Research Method Used

Research is a systematic purposive investigation looking for the facts through

verifiable methods in order to establish a relationship between them and to
conclude from them broad principles or laws. There are various types of research
based on the intent:
1. Pure and Applied Research
2. Exploratory Research
3. Descriptive Research
4. Diagnostic Study
5. Evaluation Studies
6. Action Research
This project report is based on Exploratory Research, that is, I have conducted a
preliminary study of an unfamiliar problem. I have done it to generate new ideas or
increase my familiarity with the problem. Generally the methods used are literature
survey, experience survey, case studies etc.

Data Collection Method

There are two categories of data collection methods: Primary and Secondary. I
have used both sources of data. The sources include websites, text book and
reference books. Details of these sources are available in Bibliography and
Webliography.

OBJECTIVES

To understand the concept of Working Capital.

To understand the trend exhibited by the working capital over the period.
To analyze the overall short-term fund requirements of the Company.
To analyze the current working mechanism of Sources and Investments of
funds in the Company.
To understand the need and importance of working capital finance in an
Organization.

WORKING CAPITAL MANAGEMENT

INTRODUCTION TO WORKING CAPITAL

Working Capital is the Life-Blood And Controlling Nerve Center of a Business

The term Working Capital refers to the capital required for day-to-day operations of a business
enterprise. It is represented by excess of Current assets over Current Liabilities. It is necessary
for any organization to run successfully its affairs, to provide for adequate working capital. Too
large investment in Current Assets means blocking the capital that can be used productively
elsewhere. On the other hand too little investment can be expensive. For example, insufficient
inventory may cause loss of sales to Customers.
All this indicates that proper estimation of the Working Capital requirements is a must for
running the business efficiently and profitably.

Working capital is therefore:-

Current
WORKING

CAPITAL =

Assets
||

- Current liabilities

stock + debtors + cash

The importance of having working capital is best understood as 'costs expended before payment
received for goods/service provided to the customer'. Therefore, no capital means no production
and no customers, which means no capital...

There are basically two concepts of working capital Gross Working Capital:
It is the amount of capital invested in the total Current assets of the enterprise.
Current assets are those assets, which in ordinary course of business can be
converted into cash within a short period of normally one accounting year.

Net Working Capital:

It refers to the difference between net current assets and liabilities. Current
liabilities are those claims of outsiders, which are expected to mature for
payment within an accounting year. Net working capital can be positive or
negative. A positive net working capital will arise when current assets increase
current liabilities. A negative working capital will arise when current liabilities are
in excess of current assets.
Current Assets:
Current assets, sometimes called liquid assets, are those resources of a firm, which
are either held in the form of cash or are expected to be converted in cash within
the accounting period in one-year duration. The operating cycle is the time taken to
convert the raw materials into finished goods and convert receivables (goods sold
on credit) into cash.
Current Assets include:

Cash in hand

Bank balances

Bills Receivables

Sundry Debtors (less provision for bad debts)

Short term loans and advances

Inventories of stocks, as:

Raw material

Work in progress

Stores and spares

Finished Goods

Temporary Investments of surplus funds

Prepaid expenses

Accrued Incomes.

Current Liabilities:

Current Liabilities are debts payable within an accounting period. Current assets are converted
into cash to pay current liabilities.
Current Liabilities include:

Bills Payable

Sundry creditors or Accounts Payable

Accrued or Outstanding expenses

Short term loans, Advances or deposits.

Dividends Payable

Bank Overdraft

Provision for taxation, if it does not amount to appropriation of profits.

It is a conventional rule to maintain the level of current assets twice the level of current
liabilities. A weak liquidity position poses a threat to the solvency of the company and makes it
unsafe and unsound. A negative working capital means a negative liquidity and at times it may
prove to be harmful for the companys reputation. Excessive liquidity is also bad. It may be due
to mismanagement of current assets. Therefore prompt and timely action should be taken by the
management to improve and correct the imbalances in the liquidity position of the firm.
Gross Working Capital is a Going Concern/Financial Concept where as the Net Working
Capital is an Accounting Concept of working capital.

IMPORTANCE OF WORKING CAPITAL

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.

OBJECTIVE:

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. Other objectives of working capital management are as follows: To identify cash flow cycles of the firm.
To maintain the level of current assets twice the level of current liabilities.
To help the company to maintain good business relations.
To determine the future capital, liquidity position and other requirements of
the company.

Working capital management takes place at 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

CLASSIFICATION OF WORKING CAPITAL

Working Capital is classified on the following two basis:
(a) On basis of time
(b) On basis of concept
KINDS OF WORKING CAPITAL

On basis of Concept

Gross

Net

Fixed
Capital

On basis of Time

Permanent/

Temporary/

Working

Working

Variable
Capital

Working

Working

Capital

Capital

Regular Reserve
WC

WC

Seasonal Special
WC

WC

Permanent or Fixed Working Capital:

Is the minimum amount of Working Capital required to ensure effective utilization of fixed
facilities and for maintaining the circulation of Current assets.

There is always a minimum level of Current Assets, which are continuously required by the
enterprise to carry out its normal business operations. Example: Every firm has to maintain a
minimum amount of raw materials, Work-in-Progress, Finished goods and cash balance.
Minimum level of Current Assets is called permanent or fixed working capital as this part of
Working Capital is permanently blocked in Current Assets. As the business grows, requirements
of permanent Working capital also increase due to increase in current assets.
i. Regular Working Capital: It is required to ensure circulation of Current Assets from cash

to inventories, from

inventories to receivables and from receivables to cash and so on.

ii. Reserve Working Capital: It is the excess amount over the requirement for regular Working Capital which may be
provided for contingencies that may arise at unstated periods, such as strikes, rise in prices,
depression etc.

Temporary or Variable Working Capital:

It is the amount of Working Capital, which is required to meet seasonal demands and some
special exigencies such as launching of extensive marketing campaign for conducting research
etc.

FACTORS DETERMINING THE WORKING

CAPITAL REQUIREMENTS

Nature or Characteristics of Business-The working capital requirements of an

enterprise are basically related to the conduct of the business. Every company
according to their nature of business has to maintain a certain level of working
capital.

Production Policy-The production policies pursued by the management has a

significant effect on the requirements of working capital of the business. The
production schedule has a great influence on the level of inventories. The decision of
the management regarding automation, etc., will also have its effect on working
capital requirements.

Seasonal Variations-Most firms experience seasonal and cyclical fluctuations in the

demand for their products and sevices. These business variations effect the working
capital requirement, specially the temporary working capital requirement of the firm.
When there is an upward swing in the economy, sales will increase; correspondingly,
the firms investment in inventories and book debts will also increase. Under boom,
additional investment in fixed assets may be made by some firms to increase their
productive capacity. This act of the firm will require further additions of working
cpital. When there is a decline in the economy sales will fall and consequently, levels
of inventories and book debts will also fall.

Credit policy-A company which allows liberal credits to its customers, may have
higher sales but will need more working capital as compared to a company which has
an efficient debt collection machinery and observing strict terms. The working capital
requirements can also be affected by the credit facilities enjoyed by the company.

Rate of growth of Business-As a company grows; it is logical to expect that a large

amount of working capital will be required. It is, of course, difficult to determine
precisely the relationship between the growth in the volume of business of a company
and the increase in its working capital. The composition of working capital in a
growing company also shifts with economic circumstances and corporate practices.

Business cycle-Different phases of business cycle i.e, boom, recession, recovery etc.
also affect the working capital reuirement. In case of boom condition business
activities expand .As a result, the need for cash, inventories etc. increases resulting in
more and more funds blocked in these current assets. In case of recession period,
there is usually dullness in business activities and there will be an opposite effect on
the level of working capital requirement. There will be a fall in inventories and cash
requirements etc.

Manufacturing Process/ Length of product cycle-The manufacturing process

comprises of the purchase and use of raw materials and the production of finished
goods. Longer the manufacturing cycle, larger will be the firms working capital
requirements.

WORKING CAPITAL CYCLE

The working capital cycle can be defined as:

The period of time which elapses between the point at which cash begins to be expended on the
production of a product and the collection of cash from a customer.
The faster a business expands, the more cash it requires for working capital and investment. The
cheapest and best sources of cash exist as working capital right within business. Good
management of working capital will generate cash, which will help improve profits and reduce
risks. Bear in mind that the cost of providing credit to customers and holding stocks can
represent a substantial proportion of firms total profits.

There are two elements in the business cycle that absorbs cash:

Inventory (Stocks and work-in-progress)

Receivables (Debtors owing you money)

The main sources of cash are Payables (your creditors) and Equity and Loans.
When it comes to managing working capital- TIME IS MONEY. If you can get money to move
faster around the cycle (e.g. collect monies due from debtors more quickly) or reduce the amount
of money tied up (e.g. reduce inventory levels relative to sales), the business will generate more
cash or it will need to borrow less money to fund working capital.
As a consequence, you could reduce the cost of bank interest or youll have additional free
money available to support additional sales growth or investment. Similarly, if you can negotiate
improved terms with suppliers e.g. get longer credit or an increased credit limit; you effectively
create free finance to help fund future sales.

FINANCING OF WORKING CAPITAL

There are two types of working capital requirements in a companyi)

Permanent or Fixed Working Capital Requirements

ii)

Temporary or Variable Working Capital Requirements

Depending on the above mentioned requirements following are the sources of financing working
capital-

SOURCES
Long Term Sources

Short Term Sources

Shares

Commercial Banks

Debentures

Commercial paper

Public Deposits
Loans from Financial institutions

Trade Creditors
Installment credit
Accounts payables
Accrued Expenses

WORKING CAPITAL ANALYSIS

Working capital is one of the most difficult financial concepts to understand for the smallbusiness owner. In fact, the term means a lot of different things to a lot of different people.
By definition, Working Capital is the amount by which current assets exceed current liabilities.
A useful tool for the small-business owner is the operating cycle. The operating
cycle analyzes the Accounts Receivable, Inventory and Accounts Payable cycles in
terms of days. In other words, accounts receivables are analyzed by the average
number of days it takes to collect an account. Inventory is analyzed by the average
number of days it takes to turn over the sale of a product (from the point it comes in
your door to the point it is converted to cash or an account receivable). Accounts
payables are analyzed by the average number of days it takes to pay a supplier
invoice.

Most businesses cannot finance the Operating Cycle (accounts receivable days +
inventory days) with accounts payable financing alone. Consequently, working
capital financing is needed. This shortfall is typically covered by the net profits
generated internally or by externally borrowed funds or by a combination of the two.

Most businesses need short-term working capital at some point in their operations.
For instance, retailers must find working capital to fund seasonal inventory buildup
between September and November for Christmas sales. But even a business that is
not seasonal occasionally experiences peak months when orders are unusually high.

This creates a need for Working Capital to fund the resulting Inventory and Accounts
Receivable buildup.

Some small businesses have enough cash reserves to fund seasonal Working
Capital needs. However, this is very rare for a new business. If your new venture
experiences a need for short-term Working Capital during its first few years of
operation, you will have several potential sources of funding. The important thing is
to plan ahead. If you get caught off guard, you might miss out on the one big order
that could have put your business over the hump.

Here are the five most common sources of short-term working capital financing:

Equity

Trade Creditors

Factoring

Line Of credit

Short-term Loans

Equity: If your business is in its first year of operation and has not yet become
profitable, then you might have to rely on equity funds for short-term working
capital needs. These funds might be injected from your own personal resources or
from a family member, friend or third-party investor.

Trade Creditors: If you have a particularly good relationship established with your
trade creditors, you might be able to solicit their help in providing short-term
working capital. If you have paid on time in the past, a trade creditor may be willing
to extend terms to enable you to meet a big order. For instance, if you receive a big

order that you can fulfill, ship out and collect in 60 days, you could obtain 60-day
terms from your supplier if 30-day terms are normally given. The trade creditor will
want proof of the order and may want to file a lien on it as security.

Factoring: Factoring is another resource for short-term working capital financing.

Once you have filled an order, a factoring company buys your account receivable
and then handles the collection. This type of financing is more expensive than
conventional bank financing but is often used by new businesses.

Line Of Credit: Banks to new businesses do not often give Lines of credit.
However, if your new business is well capitalized by equity and you have good
collateral, your business might qualify for one. A line of credit allows you to borrow
funds for short-term needs when they arise. The funds are repaid once you collect
the accounts receivable that resulted from the short-term sales peak. Lines of credit
typically are made for one year at a time and are expected to be paid off for 30 to
60 consecutive days sometime during the year to ensure that the funds are used for
short-term needs only.

Short-term loan: While your new business may not qualify for a line of credit from
a bank, you might have success in obtaining a one-time short-term loan (less than a
year) to finance your temporary working capital needs. If you have established a
good banking relationship with a banker, he or she might be willing to provide a
short-term note for one order or for a seasonal inventory and/or accounts receivable
buildup.
In addition to analyzing the average number of days it takes to make a product
(inventory days) and collect on an account (account receivable days) vs. the
number of days financed by accounts payable, the operating cycle analysis provides
one other important analysis.

From the operating cycle, a computation can be made of the dollars required to
support one day of accounts receivable and inventory and the dollars provided by a
day of accounts payable.
Working capital has a direct impact on CASH FLOW in a business. Since cash flow
is the name of the game for all business owners, a good understanding of working
capital is imperative to make any venture successful.

The primary objective of working capital management is to ensure that sufficient

cash is available to:

Meet day-to-day cash flow needs;

Pay wages and salaries when they fall due;

Pay creditors to ensure continued supplies of goods and services;

Pay government taxation and providers of capital dividends; and

Ensure the long-term survival of the business entity.

Poor working capital management can lead to:

Over-capitalization

(and

therefore

waste

through

under

utilization

of

resources and hence poor returns); and

Overtrading (trying to maintain a level of sales which is higher than working

capital can sustain for businesses which extend credit terms, more sales
means more debtors and higher working capital demands).