund based Limits
CC Limits - - 1.50 2.02
Bill Discounting 9.00 - - -
WCDL
- - 8.50 6.00
WCDL(FCNR)
- - - 6.23

Total of Fund Based 9.00 10.00 10.00 14.25

Limits
Grand total (A+B) 9.00 10.00 20.00 14.25

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Tandon Committee Report
Reserve Bank of India setup a committee under the chairmanship of Shri P.L. Tandon in
July 1974.

The terms of reference of the Committee were:

1. To suggest guidelines for commercial banks to follow up and supervise credit from the
point of view of ensuring proper end use of funds and keeping a watch on the safety of
advances;
2. To suggest the type of operational data and other information that may be obtained by
banks periodically from the borrowers and by the Reserve Bank of India from the leading
banks;
3. To make suggestions for prescribing inventory norms for the different industries, both
in the private and public sectors and indicate the broad criteria for deviating from these
norms
4. To make recommendations regarding resources for financing the minimum working
capital requirements
5. To suggest criteria regarding satisfactory’ capital structure and sound financial basis in
relation to borrowings
6. To make recommendations as to whether the existing pattern of financing working
capital requirements by cash credit/overdraft system etc., requires to be modified, if so, to
suggest suitable modifications.

The committee was of the opinion that:

a) Bank credit is extended on the amount of security available and not according to the
level of operations of the customer
b) Bank credit instead of being taken as a supplementary to other sources of finance is
treated as the first source of finance. Although the Committee recommended certain
modifications so as to control the bank finances.

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 • The banks should get the information regarding the operational plans of customer
in advance so as to carry a realistic appraisal of such plans and the banks should
also know the end use of bank credit so that the finances are used only for
purposes for which they are lent.
• The recommendations of the committee regarding lending norms have been
suggested under alternatives. According to the first method, the borrower will
have to contribute a minimum of 25% the working capital gap from long-term
funds, i.e., owned funds and term borrowing; this will give minimum current ratio
of 1.17 : 1
• Under the second method of the borrower will have to provide a minimum. of
25% of the total current assets from long-term funds; this will give a minimum
current ratio of 1.33:1.
In the third method, the borrower’s contribution from long-term funds will be to the
extent of the entire core current assets and a minimum of 25% of the balance current
assets, thus strengthening the current further.

In other words,

• First Method of Lending:

Banks can work out the working capital gap, i.e. total current assets
less current liabilities other than bank borrowings (called Maximum
Permissible Bank Finance or MPBF) and finance a maximum of 75
per cent of the gap; the balance to come out of long-term funds, i.e.,
owned funds and term borrowings. This approach was considered
suitable only for very small borrowers i.e. where the requirements of
credit were less than Rs.10 lacs

• Second Method of Lending:

Under this method, it was thought that the borrower should provide

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 for a minimum of 25% of total current assets out of long-term funds
i.e., owned funds plus term borrowings. A certain level of credit for
purchases and other current liabilities will be available to fund the
build up of current assets and the bank will provide the balance
(MPBF). Consequently, total current liabilities inclusive of bank
borrowings could not exceed 75% of current assets. RBI stipulated
that the working capital needs of all borrowers enjoying fund based
credit facilities of more than Rs. 10 lacs should be appraised
(calculated) under this method.

• Third Method of Lending: Under this method, the

borrower's contribution from long term funds will be to the extent of
the entire CORE CURRENT ASSETS, which has been defined by
the Study Group as representing the absolute minimum level of raw
materials, process stock, finished goods and stores which are in the
pipeline to ensure continuity of production and a minimum of 25%
of the balance current assets should be financed out of the long term
funds plus term borrowings.
(This method was not accepted for implementation and hence is of
only academic interest).

Illustration:
Rs.
Total current assets required 40,000

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Current liabilities other than bank borrowings 10,000
Core current assets 5,000

1st Method
Total current assets required 40,000
Less current liabilities 10,000
Working Capital Gap 30,000
Less 25% from Long term sources 7,500
Maximum permissible bank borrowings 22,500

2nd Method
Current Assets required 40,000
Less 25% to be provided from long term funds 10,000
Less Current Liabilities 30,000
Maximum permissible bank borrowings 20,000

3rd Method
Current assets 40,000
Less Core Current assets 5,000
35,000
Less 25% to be provided from long term funds 8,750
26,250
Less current liabilities 10,000
Maximum permissible bank borrowings 16,250

Computation of Maximum Permissible

Bank Finance (MPBF):
The Tandon Committee had suggested three methods for determining the maximum
permissible bank finance MPBF).
They are

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Method 1: MPBF=0.75(CA-CL)
Method 2: MPBF=0.75(CA)-CL
Method 3: MPBF=0.75(CA-CCA)-CL
Where CCA=Core Current Assets- this represents the permanent component of working
capital.

Other major recommendations of the committee were:

• No slip back in current ratio, normally.

• Classification guidelines for Current assets and current liabilities.
• Identification of excess borrowing.
• Information system, which was modified by Chore Committee Recommendations.
• Bifurcation of limits into loan and demand component.

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