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ACKNOWLEDGEMENT

The satisfaction and euphoria that accompanies the successful completion of any task
would be incomplete without mentioning the names of the people who made it possible,
whose constant guidance and encouragement crown all the efforts with success.

Im deeply indebted to all people who have guided, inspired and helped me in the successful
completion of this project. I owe a debt of gratitude to all of them, who were so generous
with their time and expertise.

I would like to thank Mr.

for his continuous guidance and support.

Executive Summary
I am privileged to study on the topic of Working Capital Management as a project work.
This report is designed to be a comprehensive report of Working Capital Components, which
is like the blood moving through the veins of the human body.
I have tried to cover the major aspects related to Working Capital Components in this project.
This project consists of study of general nature of circulating capital, factors determining
circulating capital requirements etc. I have attempted to fill in the gap by introducing
examples and company info to give me a stimulus in gaining my practical knowledge. In
simple language, capital is bifurcated into fixed and working capital and these two are the
two sides of the same coin. From the functional point of view, capital of the company is like
that of blood of human body without which human body gets perished.
The report is the outcome of authors who have taken up academics after serving world; it is
hope that this report will be a good blend of challenging ideas and practical tips, which can be
learnt through observations. I thank the management of publications like capital magazines,
finance magazine and Business today whose reading materials are included in this project.
The choice of topic for this individual project was really interesting and more knowledgeable
which would help me in my practical life. It has really been a pleasure and challenging
experience to study this topic.
All that remains is from me to wish you a HAPPY READING.

INTRODUCTION

MEANING OF WORKING CAPITAL


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

1)

Fixed Capital

2)

Working Capital

Every business needs investment to procure fixed assets, which remain in use for a longer
period. Money invested in these assets is called Long term Funds or Fixed Capital. Long
terms funds are required to create production facilities through purchase of fixed assets such
as Plant & Machinery, Land, Building, Furniture, etc. Investments in these assets represent
that part of firms capital which is blocked on permanent or fixed basis and is called Fixed
Capital.
Business also needs funds for short-term purposes to finance current operations. Investment
in short term assets like Cash, Inventories, Marketable Securities, Debtors etc., is called
Short-term Funds or Working Capital. Funds, thus, invested in current assets keep
revolving fast and are being constantly converted in to cash and these cash flows out again in
exchange for other current assets. Hence, it is also known as Revolving or Circulating
Capital or Short-term Capital. The Working Capital can be categorised, as funds needed for
carrying out day-to-day operations of the business smoothly. The management of the working
capital is equally important as the management of long-term financial investment. Every
running business needs working capital. Even a business which is fully equipped with all
types of fixed assets required is bound to collapse without (i) adequate supply of raw
materials for processing; (ii) cash to pay for wages, power and other costs; (iii) creating a
stock of finished goods to feed the market demand regularly; and, (iv) the ability to grant

credit to its customers. All these require working capital. Working capital is thus like the
lifeblood of a business. The business will not be able to carry on day-to-day activities without
the availability of adequate working capital.

Working capital cycle involves conversions and rotation of various constituents components
of the working capital. Initially cash is converted into raw materials. Subsequently, with the
usage of fixed assets resulting in value additions, the raw materials get converted into work in
process and then into finished goods. When sold on credit, the finished goods assume the
form of debtors who give the business cash on due date. Thus cash assumes its original form
again at the end of one such working capital cycle but in the course it passes through various
other forms of current assets too. This is how various components of current assets keep on
changing their forms due to value addition.

Cash

Creditors

Debtors

Raw Material

Working Expenses

Finished Goods

Work in process

Figure .1. WORKING CAPITAL CYCLE.


As a result, they rotate and business operations continue. Thus, the working capital cycle
involves rotation of various constituents of the working capital. While managing the working
capital, two characteristics of current assets should be kept in mind viz. (i) short life span, and

(ii) swift transformation into other form of current asset. Each constituent of current asset has
comparatively very short life span. Investment remains in a particular form of current asset
for a short period. The life span of current assets depends upon the time required in the
activities of procurement; production, sales and collection and degree of synchronisation
among them. A very short life span of current assets results into swift transformation into
other form of current assets for a running business.

These characteristics have certain implications:


Decision regarding management of the working capital has to be taken frequently and
on a repeat basis.
The various components of the working capital are closely related and
mismanagement of any one component adversely affects the other components too.
The difference between the present value and the book value of profit is not
significant.

PURPOSE OF WORKING CAPITAL

To meet the cost of inventories, raw materials purchases, work-in-process,


finished goods, etc.
To pay wages and salaries.
To meet overhead cost, factory cost, office and administration cost, taxes, etc.
To meet selling and distribution expenses, advertising, packing etc.

DEFINITION OF WORKING CAPITAL

The gross working capital concept focuses attention on two aspects of current asset
management:
(a) Optimum investment in current asset; and
(b) Financing of current assets.
Following definition of working capital defines gross working capital
Mead, Malott and Field. Working capital means current assets.
Bonneville. Any acquisition of funds which increases the current asset increases
working capital, for they are one and the same.
J.S.Mill. The sum of the current assets is the working capital of business.
Prof. K.V.Smith. Working capital management is concerned with problems that
arise in attempting to manage the current assets, the current liabilities and the
interrelationship that exist between them.
Weston and Brigham. Working capital management refers to all aspects of the
administration of both current assets and current liabilities.

OBJECTIVES OF WORKING CAPITAL

To decide upon the optimum level of investment in various current assets i.e.
determining the size of working capital.

By optimizing the investment in current assets and by reducing the level of current
liabilities, the company can reduce the locking up of funds in working capital thereby;
it can improve the return on capital employed in the business.
To decide upon the optimum mix of short-term funds in relation to long-term capital.
The company should always be in a position to meet its current obligations which
should properly be supported by the current assets available with the firm. By
maintaining excess funds in working capital means locking of funds without return.
To locate appropriate sources of short term financing.
Maintaining working capital at appropriate level.
The firm should manage its current assets in such a way that marginal return on
investment in current assets is not less than the cost of capital employed to finance the
current assets.
Availability of sufficient funds at the times of need.

CLASSIFICATION OF WORKING CAPITAL


Working capital may be classified in to two ways:
On the basis of concept.
Gross Working Capital
Net Working Capital
On the basis of time.
Permanent or Fixed Working Capital
Regular Working Capital
Reserve Margin or Cushion Working Capital

Temporary or Variable Working Capital


Seasonal Variable Working Capital
Special Variable Working Capital

PERMANENT OR FIXED WORKING CAPITAL


Permanent or fixed working capital is minimum amount which is required to ensure effective
utilization of fixed facilities and for maintaining the circulation of current assets. Every firm
has to maintain a minimum level of raw material, work- in-process, finished goods and cash
balance. This minimum level of current assts is called permanent or fixed working capital as
this part of working capital is permanently blocked in current assets. As the business grow the
requirements of working capital also increases due to increase in current assets.

Regular Working Capital. It is the minimum amount of liquid capital required to


keep up the circulation of the capital from cash to inventories; to receivable and again
to cash. This includes sufficient minimum cash balance to discount all bills and to
maintain adequate supply of raw materials etc.

Reserve Margin or Cushion Working Capital. It is the excess capital over the needs
of regular working capital that should be kept in reserve for contingencies that may
arise at any time. These contingencies include rising prices, business depression,
strikes, special operations such as experiments with new products etc.

TEMPORARY OR VARIABLE WORKING CAPITAL


Temporary or variable working capital is the amount of working capital which is required to
meet the seasonal demands and some special exigencies. Variable working capital can further
be classified as seasonal working capital and special working capital. The capital required to
meet the seasonal need of the enterprise is called seasonal working capital. Special working
capital is that part of working capital which is required to meet special exigencies such as
launching of extensive marketing for conducting research, etc. Temporary working capital
differs from permanent working capital in the sense that is required for short periods and
cannot be permanently employed gainfully in the business.

Seasonal variable working capital. The working capital required to meet the
seasonal liquidity of the business is seasonal variable working capital.

Special variable working capital. It is that part of the variable working capital which
is required for financing special operation such as extensive marketing campaigns,
experiments with products or methods of production, carrying of special jobs etc.

Consequences of under assessment of Working Capital


Growth may be stunted. It may become difficult for the enterprise to undertake
profitable projects due to non-availability of working capital.
Implementation of operating plans may become difficult and consequently the
profit goals may not be achieved.
Cash crisis may emerge due to paucity of working funds.
Optimum capacity utilisation of fixed assets may not be achieved due to nonavailability of the working capital.
The business may fail to honour its commitment in time, thereby adversely
affecting its credibility. This situation may lead to business closure.
The business may be compelled to buy raw materials on credit and sell finished
goods on cash. In the process it may end up with increasing cost of purchases and
reducing selling prices by offering discounts. Both these situations would affect
profitability adversely.
Non-availability of stocks due to non-availability of funds may result in
production stoppage.
While underassessment of working capital has disastrous implications on
business, over assessment of working capital also has its own dangers.
Consequences of over assessment of Working Capital
Excess of working capital may result in unnecessary accumulation of inventories.

It may lead to offer too liberal credit terms to buyers and very poor recovery
system and cash management.
It may make management complacent leading to its inefficiency.
Over-investment in working capital makes capital less productive and may reduce
return on investment.
Working capital is very essential for success of a business and, therefore, needs efficient
management and control. Each of the components of the working capital needs proper
management to optimise profit.
INVENTORY MANAGEMENT
Inventory includes all types of stocks. For effective working capital management, inventory
needs to be managed effectively. The level of inventory should be such that the total cost of
ordering and holding inventory is the least. Simultaneously, stock out costs should also be
minimised. Business, therefore, should fix the minimum safety stock level, re-order level and
ordering quantity so that the inventory cost is reduced and its management becomes efficient.
RECEIVABLES MANAGEMENT
Given a choice, every business would prefer selling its produce on cash basis. However, due
to factors like trade policies, prevailing marketing conditions, etc., businesses are compelled
to sell their goods on credit. In certain circumstances, a business may deliberately extend
credit as a strategy of increasing sales. Extending credit means creating a current asset in the
form of Debtors or Accounts Receivable. Investment in this type of current assets needs
proper and effective management as it gives rise to costs such as:
Cost of carrying receivable (payment of interest etc.)
Cost of bad debt losses
Thus the objective of any management policy pertaining to accounts receivables would be to
ensure that the benefits arising due to the receivables are more than the cost incurred for
receivables and the gap between benefit and cost increases resulting in increased profits. An

effective control of receivables helps a great deal in properly managing it. Each business
should, therefore, try to find out average credit extended to its client using the below given
formula:
Average Credit

Total amount of receivables


=

Extended (in days)

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

Each business should project expected sales and expected investment in receivables based on
various factors, which influence the working capital requirement. From this it would be
possible to find out the average credit days using the above given formula. A business should
continuously try to monitor the credit days and see that the average credit offered to clients is
not crossing the budgeted period. Otherwise, the requirement of investment in the working
capital would increase and, as a result, activities may get squeezed. This may lead to cash
crisis.
CASH MANAGEMENT
Cash is the most liquid current asset. It is of vital importance to the daily operations of
business. While the proportion of assets held in the form of cash is very small, its efficient
management is crucial to the solvency of the business. Therefore, planning cash and
controlling its use are very important tasks. Cash budgeting is a useful device for this
purpose.
CASH BUDGET
Cash budget basically incorporates estimates of future inflows and outflows of cash over a
projected short period of time which may usually be a year, a half or a quarter year. Effective
cash management is facilitated if the cash budget is further broken down into month, week or
even on daily basis.

WORKING CAPITAL MANAGEMENT


IMPORTANCE OF GOOD CIRCULATING CAPITAL MANAGEMENT

Working capital constitutes part of the Crown's investment in a department. Associated with
this is an opportunity cost to the Crown. (Money invested in one area may "cost"
opportunities for investment in other areas.) If a department is operating with more working
capital than is necessary, this over-investment represents an unnecessary cost to the Crown.
From a department's point of view, excess working capital means operating inefficiencies. In
addition, unnecessary working capital increases the amount of the capital charge which
departments are required to meet from 1st July, 1991.

According to Husband and Dockery, the prime object of management is to make a profit,
whether or not this is accomplished, as most business depends largely on the manner in which

the working capital is administered. The primary objective of working capital management
is to manage the firms current assets and current liabilities in such a way that a satisfactorily
level of working capital is maintained. The firm may become insolvent if it cannot maintain a
satisfactory level of working capital. Working Capital assists in increasing the profitability of
the concern. The working capital position decides the various policies in the business with
receipt to general operations viz., importance of management of working capital.

POSITIVE CORRELATION BETWEEN SALE AND CURRENT ASSETS.


There is a positive correlation between the sale of the product of the firm and its
current assets. Increase in the sale of the product requires a corresponding increase in
current assets. Therefore, the current assets must be managed properly.
INVESTMENT IN CURRENT ASSETS. Generally more than half of the total
capital of the firm is invested in current assets. Thus less than half of the capital is
blocked in fixed assets. Therefore management of working capital attracts the
attention of the management.
NO ALTERNATIVE FOR CURRENT ASSETS. While fixed capital can be
acquired on lease in emergency there is no alternative for current assets. Investment in
current assets cannot be avoided without substantial loss.
FINANCED THROUGH OUTSIDE SOURCES. Working capital needs is often
financed through outside sources. Hence, it is necessary to utilize them in the best
possible way.
IMPORTANT FOR SMALL UNITS. The management of working capital is more
important for small units because they do not rely on the long term capital market and
has easy access to short term financial sources such as trade credit, short term bank
loan etc.
APPROACHES TO WORKING CAPITAL MANAGEMENT

The objective of working capital management is to maintain the optimum balance of each of
the working capital components. This includes making sure that funds are held as cash in
bank deposits for as long as and in the largest amounts possible, thereby maximizing the
interest earned. However, such cash may more appropriately be "Invested" in other assets or
in reducing other liabilities.
Working capital management takes place on two levels:
Ratio analysis can be used to monitor overall trends in working capital and to identify
areas requiring closer management.
The individual components of working capital can be effectively managed by using
various techniques and strategies.

When considering these techniques and strategies, departments need to recognize that each
department has a unique mix of working capital components. The emphasis that needs to be
placed on each component varies according to department. For example, some departments
have significant inventory levels; others have little if any inventory. Furthermore, working
capital management is not an end in itself. It is an integral part of the department's overall
management. The needs of efficient working capital management must be considered in
relation to other aspects of the department's financial and non-financial performance.

FACTORS DETERMINING WORKING CAPITAL REQUIREMENT

NATURE OF BUSINESS
The amount of working capital is related to the nature of the business. In concerns, where the
cost of the raw materials used in manufacture of a product is very large in production to its
total cost of manufacture, the requirement of the working capital will be very large. For
instance, a cotton or sugar mill requires a large amount of working capital on the contrary; a
concern having large investments in fixed assets requires less amount of working capital.

Public utility concerns such as railway or electricity services require a lesser amount of
working capital as compared to trading or manufacturing concerns partly because of cash
nature of their business and partly because they are selling a service instead of a commodity
and there is no need of maintaining inventories.
SIZE OF BUSINESS UNIT
The general principal in this regard is that the bigger the size of business the larger will be the
amount of working capital required because the larger business units are required to maintain
big inventories for the flow of the business and to spend more in carrying out the business
operations smoothly.
SEASONAL VARIATIONS
Strong seasonal variations create special problems of working capital in controlling the
internal financial swings many companies such as sugar mills, oil mills or woolen mill etc.
they require larger amount of working capital in the season to purchase the raw materials in
large quantities and utilize them throughout the year they adjust their production schedule and
maintain a steady rate of production during off season periods. Thus they require larger
amount of working capital during season.
TIME CONSUMED IN MANUFACTURE
The average time taken in the process of manufacture is also an important factor in
determining the amount of working capital. The longer the period of manufacture, the larger
the inventory required. Though capital goods industries managed to minimize their
investment in inventories or working capital by asking advances from the customers as work
proceeds in their orders.
TURNOVER OF CIRCULATING CAPITAL
Turnover means the ratio of annual gross sales to average working assets. It means the speed
with circulating capital completes its rounds or the number of times the amount invested in

working assets has been converted into cash by sale of the finished goods and reinvested in
working assets during a year. The faster the sales, the larger the turnover. Conversely, the
greater the turnover, the larger the volume of business is to be done with given working
capital. It will require lesser amount of working capital in spite of larger sales because of
greater turnover.

USES OF ADEQUATE WORKING CAPITAL


CASH DISCOUNT

by adequate working capital the business can avail the

advantages of cash discount by paying cash for the purchase of raw materials and
merchandise. If proper cash balance is maintained, this will reduce the cost of
production.
SENSE OF SECURITY AND CONFIDENCE adequate working capital creates a
sense of security, confidence and loyalty throughout the business and also among its
customers, creditors and business associates. The proprietor, officials or management

of a concern are carefree, if they have proper capital arrangements because they need
not worry for the payment of business expenditure or creditors.
SOLVENCY AND CONTINUOUS PRODUCTION in order to maintain the
solvency of the business, it is essential that sufficient amount of funds are available to
make all the payments in time as and when they are due. In the absence of working
capital, production will suffer, era of cut throat competition. A business can never
flourish in the absence of adequate working capital.
SOUND GOODWILL AND INCREASE DEBT CAPACITY promptness of
payment in business creates goodwill and increases the debt capacity of the business.
If investors and borrowers are confident that they will get their due interest and
payment of principal in time, a firm can raise funds from the market, purchase goods
on credit and borrow short term funds from banks etc.
EASY LOANS FROM THE BANKS an adequate working capital helps the
company to borrow unsecured loans from the bank because the excess provides a
good security to the unsecured loans. If the business has a good credit standing and
trade reputation, banks favour in granting seasonal loans.
DISTRIBUTION OF DIVIDEND short of working capital a company cannot
distribute dividend to its shareholders in spite of sufficient profits. To make up for the
deficiency of working capital profits are to be retained in the business. On the other
hand, ample dividend can be declared and distributed to the market value of shares
and increase by sufficient working capital.
EXPLOITATION OF GOOD OPPORTUNITIES good opportunities can be
exploited through adequacy of capital in a concern, for example, a company may
make off seasons purchases resulting in substantial savings or it can fetch big supply
orders resulting in good profits.
MEETING UNSEEN CONTINGENCIES as stockpiling of finished goods
becomes necessary depression shoots up the working demand of capital. If a company

maintains adequate working capital unseen contingencies such as financial crises due
to heavy losses, business oscillations etc. can easily be overcome.
INCREASE IN EFFICIENCY OF FIXED ASSETS proper maintenance and
adequate working capital increases the efficiency of the fixed assets of the business. It
has been rightly said, The fate of large scale investment in fixed capital is often
determined by a relatively small amount of current assets.
HIGH MORAL the provision of adequate working capital improves the morale of
the executive as they get an environment of certainty, security and confidence which
is a great psychological factor in improving the overall efficiency of the business and
of the person who is at the helm of affairs in the company.

INCREASE PRODUCTION EFFICIENCY a continuous supply of raw materials,


research programs, innovation and technical developments and expansion programs
are successfully carried out if adequate capital is maintained in the business. It
increases production capacity which increases the efficiency and morale of the
employees.

EVILS OF INADEQUATE WORKING CAPITAL

LOSS OF CREDIT WORTHINESS AND GOODWILL a firm looses its credit


worthiness and goodwill if it fails to honour its current liabilities. It finds it difficult to
procure the requisite funds for its business operations on easy terms. This leads to
reduce profitability as well as production interruptions.
NO BENEFIT FROM FAVOURABLE OPPORTUNITIES with inadequate
working capital a firm fails to undertake profitable projects. It prevents the firm from
availing the benefits for available opportunities and stagnates its growth.

FAILURE TO AVAIL CREDIT OPPORTUNITIES due to inadequate working


capital a firm fails to avail the attractive credit opportunities.
OPERATING INEFFICIENCIES inadequate working capital leads to operating
inefficiencies as day-to-day commitments cannot be met.
LOW RATE OF RETURN ON FIXED ASSETS inadequate working capital results
in lowering down the rate of return on fixed assets as these cannot be efficiently
utilized or maintain due to inadequacy of working capital.
INCREASE IN BUSINESS RISKS inadequate working capital increases the
business risk of the firm. Unable to discharge its current liabilities it is liable to be
declared as insolvent. Thus inadequate working capital poses a serious threat to the
survival of the firm.

CANNOT ACHIEVE PROFIT TARGET due to inadequate working capital the


firm cannot achieve its profit target as it cannot implement its operating plans due to
shortage of working capital.
LOW MORALE OF BUSINESS EXECUTIVES inadequate working capital
adversely lowers the morale of the firms executives as they do not have an
environment of certainty, security and confidence, which is a necessary psychological
factor in improving the overall efficiency of the business.
WEAKENING OF FINANCIAL CAPACITY inadequate working capital weakens
the shock-absorbing capacity of the firm as it cannot meet the contingencies arising
from business oscillations, financial losses, etc.
EVILS OR REDUNDANT OR EXCESSIVE WORKING CAPITAL
IDLE FUNDS excessive and redundant working capital implies the presence of idle
funds which earn no profit for the firm. A firm with excessive working capital cannot
earn proper rate of return on its total investments, as profits are distributed on the

whole of its capital. This brings down the rate of return to the shareholders. Lower
dividend reduces the market value of shares and causes capital losses to the
shareholders.
DECLINE IN OPERATING EFFICIENCY companies often adopt some
objectionable devices to inflate profits to maintain or increase the rate of dividend.
Sometimes, unearned dividends are paid out of companies capital to keep the show of
prosperity by window dressing of accounts. In order to make up the deficiency of
reduced earnings, certain provisions, such as provision for depreciation, repairs and
renewals are not made. This leads to decline in operating efficiency and fall in profits.
LOSS OF CONFIDENCE AND GOODWILL excessive working capital leads to
lower rate of return on the companys total investments. Lower dividend leads to
reduction of the market value of the companys shares much less than the book value.
The shareholder loose confidence in the company and the goodwill or credit of the
company suffers a serious setback. Thus the financial stability of the company is
jeopardized.
MISAPPLICATION OF FUNDS companies with excessive working capital do not
utilize the resources prudently. Excessive inventories and fixed assets are purchased
by the company which do not add to its profitability and increase its maintenance cost
and losses due to theft, waste and mishandling.
EVILS OF OVER CAPITALISATION excessive working capital leads to over
capitalization, which is disastrous to the smooth survival of the company and affects
the interest of those associated with the company.
INEFFICIENT MANAGEMENT excessive working capital indicates that the
management is not interested in expanding the business, otherwise the excessive
working capital might have been utilised for this purpose.
DESTRUCTION OF TURNOVER RATIO redundant working capital destroys the
control of turnover ratio, which is commonly used in a conduct of an efficient

business. It eradicates all other guides and sign post commonly employed in
conducting and operating a business.

WORKING CAPITAL FINANCING

Now let us understand the means to finance the working capital. Working capital or current
assets are those assets, which unlike fixed assets change their forms rapidly. Due to this
nature, they need to be financed through short-term funds. Short-term funds are also called
current liabilities. The following are the major sources of raising short-term funds:
TRADE CREDIT

Trade credit refers to the credit extended by the supplier of goods and services in the normal
course of transaction/business/sale of the firm. According to trade practices, cash is not paid
immediately for purchase but after an agreed period of time. There is however, no formal/
specific negotiation for trade credit. It is an informal arrangement between the buyer and the
seller.
BANK CREDIT
Bank credit is the primary institutional source of working capital finance in India; in fact, it
represents the most important source of financing of current assets.

MAKING MORE EFFICIENT USE OF WORKING CAPITAL


The table below lists items, which influence Working Capital levels favourably and adversely
Items that reduce Working Capital levels for Items that increase Working Capital levels for
publishers
publishers

- Increased profit margins

Customers
who
pay
- Advance payments by customers

- Lower profit margins

promptly - Long print runs except where all the books are
required on publication e.g. School and
university textbooks

- Inventory which is sold and paid for quickly - Slow authors who deliver late and whose
by
customers
after
publication manuscripts
require
substantial
editing
- Lower Inventory levels by reducing print - Holding paper stock unless market conditions
quantities and working with printers who will demand and the savings are large
deliver quickly and produce low print runs - Slow schedules for the development of new
economically
titles

- Successful promotion that speeds up the rate - Making advance payments to printers
of sale
- Seasonal sales except where the publishers
prints only for the season

- Licensing (but problematic in young


economies)

- Paying suppliers on completion with credit


- Authors who deliver manuscripts on disk
ready
for
computer
make-up
- Incentives to staff, authors, suppliers,
customers, sales staff and agents to speed up
the rate of sale and of developing new books,
delivering manuscripts on schedule

METHODS OF ESTIMATING WORKING CAPITAL REQUIREMENTS

Funds required to carry the required levels of current assets, to enable the Company to carry
on its operations at the expected levels uninterruptedly, are the Working Capital requirements.
Therefore Working Capital requirement (WCR) is proportional to:
The volume of activity (i.e. level of operation )
The type of business carried on viz. manufacturing process, production program.
Though there are various methods for assessing the quantum of Working Capital requirement
for an industry, the following three are commonly known and used.
Operating Cycle Method (for W/C limits upto Rs.25000)
Usual or Traditional Method (for W/C limit upto Rs.10 lacs)
Using Tandon & Chore Committee Norms (for W/C limit above Rs.10 lacs)

WORKING CAPITAL RATIOS

Working capital ratios indicate the ability of business concern in meeting its current
obligations as well its efficiency in managing its current assets in generation of sales. These
ratios are applied to evaluate efficiency with the firm manages and utilizes its current assets.
The following three categories of ratios are used for efficient management of working capital:
Efficiency Ratios
Liquidity Ratios
Structural Health Ratios
EFFICIENCY RATIOS:
Sales
Working Capital to Sales Ratio

----------------------Working Capital

This ratio is computed by dividing working capital by sales. This ratio helps to measure the
efficiency of the utilization of networking capital. It signifies for an amount of sales a relative
amount of working capital is needed. If any increase in sales is contemplated, working capital
should be adequate and thus, this ratios management to maintain the adequate level of
working capital.

Sales
Inventory Turnover Ratio

------------Inventory

This ratio indicates the effectiveness and efficiency of the inventory management. The ratio
shows how speedily the inventory is turned into accounts receivables through sales. The
lower the inventory of sales ratio, the more efficiently the inventory is said to be managed
vis-a-versa.
Sales
Current Assets Turnover Ratio

-------------------Current Assets

This ratio indicated the efficiency with which current assets turn into sales. The lower current
assets to sales ratio implies by enlarge a more efficient use of funds. Thus, a high turnover
rate indicates reduced lock up of funds in current assets. An analysis of this ratio over a
period of time reflects working capital management of a firm.
LIQUIDITY RATIOS:
Current Assets, Loans & advances
Current Ratio

---------------------------------------------Current Liabilities and Provisions

This ratio indicates the extent of the soundness of the current financial position of an
undertaking and the degree of safety provided to the creditors. The higher the current ratio the
large amount of rupee available per rupee for current liability, the more the firms ability to
meet current obligations and the greater safety of funds of short term creditors. Current assets
are those assets, which can be converted into cash within a year. Current liabilities and
provisions are those liabilities that are payable within a year. A current ratio of 2:1 indicates a
highly solvent position. Banks consider a current ratio of 1.3:1 as minimum acceptable level
for proving working capital finance. The constituents of the current assets are as important as
the current assets themselves for evaluation of companys solvency position.

Current Assets, Loads and Advances Inventories


Quick Ratio =

----------------------------------------------------------------Current Liabilities and Provisions Bank Overdraft

Quick ratio is a more refined tool to measure the liquidity of an organization. It is better taste
of financial strength then the current ratio, because it excludes very slow moving inventories
and the items of current assets, which cannot be converted into cash easily. This ratio shows
the extent of cushion of protection provided from the quick assets to the current creditors. A
quick ratio of 1:1 is usually considered satisfactory though it is again a rule of thumb only.

STRUCTURAL HEALTH RATIOS:

Net Assets
Current Assets to Total Net Assets

-------------------Current Assets

This ratio explains the relationship between current assets and total investment in current
assets. A business enterprise should use its current assets effectively and economically

because it is out of the management of these assets that profits accrue. A business will end up
in losses if there is any lacuna in managing assets to the advantage of business. Investment in
fixed assets being in elastic in nature, there is no elbowroom to make an amends in this
sphere and its impact on profitability remains minimal.
Composition of Current Assets

An analysis of current assets component enables one to examine in which component the
working capital funds are locked up. Large tie up of funds in inventories effects profitability
of the business adversely owing to carry over costs. In addition losses are likely to occur by
way of depreciation, decay, obsolescence, evaporation and so on. Receivables constituting
another component of current assets. If the major portion of current assets is made up of cash
alone, the profitability will be decreased because cash is a non-earning asset. If the portion of
cash balance is excessive, then it can be said that management is not efficient to employee the
surplus cash.

Sales
Debtors Turnover Ratio

----------Debtors

This ratio shows the extent of trade credit granted and the efficiency in the collection of debts
thus; it is an indicative of efficiency of trade credit management. The lower the debtors to
sales ratio, the better the trade credit management and better the quality (liquidity) of debtors.
The lower debtors mean prompt payment by customers. An excessively long collection
period, on another hand, indicates a very liberal, ineffective and inefficient credit and
collection policy.
Debtors

Average Collection period (in days)

----------- X 365
Sales

Average collection period, which measures how long it takes to collect amounts from debtors.
The actual collection period can be compared with the stated credit terms of the company. If
it is longer than those terms, then this indicates some in sufficiency in the procedures for
collecting debts.
Bad Debts
Bad Debts to Sales

-------------Sales

This ratio indicates efficiency of the control procedures of the company. The actual ration is
compared with the target or norm to decide whether or not it is acceptable.
Creditors
Creditors Turnover period (in days) =

--------------Purchases

The measurement of the creditor turnover period shows the average time taken to pay for
goods and services by the company. In general the longer the credit period achieved the
better, because delays in payment mean that the operation of the company are being financed
interest free by suppliers funds. But there will be a point beyond which if they are operating
in a sellers market, may harm the company. If too long a period is taken to pay creditors, the
credit rating of the company may suffer, thereby making it more difficult to obtain supplier in
the future.

WORKING CAPITAL LEVERAGE


One of the important objectives of working capital management is by maintaining the
optimum levels of investment sin current assets and by reducing the levels of current
liabilities, the company an minimize the investment in working capital thereby improvement

in return on capital employed is achieved. The term working capital leverage refers to the
impact of level of working capital on companys profitability. The working capital
management should improve the productivity of investments in current assets and ultimately
it will increase the return on capital employed. Higher levels of investments in current assets
than is actually required mean increase in the cost of interest charges on the short-term loans
and working capital finance raised from banks etc. and will result on lower return on capital
employed and vis-e-versa. Working capital leverage measures the responsiveness of ROCE
for changes in current assets. It is measured by applying the following formula.
C.A.
Working Capital Leverage

-----------------T.A. - C.A.

Where,

C.A. = Current Assets


T.A. = Total Assets (Net Fixed Assets + Current Assets)

= Change in Current Assets

IMPACT OF INFLATION ON WORKING CAPITAL REQUIREMENT

When the inflation rate is high, it will have its direct impact on the requirement of working
capital as explained below.
Inflation will cause to show the turnover figure at higher level even if there is no
increase in the quantity of sales. The higher the sale means the higher levels of
balances in receivables.

Inflation will result in increase of raw material prices and hike in payment for
expenses and as a result increase in balance s of trade creditors and creditors for
expenses.
Increase in valuation of closing stocks result in showing higher profits but without its
realization into cash causing the firm to pay higher tax dividend and bonus. This will
lead the firm in serious problems of funds shortage and firm may enable to meets its
short term and long-term obligations.
Increase in investments is current assets means the increase in requirements of
working capital without corresponding increase in sales or profitability of the firm.
Keeping in view of the above, the finance manager should be very careful about the impact of
inflation in assessment of working capital requirements and its management.

IMPACT OF DOUBLE SHIFT WORKING ON WORKING CAPITAL REQUIREMENT

If the firm which is presently running in single shift plans to go for working in double shift
the following factors should be considered while assessing the working capital requirements
of the firm.
Working in double shift means requirement of raw materials will be doubled and other
variable expenses will also increase drastically.
With the increase in raw materials requirement and expenses, the raw material
inventory and work in
Progress will increase simultaneously the creditors for goods and creditors for
expenses balances will also increase.

Increase in production to meet the increased demand which will also increase the
stock of finished goods. The increase in sales means increase in debtors balances.
Increase in production will result in increased requirement of working capital.
The fixed expenses will increase with the working on double shift bases.
The finance manager should reassess the working capital requirements if the change is
contemplated from single shift operation to double shift.
ZERO WORKING CAPITAL
This is one of the latest trends in working capital management. The idea is to have zero
working capital. For e.g. at all times the current assets shall equal the current liabilities.
Excess investment in current assets is avoided and firm meets its current liabilities out of the
matching current assets.
As current ratio is 1 and the quick ratio below 1, there may be apprehensions about the
liquidity, but if all current assets are performing and are accounted at their realizable values,
these fears are misplaced. The firm saves opportunity cost on excess investments in current
assets and as bank cash credit limits are linked to the inventory levels, interest cost is also
sold. There would be a self-imposed financial discipline on the firm to manage their activities
within their current liabilities and current assets and there may not be attendance to over
borrow or divert funds.
Zero working capital also ensures a smooth and uninterrupted working capital cycle, and it
would pressure the finance manager to improve the quality of current assets at all times, to
keep them 100 % realizable. There would also be constant displacements in the current
liabilities and the possibility of having overdue may diminish. The tendency to postpone
current liability payments has to be curbed and working capital always maintained at zero.
Zero working capital would call for a fine balancing act in financial management, and the
success in this endeavor would get reflected in healthier bottom lines.

OVERTRADING
Overtrading arises when a business expands beyond the level of funds available overtrade
means and attempt to finance a certain volume of production and sales with inadequate
working capital. If the company does not have enough funds of its own to finance stock and
debtors it is forced, if it wishes it expand to borrow from creditors and the bank on overdraft
sooner or later such expansion, financed completely by the funds of others, will lead to a
chronic imbalance in the working capital ratio. Expansion is advantageous so long as the
business has the funds available to finance the stocks and debtors involved. Overtrading
begins at the point where the business relies on extra trade credit and increased turnover are
financed by taking longer periods of credit from suppliers and/or negotiating an extension of
overdraft limits with the bank.
Over dependence on outside finance is a sign of weakness, unless the expansion is curtailed,
suppliers may refuse credit beyond certain limits, and the bank may call for a reduction of the
overdraft. If this happens, the business may be insolvent in that it does not have sufficient
liquid resources (Cash) to pay for current operations or to repay current liabilities until
customers pay for sales made on credit terms, or unless stock is sold at a loss for immediate
cash payment.

The following ratios will analysis the situation properly:


Working Capital = Current Assets : Current Liabilities
Acid Test = Quick Assets : Current Liabilities
Stock Turnover = Stock : Cost of Sales
Debtors Turnover = Debtors : Credit Purchases
The object of using these ratios is to detect a deterioration of the liquidity position of the
business end an increasing reliance upon trade creditors and overdraft facilities

OVERCAPITALISATION OF WORKING CAPITAL

If there are excessive stocks, debtors and cash and very few creditors, there will be an over
investment in current assets. The inefficiency in managing working capital will cause this
excessive working capital resulting in lower return on capital employed and long term funds
will be unnecessarily tied up when they could be invested as well to earn profit.

SYMPTOMS OF POOR WORKING CAPITAL MANAGEMENT


In general, the following causes are seen inefficient management of working capital:

Excessive carriage of inventory over the normal levels required for the business will
result in more balance in trade creditors accounts. More creditors balances will cause
strain on the management in management of cash.

Working capital problems will arise when there is a show down in collection of
debtors.

Sometimes capital gods will be purchased from the funds available for working
capital. This will result in storage of working capital and its impact is on operations of
the company.

Unplanned production schedules will cause excessive stocks of finished gods or


failure in meeting dispatch schedules. More funds kept in the form of cash will not
generate any profit for the business.

In efficiency in using potential trade credit require more funds for financing working
capital.

Overtrading will cause shortage of working capital and its ultimate effect is on the
operations of the company.

Dependence in short term sources of finance for financing permanent working capital
causes lesser profitability and will increase strain on the management in managing
working capital.

Inefficiency in cash management causes embezzlement of cash.

Inability to get working capital limits will cause serious concern to the company and
sometime may turn out to be sick.

UNDER CAPITALIZATION

Under capitalisation is a situation where a company does not have funds sufficient to run its
normal operations smoothly. This may happen due to insufficient working capital or diversion
of working capital funds to finance capital items. If the company faces the situation of
undercapitalisation, it will face difficulties in current obligations, procurement of raw
material in stores items; meeting day-to-day running expenses etc. its impact will ultimately
be the reduced turnover and reduced profitability. The finance manager should take
immediate and proper steps to overcome the situation of unde15r capitalization by making
arrangement for the sufficient working capital. For this purpose he should prepare the
realistic cash flow and funds flow statement of the company.

RESEARCH METHODOLOGY
The methodology, we have to adopt for our study are the various tools, which basically
analyse critically financial position of the organization:
COMMON-SIZE P/L A/C

COMMON-SIZE BALANCE SHEET


COMPARTIVE P/L A/C
COMPARTIVE BALANCE SHEET
TREND ANALYSIS
RATIO ANALYSIS
The above parameters are used for critical analysis of financial position. With the evaluation
of each component, the financial position from different angles is tried to be presented in well
and systematic manner. By critical analysis with the help of different tools, it becomes clear
how the financial manager handles the finance matters in profitable manner in the critical
challenging atmosphere, the recommendation are made which would suggest the organization
in formulation of a healthy and strong position financially with proper management system.
Through the evaluation of various percentage, ratios and comparative analysis, the
organization would be able to conquer its in efficiencies and makes the desired changes.

ANALYSIS OF FINANCIAL STATEMENTS

FINANCIAL STATEMENTS:

Financial statement is a collection of data organized according to logical and consistent


accounting procedure to convey an under-standing of some financial aspects of a business
firm. It may show position at a moment in time, as in the case of balance sheet or may reveal
a series of activities over a given period of time, as in the case of an income statement. Thus,
the term Financial Statements generally refers to the two statements.

(1) The Position Statement or Balance Sheet.


(2) The Income Statement or Profit and Loss Account.

OBJECTIVES OF FINANCIAL STATEMENTS:

According to Accounting Principal Board of America (APB) states,


The following objectives of financial statements:

To provide reliable financial information about economic resources and obligation of


a business firm.

To provide other needed information about charges in such economic resources and
obligation.

To provide reliable information about change in net resources (recourses less


obligations) missing out of business activities.

To provide financial information that assets in estimating the learning potential of the
business.

LIMITATIONS OF FINANCIAL STATEMENTS:

Though financial statements are relevant and useful for a concern, still they do not present a
final picture a final picture of a concern. The utility of these statements is dependent upon a

number of factors. The analysis and interpretation of these statements must be done carefully
otherwise misleading conclusion may be drawn.
Financial statements suffer from the following limitations:

Financial statements do not given a final picture of the concern. The data given in
these statements is only approximate. The actual value can only be determined when
the business is sold or liquidated.

Financial statements have been prepared for different accounting periods, generally
one year, during the life of a concern. The costs and incomes are apportioned to
different periods with a view to determine profits etc. The allocation of expenses and
income depends upon the personal judgment of the accountant. The existence of
contingent assets and liabilities also make the statements imprecise. So, financial
statements are at the most interim reports rather than the final picture of the firm.

The financial statements are expressed in monetary value, so they appear to give final
and accurate position. The value of fixed assets in the balance sheet neither represent
the value for which fixed assets can be sold nor the amount which will be required to
replace these assets. The balance sheet is prepared on the presumption of a going
concern. The concern is expected to continue in future. So, fixed assets are shown at
cost less accumulated depreciation. Moreover, there are certain assets in the balance
sheet which will realize nothing at the time of liquidation but they are shown in the
balance sheets.

The financial statements are prepared on the basis of historical costs or original costs.
The value of assets decreases with the passage of time current price changes are not
taken into account. The statement are not prepared with the keeping in view the

economic conditions. The balance sheet loses the significance of being an index of
current economic realities. Similarly, the profitability shown by the income statements
may be represents the earning capacity of the concern.

There are certain factors which have a bearing on the financial position and operating
result of the business but they do not become a part of these statements because they
cannot be measured in monetary terms. The basic limitation of the traditional financial
statements comprising the balance sheet, profit & loss A/c is that they do not give all the
information regarding the financial operation of the firm. Nevertheless, they provide
some extremely useful information to the extent the balance sheet mirrors the financial
position on a particular data in lines of the structure of assets, liabilities etc. and the
profit & loss A/c shows the result of operation during a certain period in terms revenue
obtained and cost incurred during the year.

DATA ANALYSIS AND INTERPRETATION

Current Assets
1. Current Ratio

---------------------Current Liabilities

Year
2009
2010
2011

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

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

Current Ratio
5.75
7.31
6.29

CURRENT RATIO

8
7
6
5

Current Ratio

4
3
2
1
0
2009

2010

2011

Interpretation:
As we know that ideal Current Ratio for any firm is 2:1. If we see the current ratio of the
company for last three years it has increased from 2009 to 2010 and decreased in 2011. The

current ratio of company is more than the ideal ratio. This depicts that companys liquidity
position is sound. Its Current Assets are more than its Current Liabilities.

Quick Assets
2. Quick Ratio

---------------------Current Liabilities

Year
2009
2010
2011

Quick Assets
136,616,734
103,210,166
129,547,271

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

Quick Ratio
1.98
1.77
1.64

QUICK RATIO

2
1.8
1.6
1.4
1.2
1
0.8
0.6
0.4
0.2
0

Quick Ratio

2009

2010

2011

Interpretation:
A Quick Ratio is an indication that the firm is liquid and has the ability to meet its current
liabilities in time. The ideal Quick Ratio is 1:1. Companys quick ratio is more than ideal
ratio in the year 2009 this shows company has no liquidity problem. But it decreased from the
year 2010.

Absolute Liquid Assets


3. Absolute Liquid Ratio

----------------------------Current Liabilities

Year
2009
2010
2011

Absolute Liquid Assets


94,827,967
78,120,345
91,876,142

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

Absolute Liquid Ratio


1.371
1.340
1.161

ABSOLUTE LIQUID RATIO

1.4
1.35
1.3
1.25

Absolute Liquid Ratio

1.2
1.15
1.1
1.05
2009

2010

2011

Interpretation:
These ratio shows that company carries a small amount of cash. But there is nothing to be
worried about the lack of cash because company has reserve, borrowing power & long term
investment. In India, firms have credit limits sanctioned from banks and can easily draw cash.
Here absolute liquid ratio is decreased constantly from the year 2009.

Cost of goods sold


4. Inventory Turnover Ratio

----------------------Average Stock

Year
2009
2010
2011

Cost of goods sold


137,188,885
374,073,409
311,040,021

Average Stock
27,710,405
59,373,439
57,817,825

Inventory Turnover Ratio


4.951
6.300
5.380

INVENTORY TURNOVER RATIO

7
6
5
4

Inventory Turnover Ratio

3
2
1
0
2009

2010

2011

Interpretation:
This ratio shows how rapidly the inventory is turning into receivable through sales. In 2010
the company has high inventory turnover ratio but in 2011 it has reduced. This shows that the
companys inventory management technique is less efficient as compare to last year.

No of working days
5. Inventory Conversion Period

------------------------------Inventory Turnover Ratio

Year

No of working days

Inventory Turnover Ratio

Inventory

2009
2010
2011

365
365
365

4.951
6.300
5.380

period
73.725
57.933
67.848

conversion

INVENTORY CONVERSION PERIOD

80
70
60
50

Inventory Conversion Period

40
30
20
10
0
2009

2010

2011

Interpretation:
Inventory conversion period shows that how many days inventories take to convert from raw
material to finished goods. In the company inventory conversion period is very good. This
shows the efficiency of management to convert the inventory into cash.

Sales
6. Debtors Turnover Ratio =

-------------Debtors

Year
2009
2010
2011

Sales
313,423,033
356,411,987
418,943,765

Debtors
7,279,286
6,832,776
5,799,362

Debtors Turnover Ratio


43.057
52.162
72.240

DEBTORS TURNOVER RATIO

80
70
60
50

Debtors Turnover Ratio

40
30
20
10
0
2009

2010

2011

Interpretation:
This ratio indicates the speed with which debtors are being converted or turnover into sales.
The higher the values the higher is the turnover into sales. The higher the values of debtors
turnover, the more efficient is the management of credit. In the company the debtor turnover
ratio is increasing year to year. This shows that company is utilizing its debtors efficiently.
Now their credit policy becomes liberal as compare to previous year.

No of working days
7. Average Collection Period

----------------------------Debtors Turnover Ratio

Year

No of working days

Debtors

2009
2010
2011

365
365
365

Ratio
43.057
52.162
72.240

Turnover Average

collection

period
8 days
7 days
5 days

AVERAGE COLLECTION PERIOD

8
7
6
5

Average Collection Period

4
3
2
1
0
2009

2010

2011

Interpretation:
The Average Collection Period measures the quality of debtors and it helps in analyzing the
efficiency of collection efforts. It also helps to analysis the credit policy adopted by company.
In the firm average collection period is increasing year to year. It shows that the firm has
Liberal Credit policy. These changes in policy are due to competitors credit policy.

Cost of goods sold


8. Working Capital Turnover Ratio=

-----------------------Net working capital

Year

Cost of goods sold

Net working capital

Working

2009
2010
2011

137,188,885
374,073,409
311,040,021

259,374,353
251,908,564
269,316,787

Turnover Ratio
1.199
1.485
1.372

Capital

WORKING CAPITAL TURNOVER RATIO

1.6
1.4
1.2
1

Working Capital Turnover Ratio

0.8
0.6
0.4
0.2
0
2009

2010

2011

Interpretation:
This ratio indicates low much net working capital requires for sales. This ratio is fluctuating
throughout from year to year. This ratio is helpful to forecast the working capital requirement
on the basis of sale and cost of goods sold.

Conclusion

Working Capital is the lifeline of every industry, irrespective of whether its a manufacturing
industry, services industry. Working Capital is the prime and most important requirement for
carrying out the day to day operations of the business. Working Capital gives the muchneeded liquidity to the business. Working Capital Finance reduces the overall fund
requirement, required to build up the Current Assets, which in turn help you improve your
Turnover Ratio. We have discussed in this project, various ways in which Working Capital
requirements can be financed. There are different instruments and facilities available, which
can be used cost effectively in a given situation, by different businesses. For this, one should
have sound knowledge of these instruments and facilities.

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