PROJECT

ON FUND BASED LOANS -

Working capital represents operating liquidity available with the

business entity
. Following are the Options available for any enterprise to raise
fund i.e either
through their Own fund i.e Capital or throughfund from outside
market . Fund
from outside Market can be raised through issue of different types
of instruments
such as Shares/ Debentures/bond etc or availing loan from Bank
/financial
institution.Loan from Bank /financial Institution are availed for
financing Long
term Asset such as Fixed Asset /Machineries etc and for
financing Short Term
Asset / Current Asset . Current Asset are assets Owned by a
company which is
used in the normal course of business or generated in course of
Business such as
debtors or finished stock or cash. Any asset that is turned into
cash within twelve
Months is a current Asset . The Current Asset of Assets of a
Company area) Inventories These are arguably the most important
current assets that a

company has as it is by sale of its stocks that a company

makes its profits .
Stock, in turn consists of
Raw Materials The Primary purchase which is
utilized to
manufacture the products a company makes .

Work in Progress Goods that are in the process of

manufacture
but are yet to be Completed
Finished goods- The finished products manufactured
by the
company that are ready for Sale

Stocks are valued at the lower of cost or net realizable value. This
is to ensure
that there will be no Loss at the time of sale as that would have
accounted for.

The common methods of valuing stocks are

 FIFO or first in first out This method assumes that

the first
inventories brought are the first ones to be sold , and
that
inventories brought later are sold later
LIFO or last in first out-The Premise on which this
method is based
is the oppositeof FIFO . It is assumed that the goods
arrive last will
be sold first. The arguments for using the LIFO
method are to factor
in the most current cost into cost of goods sold .

Weighted Average-This method assumes that all

inventories are
sold simultaneously. The method specifically involves
working out
an average cost per unit at each point in time after a
purchase

It is important to ascertain the method of valuation and the

accounting principles
involved as stockcan be easily manipulated by changing the
method of valuation.

(b) Debtors - Most companies do not sell their products for cash
but on credit and
purchasers are
within an

expected to pay for the goods they have brought

agreed period of time 30 days or 60 days. The period of credit

would vary from
customer to customer and from company to company and
depends on the
creditworthiness of the customer, market conditions and
competition. Often
customers may not pay within the credit period. This may be due
to laxity in
credit administrationor inability of customers to pay .
Consequently debts are
classified as

Those over Six Months and

Others

These are further sub divided into

Debts considered Good and
Debts considered bad and doubtful

If debts are likely to be bad , they must be provided for or written

off , absence of
which would result in assets being overstated to the extent of the
bad debt .A
write off is made only when there is no scope of recovery while a
provision
(general or specific) is made to cover for any probability of
default by a debtor

C Prepaid Expenses All Payments are not made when due .

Many payments,
such as insurance premium, rent and service costs are made in
advance . The
Portion of expenses that are relate to next accounting period are
shown as
prepaid expenses in the Balance Sheet

(d) Cash &Bank Balances and Cash equivalents- Cash in

hand in petty cash boxes
, safes and balances in bank accounts are shown under this
heading in the
Balance Sheet

( e) Loans & Advances- These are Loans that have been given
to other
corporations , individuals and employees and are repayable within
a certain
period of time. This also includes amounts paid in advance for
the supply of
goods , materials and services.

(f)Other Current Assets Other Current assets are all amounts

due that are
recoverable within next twelve months .These include claims
receivables ,interest
due on investment and the like. A business also requires a
minimum level of cash
balance to meet its basic day to day expenses and provide a
cushion for
unexpected costs. In a broader sense working capital can
represent a firms
capital needs that include both current asset and other non fixed
asset
investments related to its operations , return from which may
not be immediate
but rather are accrued overa time through increased sales or
profits.

Net Working capital represents the excess of current Asset over

current Liabilities
and is an indicatorof firm s ability to meet its short term
financial obligations .

Current Liabilities Current liabilities are amounts due that are

payable within
next twelve months.These also include provisions which are
amounts set aside for
an expenses incurred for which the bill has not been received as
yet or cost has
not been fully estimated.

Creditors Trade creditors are those to whom the company

owes money
for raw materials and other articles used in the
manufacture of its
products. Companies usually purchase these on credit the
credit period
depending on the demand for the item, the standing of the
company
and market practice.
Accrued Expenses Certain expenses such as interest on
bank overdrafts,
telephone costs , electricity and overtime are paid after they
have been

incurred. This is because they fluctuate and it is not possible

to prepay or
accurately anticipate these expenses. Such expenses are
estimated based
on past trends and reported in balance sheet as accured
expenses.

Provisions- Provisions are amount set aside for an

estimated expenses or
loss. Certain Provisions such such as depreciation and
provisions for bad
debts are deducted from The concerned asset itself. There
are others, such
as claims that may be payable, for whichProvisions are
made. Other
provisions normally seen on balance sheets are those for
dividends and
taxation
Other Current Liabilities- Any other amounts due like
unclaimed dividends
and dues payable To third parties are reflected under this
balance sheet
If Current Liabilities are more than Current Assets , an
entity has a

Negative Working CapitalOr working Capital deficit. . It

implies that the
business has applied part of its current LiabilitesTowards
meeting the
shortfall in Long term Liabiltes and it is case of diversion of
fund.

Working Capital Management is essential for the Long term

success of a
business . No business can survive if it cannot meet day to
day obligations.
It is necessary for a business to have sufficient working
capital that
business is liquid but at same time, excessive conservatism
may lead to
reduce profitability.

Adequate and appropriate working capital financing provides

liquidity and
ensures that the firm has sufficient cash flow to pay its shortterm obligations.
When working capital is not sufficiently or appropriately
financed , a firm can
run out of cash and face bankruptcy . Even a profitablefirm
with competitive

goods or service can still face bankruptcy if it has not

adequately financed its
working capital needs and as a result runs of cash.

Working capital financing can be through many different

ways as under Long term sources- Equity / Long term term debt/ Internal
accruals
Cash credits against hypothecation of stock
Overdrafts/ Bill discounting against receivables
Factoring can tantamount to sale of receivables to a factor
Trade Credits- delayed payment to suppliers an credit terms
without interest funding

Small business entities have less acess to long term sources of

capital than large business Entities ,limited acess to equity
markets and fewer sources of long term debt . As such Many
small entities are heavily dependent on short term debt. Limited
equity and reliance On short term debt increases the demand on
entitys cash flow . reduces liquidity and increases Financial
leverage , all of which increase the financial risks of extending
credit .Different industry type require different levels of working
capital . Service industries would require Little or no inventory
whereas retailers would require higher inventory. Depending on
the retailers Business their inventory requirement would also
vary. Manufactures would require maintaining of high level of

inventory as they would stocks of raw materials , work in

progress and finished
Goods. Retailers selling for cash would have few receivables.
Manufacturers would have trade
Creditors as well as receivables. If Supply of raw materials is
uncertain, the level of inventory
Would be higher. In a growing business entity with the increase in
the scale of operations , inventory
Receivables and payables also increase.

The Companys operating cycle also determines the level of

working capital . The operating cycle is
the length of time between the companys outflow on raw
materials and the manufacturing expenses
And inflow of cash from the sale of goods. It is calculated as
average inventory period plus average
Debtors period less average creditors period. For example :

Operating Cycle Method

Meaning of operating cycle:

It begins with acquisition of raw materials and ends with

collection of receivables.
Stages:
1)Raw materials (RM/RM consumption)
2)Work-in-process (WIP/COP)
3)Finished Goods (FG/COS)
4)Receivables (Debtors/Credit sales)
Less:
Creditors (creditors/purchases)
Example of Operating Cycle:

Length of operating Cycle:

a. Procurement of raw material : 30 days
b. Conversion/process time : 15 days
c. Average time of holding of finished goods: 15 days
d. Average collection period : 30 days
e. Total operating cycle : 90 days
f. Operating cycle in a year : 4
g. Total operating expenses per annum : Rs.60 lacs
h. Total turnover per annum : Rs.70 lacs

i. Working capital requirement : 60/4= 15 lacs

A long operating cycle can affect profitability by increasing

borrowing
requirements, which lead to higher interest costs .

Firms need both a long term (or permanent) investment in

working capital
and a short term or cyclical one. Cyclical working capital is best
financed
by short term debt since the seasonal building up of assets to
take care
of seasonal demand will be reduced and converted to cash.

Under aggressive funding policy a business entity uses short

term funds to
finance permanent working capital. Short term funds though
cheaper are
highly risky as they can be recalled on demand. A conservative
business entity
would use long term funding for permanent working capital .For
current Assets

(CA) to be greater than current Liabilities (CL) ,Long term sources

(debt/equity )
must finance part of CAs.

Following are the Liquid indicators of firm-

Net Working Capital- Current Assets- Current Liabilities

Current Ratio = Current Assets/ Current Liabilities

Quick Ratio = Current Assets Inventory/ Current Liabilities

Lower NWC may indicate symptoms of overtrading (rapid growth

of business
without sufficient capital support ) over dependence on borrowed
short term
fund and even serious liquidity issues. Overtrading is risky from
the liquidity point
of view though profitability may not be an issue since short term
finance finance
can be withdrawn in case of loss of confidence in the business
by its creditors
or general tightening of economy.
become evident

Stressed liquidity conditions

through very high reliance on short term resources, increase in

debtors as well
as inventory, increase in creditors period and worsening cash
position . These
indicators get reflected in worsening C.R and Q.R.

The working capital financing by Indian Banks evolved over a

period . From
traditional security based lending it has now become need and
propose based
lending . As per the recommendations of various committees
appointed by
RBI from time to time , banks have been advised to fix the
Maximum Permissible
Bank finance (MPBF) limit for a borrower.
(1975) had
Recommended three methods
progressive increase in

of

Tandon Committee

arriving

at

MPBF

with

Borrowers contribution .The subsequent Chore Committee (1978)

recommended
the second method suggested by tandon committee . As Per this
method-

MPBF is arrived as shown below-

.First MethodParticulars

Amt
Lacs)
400
bank 160

Total Current Assets (A)

Less Total Current Liabilities
excluding
borrowings (B)
Working Capital Gap (A-B=C)
Borrowers Contribution (D) (25% OF C WORKING
CAPITAL GAP)
MPBF (C-D)
Total Current Liabilities (160+180)
Current Ratio

240
60
180
340
1.17

(in