Sources of working capital finance essay

INTRODUCTION TO WORKING CAPITAL

Working Capital is life blood and nerve centre of a business. Just as circulation of blood is essential for the survival of the human being similarly working capital is necessary for the survival of every business organization, whether it is a small organization or a big organization. Every business needs funds for two purposes-for the 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 & fixtures etc. Investments in these assets the present that part of the firm's capital, which is blocked on a permanent or fixed basis and is called fixed capital. Funds are also needed for short term purposes as for the purchase of raw material, payment of wages & other day to day expenses etc. these funds are known as working capital.

MEANING OF 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, and inventories or in other words the working capital is the excess of current assets over current liabilities.

CLASSIFICATON OR KINDS OF WORKING CAPITAL

Working capital may be classified in two ways: 1. On the basis of concept 2. On the basis of time

On The Basis Of Concept

On the basis of concept, working capital is classified as gross working capital and net working capital. This classification is important from the point of view of the financial manager. Gross working capital: - This is a wider term in a relation to the working capital. It includes all current assets. Thus the gross working capital is the capital invested in total current assets of the company. Examples of current assets are: Cash in hand and Bank Bill Receivables Sundry Debtors Short Term Loan & Advances Inventory of Stock Prepaid expenses

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NET WORKING CAPITAL

Net working capital is the difference between the current assets and the current liabilities. Therefore it is called net working capital. When current assets exceed current liabilities then the working capital is positive otherwise negative. Examples of current liabilities. Bill Payable Sundry creditors Outstanding expenses

Short term loans Dividend payable Bank overdraft 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 working capital is the minimum amount which is required and ensures effective utilization of fixed facilities and or maintaining the circulation of current assets. There is always a minimum level of current assets which is continuously required by the enterprise to carry out its normal business operations. For example, work-in-progress, finished goods and cash balance. This minimum level of current assets is called permanent working capital as this part of the capital is permanently blocked in current assets. As the business grows, the requirements of permanent working capital also increase due to the increase in current assets. TEMPORARY OR VARIABLE WORKING CAPIAL: Temporary working capital is the amount of working capital which is required to meet the seasonal demands and some special exigencies. Variable working capital can be further classified as seasonal working capital and special working capital. Most of the enterprises have to provide additional working capital to meet the seasonal and social needs. The capital required to meet the seasonal needs of the enterprise is called seasonal working capital. Special working capital is that part of working capital which is required to meet exigencies such as launching of extensive marketing campaign for conducting research, etc

FACTORS DETERMINING THE WORKING CAPITAL

The working capital requirement of the concern depends upon a large numbers of factors such as nature and the size of business, the character of their operations, the length of production cycles, the rate of stock turnover and the state of economic situation. It is not possible to rank them because all such factors are of different importance and influence of individual factor changes for a firm overtime. However, the following are important factors generally influencing the working capital requirements. Nature and character of business. Size of business\scale of operation. Production policy. Manufacturing process\length of production cycle. Seasonal variation. Working capital cycle. Rate of stock turnover. Credit policy Business cycle. ? Rate of growth of business. ? Earning capacity and dividend policy.

? Price level changes. ? Other factors.

IMPOTANCE OF ADEQUATE WORKING CAPITAL

Working Capital is the blood and the nerve centre of business. Just as the blood circulation is essential in the human bodies for maintaining life, working capital is very important to maintain the running of business. No business can run successfully without an adequate amount of working capital. The advantages are as follows: Solvency of the business. Adequate working capital helps in maintaining solvency of the business by providing uninterrupted flow of production. Goodwill. Sufficient working capital enables a business concern to make prompt payments. Easy loan. A concern having adequate working capital high solvency and good credit standing can arrange loans from banks and others on easy terms. Cash discounts. Adequate working capital also enables a concern to avail cash discounts on the purchase and hence it reduces costs. Regular payments of salaries, wages and other day to day commitments. A company which has adequate working capital can make regular payments of salaries, wages and other day to day commitments with raises the morale of its employees, increases their efficiency, reduces wastages and enhances production and profits. Exploitation of favorable market conditions. Only concerns with adequate working capital can exploit favorable market conditions such as purchasing its requirement in bulk when the prices are lower and holding its inventory for higher prices. Ability to face crises. Adequate working capital enables the concern face business crises in emergencies such as depression because during such periods, generally, there is much pressure on working capital

THE NEED OF WORKING CAPITAL

The need for working capital cannot be over emphasized. Every business needs some amount of working capital. The need for working capital arises due to the time gap between the productions and realized 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 purchase of raw materials, components and spares. To pay wages and salaries. To incur day-to-day expenses and overhead costs such as fuel, power and office expenses etc. To meet the selling costs as packing, advertising, etc. To maintain the inventories of raw material, work-in-progress, stores and spares and finish stock. To provide credit facilities to the customers.

DETERMINANTS OF WORKING CAPITAL Nature of business:

The working capital requirement of the firm is closely related to the nature of its business. A service firm, like an electricity undertaking or a transport corporation, which has a short operating cycle and which sells predominantly on cash basis, has a modest working capital requirement. On the other hand, a manufacturing concern like a machine tools unit, which has a long operating cycle and which sells largely on credit, has a very substantial working capital requirement.

Seasonality of operations:
Firms, which have marked seasonality in their operations usually, have highly fluctuating working capital requirements. If the operations are smooth and even through out the year the working capital requirement will be constant and will not be affected by the seasonal factors.

Production policy:
A firm marked by pronounced seasonal fluctuations in its sales may pursue a production policy, which may reduce the sharp variations in working capital requirements.

Market conditions:
The market competitiveness has an important bearing on the working capital needs of a firm. When the competition is keen, a large inventory of finished goods is required to promptly serve customers who may not be inclined to wait because other manufactures are ready to meet their needs. In view of competitive conditions prevailing in the market the firm may have to offer liberal credit terms to the customers resulting in higher debtors. Thus, the working capital requirements tend to be high because of greater investment in finished goods inventory and account receivables. On the other hand, a monopolistic firm may not require larger working capital. It may ask customer to pay in advance or to wait for some time after placing the order.

Conditions of Supply:
The time taken by a supplier of raw materials, goods, etc. after placing an order, also determines the working capital requirement. If goods as soon as or in a short period after placing an order, then the purchaser will not like to maintain a high level of inventory f that good. Otherwise, larger inventories should be kept e.g. in case of imported goods.

Business Cycle Fluctuations:

Different phases of business cycle i.e., boom, recession, recovery etc. also effect the working capital requirement. In case of recession period there is usually dullness in business activities and there will be an opposite effect on the level of wor5king capital requirement. There will be a fall in inventories and cash requirement etc.

Credit policy:
The credit policy means the totality of terms and conditions on which goods are sold and purchased. A firm has to interact with two types of credit policies at a time. One, the credit policy of the supplier of raw materials, goods, etc., and two, the credit policy relating to credit which it extends to its customers. In both the cases, however, the firm while deciding the credit policy has to take care of the credit policy o the market. For example, a firm might be purchasing goods and

services on credit terms but selling goods only for cash. The working capital requirement of this firm will be lower than that of a firm, which is purchasing cash but has to sell on credit basis.

Operating Cycle:
Time taken from the stage when cash is put into the business up to the stage when cash is realized. Thus, the working capital requirement of a firm is determined by a host of factors. Every consideration is to be weighted relatively to determine the working capital requirement. Further, the determination of working capital requirement is not once a whole exercise; rather a continuous review must be made in order to assess the working capital requirement in the changing situation. There are various reasons, which may require the review of the working capital requirement e.g., change in credit policy, change in sales volume, etc.

ISSUES IN WORKING CAPITAL MANAGEMENT

Working capital management refers to the administration of all components of working capital cash, marketable securities, debtors (receivables), and stock (inventories) and creditors (payables). The financial manager must determine levels and composition of current assets. He must see that right sources are tapped to finance current assets, and that current liabilities are paid in time. There are many aspects of working capital management which make it an important function of the financial manager. Time. Working capital management requires much of the financial manager's time. Investment. Working capital represents a large portion of the total investment in assets. Actions should be taken to curtail unnecessary investment in current assets. Criticality. Working capital management has great significance for all firms but it is very critical for small firms. Small firms in India face a severe problem of collecting their dues debtors. Further, the role of current liabilities is more significant in case of small firms, as, unlike large firms, they face difficulties in raising long-term finances. Growth. The need for working capital is directly related to the firm's growth. As sales grow, the firm needs to invest more in inventories and debtors. Continuous growth in sales may also require additional investment in fixed assets.

Liquidity vs. Profitability: Risk-Return Trade-off

A large investment in current assets under certainty would mean a low rate of return on investment for the firm, as excess investment in current assets will not earn enough return. A smaller investment in current assets, on the other hand, would mea interrupted production and sales, because of frequent stock-outs and inability to pay creditors in time due to restrictive policy. Given a firm's technology and production policy, sales and demand conditions, operating efficiency etc., its current assets holdings will depend upon its working capital policy. These policies involve risk-return trade-offs. A conservative policy means lower return and risk, while an aggressive policy produces higher return and risk. The two important aims of the working capital management are: profitability and solvency. Solvency, used in the technical sense, refers to the firm's continuous ability to meet maturing obligations. If the fir maintains a relatively large investment in current assets, it will have no

difficulty in paying claims of creditors when they become due and will be able to fill all sales orders and ensure smooth production. Thus, a liquid firm has less risk of insolvency; that is, it will hardly experience a cash shortage or a stock-out situation. However, there is a cost associated with maintaining a sound liquidity position. A considerable amount of the firm's will be tied up in current assets, and to the extent this investment is idle, the firm's profitability will suffer. To have higher profitability, the firm may sacrifice solvency and maintain a relatively low level of current assets. When the firm does so, its profitability will improve as fewer funds are tied up in idle current assets, but its solvency would be threatened and would be exposed to greater risk of cash shortage and stock-outs.

ESTIMATING WORKIN CAPITAL NEEDS

Current Assets Holding Period. To estimate working capital requirement on the basis of average holding period of current assets and relating them to costs based on the company's experience in the previous years. This method is essentially based on the operating cycle concept. Ratio of Sales. To estimate working capital requirements as a ratio of sales on the assumption that current change with sales Ratio of Fixed Investment. To estimate working capital requirements as a percentage of fixed investment.

POLICIES FOR FINANCING FIXED ASSETS

A firm can adopt different financing policies vis--vis current assets. Three types of financing may be distinguished: Long-term Financing. The sources of long-term financing include ordinary share capital, preference share capital, debentures, long-term borrowings from financial institutions and reserves and surplus (retained earnings). Short-Term Financing. The short-term financing is obtained for a period less than one year. It is arranged in advance from banks and other surplus of short-term finance in the money market. It includes working capital funds from banks, public deposits, commercial paper, factoring of receivables etc Spontaneous Financing. It refers to the automatic sources of short-term funds arising in the normal course of a business. Trade (supplier's) credit and outstanding expenses are examples of spontaneous financing. The real choice of financing current assets, once the spontaneous sources of financing have been fully utilized, is between the long-term and short-term sources of finance. Depending on the mix of short-term and long-term financing, the approach followed by a company may be refereed to as: Matching approach Conservative approach Aggressive approach

Matching Approach
The firm following matching approach (also known as hedging approach) adopts a financial plan which matches the expected life of the sources of funds raised to finance assets. For e.g., a tenyear loan may be raised to finance a plant with an expected life of ten years. The justification for the exact matching is that, since the purpose of financing is to pay for the assets, the source of

financing for short-term assets is expensive, as funds will not be utilized for the full period. Similarly, financing the long-term assets with short-term financing is costly as well as inconvenient as arrangement for the new short-term financing will have to be made on a continuing basis. The above figure illustrated the matching approach over time. The firm's fixed assets and permanent current assets are financed with long-term funds and as the level of these assets increases, the long-term financing level also increases. The temporary or variable current assets are financed with short-term funds and as their level increases, the level of short-term financing also increases.

Conservative approach
Under a conservative plan, the firm finances its permanent assets and also a part of temporary currents assets with long-term financing. In the periods when the firm has no need for temporary current assets, the idle long-term funds can be invested in the tradable securities to conserve liquidity. The conservative plan relies heavily on long-term financing and, therefore, the firm has less risk of facing the problem of shortage of funds. The above figure illustrates conservative approach over time. It can be seen that when the firm has no temporary current assets [e.g., at (a) and (b)], the long-term funds released can be invested in marketable securities to build up the liquidity position of the firm.

Aggressive approach
An aggressive approach policy is said to be followed by the firm when it uses more short-term financing than warranted by the matching plan. The firm finances a part of its permanent current assets with short term financing. The relatively more use of short-term financing makes the firm more risky. Sources of working capital in India: Sources of fixed/regular or long term working capital For any business some part of the working capital is such which is constantly required. It is known as regular or fixed working capital. Following are the sources of the availability of such kind of working capital: Issue of shares : In India for the long term periods it is a main source of procuring working capital. Re-investment of profits: It is the cheapest and most convenient means of procuring finance .under this means company is not required to bear compulsory burden of interest payment. Long term loans: The company could receive the long term loans only when the income earning capacity of the company is good enough. Issue of debentures: In the modern era debentures are considered to be an important source of procuring the finance .Interest rate has to be paid on debentures and the is refunded after a specific period. Sources of seasonal/short term or specific working capital: Commercial banks: The commercial banks, for providing working capital to the industries , mostly grant the financial help.The commercial banks also contribute to the working capital by purchasing shares and debentures.

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2. Public deposits: In our country ,a major portion of the working capital is procured through public deposits. under this system common masses deposit their money for a specific period on a certain rate of interest. 3. Government help : For encouraging the industries, government provides some financial help, eg. Grants, exemption in taxes, subsidies, etc. 4. Loans from financial institution : the need of working capital could also be met by taking loans from various investment companies, insurance companies, trusts etc. 5. Short term usual commercial means : Their main examples are getting the bills receivable discounted , seeking loans on the basis of various credit instrument , seeking advances from customers.

COMPANY PROFILE Ranbaxy Introduction

19 Nehru Place New Delhi 110 019 India Telephone:+91 11 2645 2666 Fax:+91 11 2600 2091 Web site: http://www.ranbaxy.com Public Company Incorporated:1962 Employees:6,797 Sales:$1.18 billion (2004) Stock Exchanges:India Ticker Symbol:500359.BO NAIC:325412 Pharmaceutical Preparation Manufacturing; 325411 Medicinal and Botanical Manufacturing; 325620 Toilet Preparation Manufacturing Ranbaxy Laboratories Ltd. is the largest pharmaceutical company in India, and one of the world's top 100 pharmaceutical companies. Long a specialist in the preparation of generic drugs, Ranbaxy is also one of the world's top 10 in that pharmaceutical category as well. Yet, with India's agreement to apply international patent law at the beginning of 2005, Ranbaxy has begun converting itself into a full-fledged research-based pharmaceutical company. A major part of this effort has been the establishment of the company's own research and development center, which has enabled the company to begin to enter the new chemical entities (NCE) and novel drug delivery systems (NDDS) markets. In the mid-2000s, the company had a number of NCEs in progress, and had already launched its first NDDS product, a single daily dosage formulation of ciprofloxacin. Ranbaxy is a truly global operation, producing its pharmaceutical preparations in manufacturing facilities in seven countries, supported by sales and marketing subsidiaries in 44 countries, reaching more than 100 countries throughout the world. The United States, which alone accounts for nearly half of all pharmaceutical sales in the world, is the company's largest international market, representing more than 40 percent of group sales. In Europe, the

company's purchase of RPG (Aventis) S.A. makes it the largest generics producer in that market. The company is also a leading generics producer in the United Kingdom and Germany and elsewhere in Europe. European sales added 16 percent to the company's sales in 2004. Ranbaxy's other major markets include Brazil, Russia, and China, as well as India, which together added 26 percent to the group's sales. Ranbaxy posted revenues of $1.18 billion in 2004. The company, which remains controlled and led by the founding Singh family, is listed on the National Stock Exchange of India in Mumbai.

Idea Cellular Ltd

IDEA Cellular is a publicly listed company, having listed on the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE) in March 2007. IDEA Cellular is a leading GSM mobile service operator with pan India licenses. With a customer base of over 47 million in 18 service areas, operations are soon expected to start in Kolkata & West Bengal, North East & Assam. A brand known for many firsts, IDEA was the first to launch GPRS and EDGE in India. IDEA has partnered with Research in Motion (RIM) to offer Blackberry services on its network. IDEA 'NetSetter'- Plug & Play, EDGE enabled USB Data Card offers affordable data connectivity with faster speed and consistency. IDEA offers seamless coverage to roaming customers traveling to any part of the country, as well as to international traveling customers across over 200 countries. IDEA Cellular has partnership with over 400 operators worldwide to ensure that customers are always connected while on the move, across the globe. IDEA has received several national and international recognitions for its path-breaking innovations in mobile telephony products & services. It won the GSM Association Award for "Best Billing and Customer Care Solution" for 2 consecutive years. It was awarded "Mobile Operator of the Year Award - India" for 2007 and 2008 at the Annual Asian Mobile News Awards. IDEA Cellular is part of the Aditya Birla Group, India's first truly multinational corporation. The group operates in 25 countries, and is anchored by over 1,25,000 employees belonging to 25 nationalities. The Group has been adjudged 'The Best Employer in India and among the Top 20 in Asia' by the Hewitt-Economic Times and Wall Street Journal Study 2007.

Videocon Industries Ltd.

Videocon Industries Ltd. 14 Kms Stone, Paithan Road, Chitegaon, Aurangabad India www.videoconworld.com No. employees:8,500 Turnover:2,775.92 (US$m) Financial year end:September Company Overview

Videocon Industries Ltd. (Videocon) is a part of Videocon group, principally engaged in the production of electronic products. The company is also engaged in the exploration of oil and gas. The product and service portfolio of Videocon includes televisions, DVD players, multimedia speakers, washing machines, refrigerators, microwave ovens, and air conditioners; end-to-end management of business-critical services, systems and equipment; glass products for televisions, panels and funnels; and Oil and Gas services. Its plants are located in Bharuch, Imarat Kancha, Kolkata, Hosur, Bangalore and Aurangabad in India. Videocon operates across China, France, Poland, Bangladesh, India, Italy, Oman, Russia, and U.A.E. The company is headquartered at Aurangabad, India. The company reported revenues of (Rupee) INR 119,808.58 million during the fiscal year ended September 2008, a decrease of 5.37% from 2007. The operating profit of the company was INR 14,403.34 million during the fiscal year 2008, an increase of 55.69% over 2007. The net profit of the company was INR 10,989.31 million during the fiscal year 2008, an increase of 57.20% over 2007. The following are the various sources of funds used by Ranbaxy :

OWNER'S FUNDS
A. EQUITY SHARE CAPITAL: Equity shares, also known as ordinary shares or common shares, represent the owners' capital in a company. The holders of these shares are the real owners of the company. Equity capital is paid after meeting all other claims including that of preference shareholders. It can be seen from the balance sheet that the equity share capital of the company was 185.89 (Rs crores) in year 2004 and it increased to 210.19 (Rs crore) in year 2008. B. RESERVES AND SURPLUS: Reserves and surplus of a company are the retained earnings which are ploughed back in the company. It is a technique of financial management under which all profits of a company are not distributed amongst the shareholders as dividend, but a part of the profits is retained or re-invested in the company. It can be seen from the balance sheet, the reseves & surplus of the company were 2,320.79 (Rs crores) and it increased to 3,330.92 (Rs crores).

LOAN FUNDS:
A. SECURED LOANS: The loans which are paid by the banks against some security are termed as secured loans. As we analyse the balance sheet of the company, we can observe that the secured loans of the company were 133.37 (Rs. In crores) in year 2004 and it decreased significantly to the two next years, as it was 224.29 (Rs. In crores) in year 2006 and then it again showed a significant increased to 365.07 (Rs crores) in the year 2007 and in the last year i.e 2008, it again decreased to 162.07(Rs crores) . B. UNSECURED LOANS: The loans which are paid by the banks without any security are termed as unsecured loans. As, we can analyze from the balance sheet that the unsecured loans of the company have increased in the past years. These were 2.49 (Rs crores) in year 2004 and increased to 3,563.30 (Rs crores) in year 2008.

OWNER'S FUNDS:

A. EQUITY SHARE CAPITAL: The equity share capital of the company, as can be seen from the balance sheet is decreasing from 2,742.53 (Rs crores) in the year 2004 to 2,635.36 (Rs crores) in the year 2008. B. RESERVES & SURPLUS: It can be seen from the balance sheet, the reseves & surplus of the company were -1,719.90 (Rs crores) and it increased to 906.91 (Rs crores).

LOAN FUNDS:
A. SECURED LOANS: . As we analyse the balance sheet of the company, we can observe that the secured loans of the company were 1,506.41 (Rs crores) in year 2004 and it decreased significantly to the two next years, as it was 1,470.75 (Rs crores) in year 2006 and then it again showed a significant increased to 5,454.43 (Rs crores) in the year 2008. B. UNSECURED LOANS: As, we can analyze from the balance sheet that the unsecured loans of the company have increased in the past years. These were 757.13 (Rs crores) in year 2004 and increased to 1,060.33 (Rs crores) in year 2008.

OWNER'S FUNDS:
A. EQUITY SHARE CAPITAL: The equity share capital of the company, as can be seen from the balance sheet is increasing from 32.89 (Rs crores) in the year 2004 to 229.30 (Rs crores) in the year 2008. B. RESERVES & SURPLUS: It can be seen from the balance sheet, the reserves & surplus of the company were -41.21 (Rs crores) and it increased to 6,538.49 (Rs crores).

LOAN FUNDS:
A. SECURED LOANS: . We can observe that the secured loans of the company were nil in the year 2004 and it increased to 4,401.25 (Rs crores) in the year 2008. B. UNSECURED LOANS: As, we can analyze from the balance sheet that the unsecured loans of the company have increased in the past years. These were 90.07 (Rs crores) in year 2004 and increased to 3,604.34 (Rs crores) in year 2008.

REFERENCES
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www.ranbaxy.com/operations/operationcountry.aspx www.videoconworld.com www.ideacellular.com www.money.rediff.com/companies/ranbaxy...ltd/.../balance-sheet www.money.rediff.com/companies/ideacellular...ltd/.../balance-sheet www.money.rediff.com/companies/videocon...ltd/.../balance-sheet

READINGS:
Pandey I.M., Financial Management; Vikas Publishing House Pvt. Ltd. Chandra Prasanna; Financial Management: Theory and Practice; Tata Mc Graw Hill.