WORKING CAPITAL

WORKING CAPITAL - Meaning of Working Capital Capital required for a business can
be classified under two main categories via, 1) 2) Fixed Capital Working Capita
l Every business needs funds for two purposes For its establishment To carry out
its day- to-day operations Long terms funds are required to create production f
acilities through purchase of fixed assets such as P&M, land, building, furnitur
e, 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 al
so needed for short-term purposes for the purchase of raw material, payment of w
ages 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 whi
ch is required for financing short- term or current assets such as cash, marketa
ble securities, debtors & inventories. Funds, thus, invested in current assts ke
ep revolving fast and are being constantly converted in to cash and this cash fl
ows out again in exchange for other current assets. Hence, it is also known as r
evolving or circulating capital or short term capital. CONCEPT OF WORKING CAPITA
L There are two concepts of working capital: 1. 2. Gross working capital Net wor
king capital
The gross working capital is the capital invested in the total current assets of
the enterprise. Current assets are those Assets which can convert in to cash wi
thin a short period normally one accounting year.
CONSTITUENTS OF CURRENT ASSETS 1) 2) 3) 4) 5) Cash in hand and cash at bank Bill
s receivables Sundry debtors
Short term loans and advances.
Inventories of stock as: a. b. c. d.
Raw material
Work in process Stores and spares Finished goods
6. Temporary investment of surplus funds. 7. Prepaid expenses 8. Accrued incomes
. 9. Marketable securities. In a narrow sense, the term working capital refers t
o the net working. Net working capital is the excess of current assets over curr
ent liability, or, say: NET WORKING CAPITAL = CURRENT ASSETS – CURRENT IABILITIE
S. Net working capital can be positive or negative. When the current assets exce
eds the current liabilities are more than the current assets. Current liabilitie
s 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 curre
nt assts or the income business.
CONSTITUENTS OF CURRENT LIABILITIES 1. 2. 3. 4. 5. 6. 7. Accrued or outstanding
expenses.
Short term loans, advances and deposits.
Dividends payable. Bank overdraft. Provision for taxation, if it does not amount
to approximate of profit. Bills payable. 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 concep
ts have their own merits. The gross concept is sometimes preferred to the concep
t 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 i
s more interested in total current assets with which it has to operate then the
source from where it is made available. 3. It take into consideration of the fac
t every increase in the funds of the enterprise would increase its working capit
al. 4. This concept is also useful in determining the rate of return on investme
nts in working capital. The net working capital concept, however, is also import
ant for following reasons: It’s a qualitative concept, which indicates the firm’
s ability to meet to its operating expenses and short-term liabilities. IT indic
ates the margin of protection available to the short term creditors. It is an in
dicator of the financial soundness of enterprises. It suggests the need of finan
cing a part of working capital requirement out of the permanent sources of funds
.
CLASSIFICATION OF WORKING CAPITAL
Working capital may be classified in two ways:
O O On the basis of concept. On the basis of time.
On the basis of concept working capital can be classified as gross working capit
al and net working capital. On the basis of time, working capital may be classif
ied 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 an
d for maintaining the circulation of current assets. Every firm has to maintain
a minimum level of raw material, work- inprocess, finished goods and cash balanc
e. This minimum level of current assets is called permanent or fixed working cap
ital as this part of working is permanently blocked in current assets. As the bu
siness grow the requirements of working capital also increases due to increase i
n current assets.
TEMPORARY OR VARIABLE WORKING CAPITAL Temporary or variable working capital is t
he amount of working capital which is required to meet the seasonal demands and
some special exigencies. Variable working capital can further be classified as s
easonal working capital and special working capital. The capital required to mee
t the seasonal need of the enterprise is called seasonal working capital. Specia
l working capital is that part of working capital which is required to meet spec
ial exigencies such as launching of extensive marketing for conducting research,
etc. Temporary working capital differs from permanent working capital in the se
nse that is required for short periods and cannot be permanently employed gainfu
lly in the business.
IMPORTANCE OR ADVANTAGE OF ADEQUATE WORKING CAPITAL SOLVENCY OF THE BUSINESS: Ad
equate working capital helps in maintaining the solvency of the business by prov
iding uninterrupted of production. Goodwill: Sufficient amount of working capita
l enables a firm to make prompt payments and makes and maintain the goodwill. Ea
sy loans: Adequate working capital leads to high solvency and credit standing ca
n 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 wo
rking capital ensures regular supply of raw material and continuous production.
Regular Payment of Salaries, Wages and Other Day TO Day Commitments: It leads to
the satisfaction of the employees and raises the morale of its employees, incre
ases their efficiency, reduces wastage and costs and enhances production and pro
fits. Exploitation Of Favorable Market Conditions: If a firm is having adequate
working capital then it can exploit the favorable market conditions such as purc
hasing its requirements in bulk when the prices are lower and holdings its inven
tories for higher prices. Ability to Face Crises: A concern can face the situati
on during the depression. Quick And Regular Return On Investments: Sufficient wo
rking capital enables a concern to pay quick and regular of dividends to its inv
estors and gains confidence of the investors and can raise more funds in future.
High Morale: Adequate working capital brings an environment of securities, conf
idence, high morale which results in overall efficiency in a business. EXCESS OR
INADEQUATE WORKING CAPITAL Every business concern should have adequate amount o
f working capital to run its business operations. It should have neither redunda
nt or excess working capital nor inadequate nor shortages of working capital. Bo
th excess as well as short working
capital positions are bad for any business. However, it is the inadequate workin
g capital which is more dangerous from the point of view of the firm.
DISADVANTAGES OF REDUNDANT OR EXCESSIVE WORKING CAPITAL 1. Excessive working cap
ital means ideal funds which earn no profit for the firm and business cannot ear
n the required rate of return on its investments. 2. Redundant working capital l
eads to unnecessary purchasing and accumulation of inventories. 3. Excessive wor
king capital implies excessive debtors and defective credit policy which causes
higher incidence of bad debts. 4. It may reduce the overall efficiency of the bu
siness.
5. If a firm is having excessive working capital then the relations with banks a
nd other financial institution may not be maintained. 6. 7. Due to lower rate of
return n investments, the values of shares may also fall. The redundant working
capital gives rise to speculative transactions
DISADVANTAGES OF INADEQUATE WORKING CAPITAL Every business needs some amounts of
working capital. The need for working capital arises due to the time gap betwee
n production and realization of cash from sales. There is an operating cycle inv
olved in sales and realization of cash. There are time gaps in purchase of raw m
aterial and production; production and sales; and realization of cash. Thus work
ing 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. To meet the selling cos
ts as packing, advertising, etc. To provide credit facilities to the customer To
maintain the inventories of the raw material, work-in-progress, stores and spar
es and finished stock.
For studying the need of working capital in a business, one has to study the bus
iness 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 expe
nses are called preliminary expenses and are capitalized. The amount needed for
working capital depends upon the size of the company and ambitions of its promot
ers. Greater the size of the business unit, generally larger will be the require
ments of the working capital. The requirement of the working capital goes on inc
reasing with the growth and expensing of the business till it gains maturity. At
maturity the amount of working capital required is called normal working capita
l. There are others factors also influence the need of working capital in a busi
ness. FACTORS DETERMINING THE WORKING CAPITAL REQUIREMENTS 1. NATURE OF BUSINESS
: The requirements of working is very limited in public utility undertakings suc
h as electricity, water supply and railways because they offer cash sale only an
d supply services not products, and no funds are tied up in inventories and rece
ivables. On the other hand the trading and financial firms requires less investm
ent in fixed assets but have to invest large amt. of working capital along with
fixed investments. 2. SIZE OF THE BUSINESS: Greater the size of the business, gr
eater is the requirement of working capital. 3. PRODUCTION POLICY: If the policy
is to keep production steady by accumulating inventories it will require higher
working capital. 4. LENTH OF PRDUCTION CYCLE: The longer the manufacturing time
the raw material and other supplies have to be carried for a longer in the proc
ess with progressive increment of labor and service costs before the final produ
ct is obtained. So working capital is directly proportional to the length of the
manufacturing process. 5. SEASONALS VARIATIONS: Generally, during the busy seas
on, a firm requires larger working capital than in slack season. 6. WORKING CAPI
TAL CYCLE: The speed with which the working cycle completes one cycle determines
the requirements of working capital. Longer the cycle larger is the requirement
of working capital.
DEBTORS
CASH
FINISHED GOODS
RAW MATERIAL
WORK IN PROGRESS
7. RATE OF STOCK TURNOVER: There is an inverse co-relationship between the quest
ion of working capital and the velocity or speed with which the sales are affect
ed. A firm having a high rate of stock turnover wuill needs lower amt. of workin
g capital as compared to a firm having a low rate of turnover. 8. CREDIT POLICY:
A concern that purchases its requirements on credit and sales its product / ser
vices on cash requires lesser amt. of working capital and vice-versa. 9. BUSINES
S CYCLE: In period of boom, when the business is prosperous, there is need for l
arger amt. of working capital due to rise in sales, rise in prices, optimistic e
xpansion of business, etc. On the contrary in time of depression, the business c
ontracts, sales decline, difficulties are faced in collection from debtor and th
e firm may have a large amt. of working capital. 10. RATE OF GROWTH OF BUSINESS:
In faster growing concern, we shall require large amt. of working capital. 11.
EARNING CAPACITY AND DIVIDEND POLICY: Some firms have more earning capacity than
other due to quality of their products, monopoly conditions, etc. Such firms ma
y generate cash profits from operations and contribute to their working capital.
The dividend policy also affects the requirement of working capital. A firm mai
ntaining a steady high rate of cash dividend irrespective of its profits, needs
working capital than the firm that retains larger part of its profits and does n
ot pay so high rate of cash dividend. 12. PRICE LEVEL CHANGES: Changes in the pr
ice level also affect the working capital requirements. Generally rise in prices
leads to increase in working capital.
Others FACTORS: These are: • • • • • • • Operating efficiency Management ability
Irregularities of supply Import policy Asset structure Importance of labor Bank
ing facilities, etc
MANAGEMENT OF WORKING CAPITAL Management of working capital is concerned with th
e problem that arises in attempting to manage the current assets, current liabil
ities. The basic goal of working capital management is to manage the current ass
ets 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 bot
h the situations are bad for any firm. There should be no shortage of 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 org
anization. So working capital management is three dimensional in nature as 1. It
concerned with the formulation of policies with regard to profitability, liquid
ity and risk. 2. It is concerned with the decision about the composition and lev
el 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 c
apital is the life blood and the centre of a business. Adequate amount of workin
g 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 tim
e. The liquidity position of the firm is totally effected by the management of w
orking capital. So, a study of changes in the uses and sources of working capita
l is necessary to evaluate the efficiency with which the working capital is empl
oyed in a business. This involves the need of working capital analysis.
The analysis of working capital can be conducted through a number of devices, su
ch as: 1. 2. 3. Ratio analysis. Fund flow analysis. Budgeting.
1. RATIO ANALYSIS A ratio is a simple arithmetical expression one number to anot
her. The technique of ratio analysis can be employed for measuring short-term li
quidity or working capital position of a firm. The following ratios can be calcu
lated for these purposes: 1. Current ratio. 2. Quick ratio 3. Absolute liquid ra
tio 4. Inventory turnover. 5. Receivables turnover. 6. Payable turnover ratio. 7
. Working capital turnover ratio. 8. Working capital leverage 9. Ratio of curren
t 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 fun
ds were derived and the use to which these sources were put. The fund flow analy
sis consists of: a. b. Preparing schedule of changes of working capital Statemen
t of sources and application of funds.
It is an effective management tool to study the changes in financial position (w
orking capital) business enterprise between beginning and ending of the financia
l dates.
3. WORKING CAPITAL BUDGET A budget is a financial and / or quantitative expressi
on of business plans and polices to be pursued in the future period time. Workin
g capital budget as a part of the total budge ting process of a business is prep
ared estimating future long term and short term working capital needs and source
s to finance them, and then comparing the budgeted figures with actual performan
ce for calculating the variances, if any, so that corrective actions may be take
n in future. He objective working capital budget is to ensure availability of fu
nds as and needed, and to ensure effective utilization of these resources. The s
uccessful implementation of working capital budget involves the preparing of sep
arate budget for each element of working capital, such as, cash, inventories and
receivables etc. ANALYSIS OF SHORT – TERM FINANCIAL POSITION OR TEST OF LIQUIDI
TY The short –term creditors of a company such as suppliers of goods of credit a
nd commercial banks short-term loans are primarily interested to know the abilit
y of a firm to meet its obligations in time. The short term obligations of a fir
m 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 as
sets. Therefore, it is important proper balance in regard to the liquidity of th
e firm. Two types of ratios can be calculated for measuring short-term financial
position or short-term solvency position of the firm. 1. 2. Liquidity ratios. C
urrent assets movements ‘ratios.
A) LIQUIDITY RATIOS Liquidity refers to the ability of a firm to meet its curren
t obligations as and when these become due. The short-term obligations are met b
y realizing amounts from current, floating or circulating assts. The current ass
ets should either be liquid or near about liquidity. These should be convertible
in cash for paying obligations of shortterm nature. The sufficiency or insuffic
iency of current assets should be assessed by comparing them with short-term lia
bilities. If current assets can pay off the current liabilities then the liquidi
ty position is satisfactory. On the other hand, if the current liabilities canno
t be met out of the current assets then the liquidity position is bad. To measur
e the liquidity of a firm, the following ratios can be calculated:
1. 2. 3.
CURRENT RATIO QUICK RATIO ABSOLUTE LIQUID RATIO
1. CURRENT RATIO Current Ratio, also known as working capital ratio is a measure
of general liquidity and its most widely used to make the analysis of short-ter
m financial position or liquidity of a firm. It is defined as the relation betwe
en current assets and current liabilities. Thus, CURRENT RATIO = CURRENT ASSETS
/ CURRENT LIABILITES The two components of this ratio are: 1) 2) CURRENT ASSETS
CURRENT LIABILITES
Current assets include cash, marketable securities, bill receivables, sundry deb
tors, inventories and work-in-progresses. Current liabilities include outstandin
g expenses, bill payable, dividend payable etc. A relatively high current ratio
is an indication that the firm is liquid and has the ability to pay its current
obligations in time. On the hand a low current ratio represents that the liquidi
ty position of the firm is not good and the firm shall not be able to pay its cu
rrent liabilities in time. A ratio equal or near to the rule of thumb of 2:1 i.e
. current assets double the current liabilities is considered to be satisfactory
. CALCULATION OF CURRENT RATIO e.g. Year Current Assets Current Liabilities Curr
ent Ratio 2003 81.29 27.42 2.96:1 2004 83.12 20.58 4.03:1 2005 13,6.57 33.48 4.0
8:1 (Rupees in crore)
Interpretation:As we know that ideal current ratio for any firm is 2:1. If we se
e the current ratio of the company for last three years it has increased from 20
03 to 2005. The current ratio of company is more than the ideal ratio. This depi
cts that company’s liquidity position is sound. Its current assets are more than
its current liabilities. 2. QUICK RATIO Quick ratio is a more rigorous test of
liquidity than current ratio. Quick ratio may be defined as the relationship bet
ween quick/liquid assets and current or liquid liabilities. An asset is said to
be liquid if it can be converted into cash with a short period without loss of v
alue. It measures the firms’ capacity to pay off current obligations immediately
. QUICK RATIO = QUICK ASSETS / CURRENT LIABILITES Where Quick Assets are: 1) Mar
ketable 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 l
iabilities in time and on the other hand a low quick ratio represents that the f
irms’ liquidity position is not good. As a rule of thumb ratio of 1:1 is conside
red 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 obligati
ons. However, a firm having high quick ratio may not have a satisfactory liquidi
ty position if it has slow paying debtors. On the other hand, a firm having a lo
w liquidity position if it has fast moving inventories. CALCULATION OF QUICK RAT
IO e.g. Year Quick Assets Current Liabilities Quick Ratio (Rupees in Crore) 2003
44.14 27.42 1.6 : 1 2004 47.43 20.58 2.3 : 1 2005 61.55 33.48 1.8 : 1
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 liq
uidity problem. 3. 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 a
s to exclude even receivables from the current assets and find out the absolute
liquid assets. Absolute Liquid Assets includes : ABSOLUTE LIQUID RATIO = ABSOLUT
E LIQUID ASSETS /CURRENT LIABILITES ABSOLUTE LIQUID ASSETS = CASH & BANK BALANCE
S. e.g. Year Absolute Liquid Assets Current Liabilities Absolute Liquid Ratio In
terpretation : These ratio shows that company carries a small amount of cash. Bu
t there is nothing to be worried about the lack of cash because company has rese
rve, borrowing power & long term investment. In India, firms have credit limits
sanctioned from banks and can easily draw cash. B) CURRENT ASSETS MOVEMENT RATIO
S Funds are invested in various assets in business to make sales and earn profit
s. The efficiency with which assets are managed directly affects the volume of s
ales. The better the management of assets, large is the amount of sales and prof
its. Current assets movement ratios measure the efficiency with which a firm man
ages its resources. These ratios are called turnover ratios because they indicat
e the speed with which assets are converted or turned over into sales. 2003 4.69
27.42 .17 : 1 (Rupees in Crore) 2004 1.79 20.58 .09 : 1 2005 5.06 33.48 .15 : 1
Depending upon the purpose, a number of turnover ratios can be calculated. They
are : 1. 2. 3. 4. Inventory Turnover Ratio Debtors Turnover Ratio Creditors Turn
over Ratio Working Capital Turnover Ratio
The current ratio and quick ratio give misleading results if current assets incl
ude high amount of debtors due to slow credit collections and moreover if the as
sets include high amount of slow moving inventories. As both the ratios ignore t
he 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 cert
ain 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. Bec
ause it is harmful to hold more inventory as some amount of capital is blocked i
n it and some cost is involved in it. It will therefore be advisable to dispose
the inventory as soon as possible. INVENTORY TURNOVER RATIO = COST OF GOOD SOLD
/ INVENTORY AVERAGE
Inventory turnover ratio measures the speed with which the stock is converted in
to sales. Usually a high inventory ratio indicates an efficient management of in
ventory because more frequently the stocks are sold; the lesser amount of money
is required to finance the inventory. Whereas, the low inventory turnover ratio
indicates that the inefficient management of inventory. A low inventory turnover
implies over investment in inventories, dull business, poor quality of goods, s
tock accumulations and slow moving goods and low profits as compared to total in
vestment. AVERAGE STOCK = (OPENING STOCK + CLOSING STOCK) / 2 (Rupees in Crore)
Year Cost of Goods sold Average Stock Inventory Turnover Ratio 2003 110.6 73.59
1.5 times 2004 103.2 36.42 2.8 times 2005 96.8 55.35 1.75 times
Interpretation : This ratio shows how rapidly the inventory is turning into rece
ivable through sales. In 2004 the company has high inventory turnover ratio but
in 2005 it has reduced to 1.75 times. This shows that the company’s inventory ma
nagement technique is less efficient as compare to last year. 2. INVENTORY CONVE
RSION PERIOD: INVENTORY CONVERSION PERIOD = INVENTORY TURNOVER RATIO e.g. Year D
ays Inventory Turnover Ratio Inventory Conversion Period Interpretation : Invent
ory conversion period shows that how many days inventories takes to convert from
raw material to finished goods. In the company inventory conversion period is d
ecreasing. This shows the efficiency of management to convert the inventory into
cash. 3. DEBTORS TURNOVER RATIO: A concern may sell its goods on cash as well a
s on credit to increase its sales and a liberal credit policy may result in tyin
g 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 cu
rrent assets. So liquidity position of a concern also depends upon the quality o
f trade debtors. Two types of ratio can be calculated to evaluate the quality of
debtors. a) b) Debtors Turnover Ratio Average Collection Period 2003 365 1.5 24
3 days 2004 365 2.8 130 days 2005 365 1.8 202 days 365 (net working days) /
DEBTORS TURNOVER RATIO = TOTAL SALES (CREDIT) / AVERAGE DEBTORS
Debtor’s velocity indicates the number of times the debtors are turned over duri
ng a year. Generally higher the value of debtor’s turnover ratio the more effici
ent 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 t
he same business and a trend may be found to make a better interpretation of the
ratio. AVERAGE DEBTORS= (OPENING DEBTOR+CLOSING DEBTOR) / 2 e.g. Year Sales Ave
rage Debtors Debtor Turnover Ratio Interpretation : This ratio indicates the spe
ed 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 m
ore efficient is the management of credit. But in the company the debtor turnove
r 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 prev
ious year. 4. AVERAGE COLLECTION PERIOD: Average Collection Period = No. of Work
ing 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 co
llection period implies quick payment by debtors and vice-versa. Average Collect
ion Period = 365 (Net Working Days) Debtors Turnover Ratio Year Days Debtor Turn
over Ratio Average Collection Period 2003 365 9.6 38 days 2004 365 8.3 44 days 2
005 365 7.5 49 days 2003 166.0 17.33 9.6 times 2004 151.5 18.19 8.3 times 2005 1
69.5 22.50 7.5 times
Interpretation : The average collection period measures the quality of debtors a
nd 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 pe
riod 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 CAPITA
L TURNOVER RATIO: Working capital turnover ratio indicates the velocity of utili
zation of net working capital. This ratio indicates the number of times the work
ing capital is turned over in the course of the year. This ratio measures the ef
ficiency with which the working capital is used by the firm. A higher ratio indi
cates efficient utilization of working capital and a low ratio indicates otherwi
se. But a very high working capital turnover is not a good situation for any fir
m. Working Capital Turnover Ratio = Working Capital Turnover e.g. Year Sales Net
working Capital Working Capital Turnover Interpretation : This ratio indicates l
ow much net working capital requires for sales. In 2005, the reciprocal of this
ratio (1/1.64 = .609) shows that for sales of Rs. 1 the company requires 60 pais
a as working capital. Thus this ratio is helpful to forecast the working capital
requirement on the basis of sale. INVENTORIES (Rs. in Crores) Year Inventories
2002-2003 37.15 2003-2004 35.69 2004-2005 75.01 2003 166.0 53.87 3.08 2004 151.5
62.52 2.4 2005 169.5 103.09 1.64 = Cost of Sales / Net Working Capital Sales /
Networking Capital
Interpretation: Inventories are a major part of current assets. If any company w
ants to manage its working capital efficiency, it has to manage its inventories
efficiently. The graph shows that inventory in 2002-2003 is 45%, in 2003-2004 is
43% and in 2004-2005 is 54% of their current assets. The company should try to
reduce the inventory up to 10% or 20% of current assets. CASH BANK BALANCE: (Rs.
in Cores) Year Cash Bank Balance 2002-2003 4.69 2003-2004 1.79 2004-2005 5.05
Interpretation : Cash is basic input or component of working capital. Cash is ne
eded to keep the business running on a continuous basis. So the organization sho
uld have sufficient cash to meet various requirements. The above graph is indica
te that in 2003 the cash is 4.69 crores but in 2004 it has decrease to 1.79. The
result of that it disturb the firms manufacturing operations. In 2005, it is in
creased upto approx. 5.1% cash balance. So in 2005, the company has no problem f
or meeting its requirement as compare to 2004. DEBTORS: (Rs. in Crores) Year Deb
tors 2002-2003 17.33 2003-2004 19.05 2004-2005 25.94
Interpretation : Debtors constitute a substantial portion of total current asset
s. In India it constitute one third of current assets. The above graph is depict
that there is increase in debtors. It represents an extension of credit to cust
omers. The reason for increasing credit is competition and company liberal credi
t policy.
CURRENT ASSETS: (Rs. in Crores) Year Current Assets 2002-2003 81.29 2003-2004 83
.15 2004-2005 136.57
Interpretation: This graph shows that there is 64% increase in current assets in
2005. This increase is arising because there is approx. 50% increase in invento
ries. Increase in current assets shows the liquidity soundness of company.
CURRENT LIABILITY: (Rs. in Crores) Year Current Liability 2002-2003 27.42 2003-2
004 20.58 2004-2005 33.48
Interpretation: Current liabilities shows company short term debts pay to outsid
ers. In 2005 the current liabilities of the company increased. But still increas
e in current assets are more than its current liabilities.
NET WOKRING CAPITAL: (Rs. in Crores) Year Net Working Capital 2002-2003 53.87 20
03-2004 62.53 2004-2005 103.09
Interpretation: Working capital is required to finance day to day operations of
a firm. There should be an optimum level of working capital. It should not be to
o less or not too excess. In the company there is increase in working capital. T
he increase in working capital arises because the company has expanded its busin
ess.
RESEARCH METHODOLOGY The methodology, I have adopted for my study is the various
tools, which basically analyze critically financial position of to the organiza
tion:
COMMON-SIZE P/L A/C COMMON-SIZE BALANCE SHEET COMPARTIVE P/L A/C COMPARTIVE BALA
NCE 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 i
s 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 formulatio
n of a healthy and strong position financially with proper management system. I
sincerely hope, through the evaluation of various percentage, ratios and compara
tive analysis, the organization would be able to conquer it’s in efficiencies an
d makes the desired changes.
ANALYSIS OF FINANCIAL STATEMENTS
FINANCIAL STATEMENTS: Financial statement is a collection of data organized acco
rding 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 ov
er 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 the profit and loss Acco
unt. OBJECTIVES OF FINANCIAL STATEMENTS: According to accounting Principal Board
of America (APB) states The following objectives of financial statements: 1. To
provide reliable financial information about economic resources and obligation
of a business firm. 2. To provide other needed information about charges in such
economic resources and obligation.
3. To provide reliable information about change in net resources (recourses less
obligations) missing out of business activities. 4. To provide financial inform
ation that assets in estimating the learning potential of the business. LIMITATI
ONS 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 c
oncern. The utility of these statements is dependent upon a number of factors. T
he analysis and interpretation of these statements must be done carefully otherw
ise misleading conclusion may be drawn. Financial statements suffer from the fol
lowing limitations: 1. Financial statements do not given a final picture of the
concern. The data given in these statements is only approximate. The actual valu
e can only be determined when the business is sold or liquidated. 2. Financial s
tatements have been prepared for different accounting periods, generally one yea
r, during the life of a concern. The costs and incomes are apportioned to differ
ent 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 c
ontingent assets and liabilities also make the statements imprecise. So the fina
ncial statements are at the most interim reports rather than the final picture o
f the firm. 3. The financial statements are expressed in monetary value, so they
appear to give final and accurate position. The value of fixed assets in the ba
lance sheet neither represent the value for which fixed assets can be sold nor t
he amount which will be required to replace these assets. The balance sheet is p
repared on the presumption of a going concern. The concern is expected to contin
ue in future. So, the fixed assets are shown at cost less accumulated depreciati
on. Moreover, there are certain assets in the balance sheet which will realize n
othing at the time of liquidation but they are shown in the balance sheets. 4. T
he financial statements are prepared on the basis of historical costs or origina
l costs. The value of assets decreases with the passage of time current price ch
anges are not taken into account. The statement are not prepared with the keepin
g in view the economic conditions. The balance sheet loses the significance of b
eing an index of current economic realities. Similarly, the profitability shown
by the income statements may be representing the earning capacity of the concern
.
5. 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 statemen
ts because they cannot be measured in monetary terms. The basic limitation of th
e traditional financial statements comprising the balance sheet, profit & loss A
/c is that they do not give all the information regarding the financial operatio
n of the firm. Nevertheless, they provide some extremely useful information to t
he 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. FINANCIAL STATEMENT ANALYSIS It is the proces
s of identifying the financial strength and weakness of a firm from the availabl
e accounting data and financial statements. The analysis is done CALCULATIONS OF
RATIOS Ratios are relationship expressed in mathematical terms between figures,
which are connected with each other in some manner. CLASSIFICATION OF RATIOS Ra
tios can be classified in to different categories depending upon the basis of cl
assification The traditional classification has been on the basis of the financi
al statement to which the determination of ratios belongs. These are:Profit & Lo
ss account ratios Balance Sheet ratios Composite ratios