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project report on working capital

  1. 1. PROJECT REPORT ON WORkiNg CaPiTal aNd COsT Of gOOds sOldA Report Submitted In Partial Fulfilment of the Requirements For The Award of the Degree of MasTER Of BUsiNEss adMiNisTRaTiONCollaborative program of M.S.Ramaiah Management Institute with PRIST University BY DEEPAK KUMAR REG.NO:- CM2091860012 Under the guidance of Dr. H. Muralidharan PRisT UNiVERsiTY Vallam, Thanjavur, 2010
  2. 2. STUDENTS DECLARATIONI declare that the project titled “WORKING CAPITAL AND COST OF GOODS SOLD” is anoriginal project done by me and no part of the project is taken from any other project ormaterials published or otherwise or submitted earlier to any other college or university. Student’s Signature DEEPAK KUMAR REG.NO-CM2091860012 2|Page
  3. 3. AUTHENTICATION CERTIFICATEThis is to certify that the work presented in this dissertation entitled “ON PROJECT” ATVARIAN (I) PVT.LTD ON THE TOPIC OF WORKING CAPITAL AND COST OF GOODSSOLD has done by Deepak Kumar CM2091860012 under my guidance is beingsubmitted to M.S RAMAIAH MANAGEMENT INSTITUTE. Signature of Project Guide Dr. H. Muralidharan M S Ramaiah Management Institute, Bangalore 3|Page
  4. 4. ACKNOWLEDGEMENTIt is really a matter of great pleasure to acknowledge the invaluable guidance, enormous assistanceand excellent co-operation extended to me finance department, Varian India Pvt Ltd, Kolkata incompletion of my project.I express my sincere gratitude to Mr. D. GANGULY (DGM FINANCE), MISS NIMISHA, whogave me the project guidelines and were a source of constant inspiration and help throughout theproject work.I extend my special gratitude to our beloved Dean Dr. CS.Thammaiah for inspiring me to take upthis projectI wish to acknowledge my sincere gratitude and indebtedness to my project guide Dr. H.Muralidharan of M.S. RAMAIAH MANAGEMENT INSTITUTE OF Bangalore for his valuableguidance and constructive suggestions in the preparation of project report.Finally yet importantly, I would like to thank my parents and my friends for their constant supportand encouragement to do the best.I HAVE BEEN IMMENSELY BENEFITTED BY THIS PROJECT. 4|Page
  5. 5. CONTENTPart A: Organizational studySl. no Topic Page no.1 Sectorial analysis 10-142 Introduction to VARIAN 15 15 • Company profile 15 • History • Values 15 • Vision 16 • Mission 16 • Achievement 163 Products 17-194 VARIAN care program 205 Philosophy and human face 20-216 Quality policy 217 Environment ,health & safety policy 228 Organizational structure 239 Financial highlights 24-2510 Swot analysis 26-27 5|Page
  6. 6. Part B: Project report Sl. no Topic Page no1 Executive summary 292 Research design 30 30 • Statement of the problem • Objective of the study 30 • Limitation of the study 31 • Types of data collection • Data collection technique 31 • Sample design 323 Working capital (Definition) 33-354 permanent and temporary working capital 35-365 Working capital needs of a business 36-376 Working capital cycle 37-417 Factor determining the working capital requirement 41-438 Consequences of under assessment on working capital 43-449 Consequences of over assessment on working capital 4410 Impact of inflation on working capital requirement 44-4511 Impact of double shift working capital requirement 4512 Zero working capital 4613 Adequate working capital 46-4714 Working capital leverage 47-4815 Approaches to working capital finance 48-5016 Financing working capital 50-51 6|Page
  7. 7. 17 Committee recommendation of working capital finance 52-5418 Method for estimating working capital requirement 54-5519 Inventory management 55-5620 Objective of inventory management 56-5721 Inventory management techniques 58-5922 Receivable management 59-6123 Receivable collection policy 6224 Process of receivable management 6225 Cash management 6326 Effects of cash deficits 6427 Cash budget 64-6528 Method of cash flow budgeting 65-6629 Cash management model 66-6730 Analysis and interpretation • Types of ratio 6831 Profitability ratio 69-7132 Activity ratio 72-7333 Liquidity ratio 74-7634 Classification of costs 77-7935 Proforma of cost sheet 79-8136 Conclusion 8237 Recommendation 8338 Bibliography 8439 Annexure 85-87 7|Page
  9. 9. SECTORIAL ANALYSISIndia’s biotechnology sector is at a crossroads. On the one hand, it must find affordable solutionsto the pressing national needs in agriculture, health and energy, but on the other, it must becompetitive enough to take advantage of the lucrative international markets. The IndianGovernment established an independent Department of Biotechnology (DBT) in the Ministry ofScience and Technology as early as 1986, much before ‘biotechnology’ became a buzzword.Government funding to the S&T sector increased by eight times from the 8th Five-Year Plan tothe 11th Five-Year Plan and support to the life sciences sector steadily increased by 16 times inthe same period As a result, a firmer foundation of life sciences and biotechnology has beencreated over the years in public-funded institutions, over which a strong edifice of innovation andenterprise could be built now. Fiscal incentives include relaxed price controls for drugs, subsidieson capital limits, and tax holidays for R&D spending. Several State Governments (e.g. AndhraPradesh, Karnataka, Maharashtra, Himachal Pradesh, Uttar Pradesh, Kerala and Gujarat) havecome up with added financial (e.g. tax concessions) and policy incentives (biotech parks,incubators of their own) to spur investment in biotechnology. DBT and other organizations haveproactively taken up a number of initiatives in creating trained human resource, institutionalinfrastructure (e.g. microbial culture collections, cell and tissue lines, gene banks, laboratoryanimals, facilities for oligonucleotide synthesis, etc.) and a strong research base in the country inareas relating to agriculture and forestry, human health, animal productivity, environmental safetyand industrial production. Plan Total S&T ( in crore) DBT (in crore)8th five year plan 9393 4069th five year plan 12022 67510th five year plan 25301 115011th five year plan 75304 6400 9|Page
  10. 10. 90000 80000 6400 70000 60000 50000 DBT 40000 75304 Total S& T 30000 1150 20000 10000 675 25301 406 9393 12022 0 8th five year plan 9th five year plan 10 th five year plan11th five year planFigure: From the 8th Five-Year Plan to the 11th Five-Year Plan, government’s total S&T budgetincreased by eight times and DBT’s budget by 16 times.Segments of biotechnology sector  Biopharma segment The biopharma segment mainly concentrates on vaccines, non-vaccine therapeutics, other novel products and contract services4. Its strong impact has been on promoting low-cost commodities and forcing a price reduction on MNC bio products.  Bio services. Bio Services segment comprises of clinical research, contract manufacturing and contract researches.  Bio agriculture  Bio industrial 10 | P a g e
  11. 11. Bio industrial Services is a contract laboratory specializing in the analysis of a variety of products and raw materials for the Pharmaceutical industry, Veterinary Health industry, Cosmetics and the Food and additives market.  Bio informatics Bioinformatics was applied in the creation and maintenance of a database to store biological information at the beginning of the "genomic revolution", such as nucleotide and amino acid sequences. Development of this type of database involved not only design issues but the development of complex interfaces whereby researchers could both access existing data as well as submit new or revised data.Category Percentage (%)Bio pharma 67Bio services 15Bio agriculture 12Bio industrial 4Bio informatics 2 Bio industrial Bio informatics percentage(%) 4% 2% Bio agriculture 12% Bio pharma Bio services Bio agriculture Bio services 15% Bio industrial Bio informatics 11 | P a g e Bio pharma 67%
  12. 12. Figure. Chart showing the segments of biotechnology sector.12 | P a g e
  13. 13. Year Bio Pharma Bio Services Bio Agriculture Bio Industry Bio Informatics 2002-03 1790 135 110 235 70 2003-04 2752 275 130 238 80 2004-05 3570 425 330 320 100 2005-06 4768 720 598 375 120 2006-07 5973 1102 926 395 145 2007-08 6399 1572 1201 410 190Table: Revenue generated by biotechnology sector in crore. 10000 9 000 8 000 7 000 Bio informatics 6 000 Bio industry 5 000 Bio agriculture 4 000 Bio services 3 000 Bio pharma 2 000 1 000 0 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08Chart: Revenue generated by biotechnology sector in crore. 13 | P a g e
  14. 14. COMPANY PROFILEVarian, Inc. is a leading worldwide supplier of scientific instruments and vacuum technologies forlife science and industrial applications. The company provides complete solutions, includinginstruments, vacuum products, laboratory consumable supplies, software, training and supportthrough its global distribution and support systems. Varian, Inc. employs approximately 3,500people worldwide and operates manufacturing facilities in North America, Europe and AsiaPacific. Varian, Inc. had fiscal year 2009 sales of $807 million, and its common stock is traded onthe NASDAQ Global Select Market under the symbol "VARI." It has been opened his company inKolkata since 2007 with 8 products.History:-Varian, Inc. was formed in 1999 when Varian Associates Inc.--a pioneer of the renowned high-tech hotbed of Silicon Valley, California. reorganized into three independent public companies:Varian Medical Systems Inc.; Varian Semiconductor Equipment Associates Inc.; and Varian, Inc.Varian, Inc. operates as a leading supplier in scientific instruments, vacuum technologies, andcontract manufacturing and has 14 locations in North America, Europe, and the Pacific Rim. Thecompany caters to the life science, health care, semiconductor processing, and industrial industriesand has over 20,000 customers. Varians three main business segments include ScientificInstruments, Electronics Manufacturing, and Vacuum Technologies.VALUES:-Our values guide the way we do business–our customers, suppliers and employees see them inaction every day when they work with us. We believe it’s these values that have helped us enableour customers to excel, and have helped us attract and retain our most valuable asset–ourexceptional people. 14 | P a g e
  15. 15. VISION:-The people of Varian, Inc. enhance customers success by devising integrated, creative solutions totheir most pressing technological and process requirements. Grounded in an unbendingcommitment to Inspiring Excellence, we strive to deliver the highest quality products and services,offering exceptional value to our customers. As a result, we create growth opportunities foremployees while working to achieve the best financial performance in our industry, providingshareholders with an excellent return on their investment.MISSION:-“To be the market leader by providing customer delight through excellent quality, service andcost-effectiveness in a progressive, innovative and challenging environment. We endeavour toprovide an enriching, rewarding and environment friendly work experience to our employees in anachievement-based, high- performance culture. We will provide maximum satisfaction to all ourstakeholders”.Achievement:-  2009 Number 12 in the Business Week 50 listing of best performing public corporations  2007 Number 14 in the Business Week 50 listing of best performing public corporations  2007, 2008, 2009 named one of Industry Weeks "50 Best Manufacturing Companies" in the U.S.  2006 R&D 100 Award  2006 Forbes Global High Performer  2004, 2005 Forbes Platinum 400 list 15 | P a g e
  16. 16. PRODUCTSVARIAN provides leading edge tools and solutions for diverse, high growth applications in lifescience and industry.Scientific Instruments:-We’re leaders and innovators in creating solutions that solve a wide range of challenges in lifescience and industry. In particular, we excel in creating high performance products, oftencombining our diverse technologies and capabilities to create new ways to meet the evolvingneeds of our customers. Our instruments, consumable supplies, and solutions are key tools in bio-molecular and academic research, pharmaceutical R&D and manufacturing, and industrial R&Dand quality control, and in developing everything from disease-resistant crops to cosmetics totesting drinking water and monitoring quality in the petrochemical industry.Vacuum Technologies :-We specialize in listening carefully to customer requirements and developing vacuum systemstailored to meet each one’s unique needs. We do this by leveraging our broad product range andour 50 years of fundamental expertise in vacuum technologies. Whether a customer is building amass spectrometer or a medical linear accelerator, a system for producing flat panel displays orcoating architectural glass, or experimenting in high-energy, physics experiment, Varian, alongside its customers to solve vacuum challenges. 16 | P a g e
  17. 17. Chromatography:-GCFlexible solutions, for every application,From portable Micro-GC to customConfigurations.Flash ChromatographyAutomated systems improve performance andMinimize routine tasks to increase productivityMolecular spectroscopy:-UV-Vis-NIROutstanding performance, flexibility andEase of use is what you expect fromThe range of Varian spectrophotometers,From routine to research applications.FT-IR ImagingMicroscopes and imaging productsFor medical, biological and industrialApplications, with unmatched spatialResolution, speed and ease of use. 17 | P a g e
  18. 18. Application-based consumables:-Application-BasedDrug Testing and ScreeningVarian offers a range of USP-compliantDissolution vessels, paddles, and baskets,All serialized for traceability.Biotech ParticlesHighly reproducible, functionalizedMagnetic, latex and custom particles forBiotech applications, and solid phase synthesis supports.Vacuum Technologies for Science and IndustryPrimary Vacuum Dry Scroll PumpsConsistent performance in a reliable,dry vacuum in a small, economicalPackage.Vacuum ControlPrecise, user-friendly massSpectrometer and ion pump leakDetectors are available with wirelessRemote capability. 18 | P a g e
  19. 19. Varian Care ProgramThe Varian Care Program adds value to your business by ensuring ongoing productivity. Whetheryou need service, training or preventive maintenance, you need more than a skilled technician.You need a good listener who will understand your situation and give you the best advice andservice possible. Our dedicated field support representatives and specialists take pride in theirwork and are committed to ensuring you get the most from your investment. Our goal is to helpyou increase your productivity, maximize your uptime and achieve the highest return possible onyour investment. Our experienced and highly qualified support organization is strategicallylocated throughout the world to ensure rapid response.Philosophy & Human FaceOptimum utilization of knowledge:The Group understand and values the power of knowledge and information .Thus, each employeeis encouraged to garner and utilize his knowledge data to optimum for intrinsic development andorientation.Solving problem with the Heart:Emotions are strongly considered. Emotional approach is effective as rational for resolvingproblems. The key is to understand the people and their reaction to increase tolerance towardsthem.Playing the Devils Advocate:Using a negative point of view and playing the Devils advocate in all aspects of decision-makinghelp to eliminate the week points and make the plan more robust and fool proof. Negative thinkingto a certain extent is a far- sighted technique for positive outcome and helps dilute the over-confidence aspect that might hinder the success of the plan. 19 | P a g e
  20. 20. Be Positive:Optimism keeps one float. Positive thinking generates positive energy that can convert an adversesituation into striking opportunity.Out-of-the box thinkingCreativity fuels innovations. Thinking out of the box can result in key insights that can yieldexcellent results.Managing and controlIt is the duty of people at the helm of affairs to impart a guideline when things are not clear. Theymust encourage creative thinking for a solution-oriented approach and have back–up plans foradverse situations ready.Quality Policy VARIAN INDIA PVT LTD is committed to delight customer by implementing Total QualityManagement (TQM)We shall achieve this by:  Providing consistent product quality at right time and price.  Effectively and efficiently utilization Man, Material and Technologies.  Developing employees by providing adequate training.  Involving and motivating all employees (TET) for continual improvement in work place and processes. 20 | P a g e
  21. 21. Environment, Health and Safety PolicyVarian India Pvt Ltd, Kolkata engaged in manufacturing and supply of aggregates andcomponents is committed to improved Environment, Health and Safety performance continuallythrough:  Prevention of pollution at all times throughout entire process of activity to give a clean environment.  Compliance at all items with legal and other requirements applicable to environmental aspect .  Conserving natural resources and preserving through 3 Rs:  Reduce,  Recycle, and  Reuse  Imbibing awareness and participation of all personnel working under the control of the organization at all levels through appropriate training.  Creating a safe working environment to prevent injury and ill health  Sharing information on safety hazards with all personnel working under the control of the organization and interested party. 21 | P a g e
  22. 22. Organisational structure:- Chairman & Managing DirectorDirector Director Director Director Director Director (HR) (Finance) (Projects) (Operation) (Commercials) (Technical)Executive Director Executive Director Executive Director Executive Director (East Region) (North Region) (South Region) (West Region) General Manager General Manager General Manager General Manager Kolkata New Delhi Chennai , Bangalore Mumbai 22 | P a g e
  23. 23. FINANCIAL HIGHLIGHTS:-Sales($ in 772.8 834.7 920.6 1012.5 806.7mn*)year 2005 2006 2007 2008 2009 23 | P a g e
  24. 24. Profit($ in 1.34 2.17 2.05 1.59 3.67 Mn*) year 2005 2006 2007 2008 2009 24 | P a g e
  25. 25. SWOT ANLYSISStrengths: -  The company is not able to respond very quickly as we have no red tape, no need for higher management approval, etc.  The company is able to give really good customer care, as the current small amount of work means we have plenty of time to devote to customers.  The company’s lead consultant has strong reputation within the market.  The company is able to change direction quickly if we find that our marketing is not working.  The company has small overheads, so can offer good value to customers.Weaknesses: -  The company has no market presence or reputation.  The company has a small staff with a shallow skills base in many areas.  The company is vulnerable to vital staff being sick, leaving, etc.  The company’s cash flow will be unreliable in the early stages.  Lack of consistency.Opportunities: -  The company’s business sector is expanding, with many future opportunities for success.  The company’s local council wants to encourage local businesses with work where possible.  The company’s competitors may be slow to adopt new technologies.Threats:  Will developments in technology change this market beyond our ability to adapt?  A small change in focus of a large competitor might wipe out any market position we achieves.  The consultancy might therefore decide to specialize in rapid response, good value services to local businesses. Marketing would be in selected local publications, to get the greatest possible market presence for where possible. 25 | P a g e
  26. 26. PART B:PROJECT REPORT 26 | P a g e
  27. 27. EXECUTIVE SUMMARYVARIAN INDIA PVT LTD is leading scientific instrument and vacuum technology manufacturerand supplier. It was started in 1948 in California by brothers RUSSEL and SIGURD VARIAN.VARIAN is one of the largest scientific instrument and vacuum technology manufacturing entitiesin the country. The company has spread its wings to reach its customers more effectively bysetting up five branches in India. (Kolkata, Chennai, Mumbai, New Delhi, Bangalore)Working capital (abbreviated WC) is a financial metric which represents operating liquidityavailable to a business, organization, or other entity, including governmental entity. Along withfixed assets such as plant and equipment, working capital is considered a part of operating capital.Net working capital is calculated as current assets minus current liabilities. It is a derivation ofworking capital that is commonly used in valuation techniques such as DCFs (Discounted cashflows). If current assets are less than current liabilities, an entity has a working capital deficiency,also called a working capital deficit. Working Capital = Current Assets Net Working Capital = Current Assets − Current Liabilities 27 | P a g e
  28. 28. RESEARCH DESIGNStatement of the problemWorking capital management is concerned with the problem arise in attempting to manage thecurrent assets, current liabilities and interrelation between both. It operational goal is to managethe smooth functioning of day-to- day operation of an organization.Objective of the StudyThe objectives of the study are: 1. To know how the working capital requirement of the organisation are managed 2. To know the importance and requirement of working capital management for the smooth functioning of the organisation. 3. To study the working capital components such as receivables accounts, cash management, Inventory position 4. To recommend any changes, if required.Limitations of the study Following limitations were encountered while preparing this project: 1) Limited data: - This project has completed with annual reports; it just constitutes one part of data collection i.e. secondary. There were limitations for primary data collection because of confidentiality. 2) Limited period: - This project is based on five year annual reports. Conclusions and recommendations are based on such limited data. The trend of last five year may or may not reflect the real working capital position of the company 3) Limited area: - Also it was difficult to collect the data regarding the competitors and their financial information. Industry figures were also difficult to get. 28 | P a g e
  29. 29. Types of data collection There are two types of data collection methods available. 1. Primary data collection:- The data which is collected fresh or first hand, and for first time which is original in nature. Primary data can collect through personal interview, questionnaire etc. to support the secondary data. 2. Secondary data collection:- The secondary data are those which have already collected and stored. Secondary data easily get those secondary data from records, journals, annual reports of the company etc. It will save the time, money and efforts to collect the data. Secondary data also made available through trade magazines, balance sheets, books etc. This project is based on primary data collected through personal interview of head of account department, head of SQC department and other concerned staff member of finance department. But primary data collection had limitations such as matter confidential information thus project is based on secondary information collected through five years annual report of the company, supported by various books and internet sides. The data collection was aimed at study of working capital management of the company. The data required for the study was taken from the Finance department; some of the data were also taken from the sales department and purchase department. Thus all the data collected were of secondary type and no primary data was taken and used. Some of the employees were interviewed to know about the prevailing, which helped to great extent in making decisions about the importance of the items.Data collection technique The methodology adopted to collect the primary data was Personal Interview Methods, while at the same time secondary data are taken from company magazine. 29 | P a g e
  30. 30. Sampling DesignType of sampling: Systematic sampling to the employeesSample size: 6Area of sampling: Finance Dept. Varian India Pvt Ltd.Sample collection Technique: Personal Interview 30 | P a g e
  31. 31. Working Capital :-Definition of working capitalThe Capital required to run the day-to-day operation of an organization is known as WorkingCapital. It can be either gross working capital or net working Capital. Gross working capitalmeans the total of the all current assets whereas Net working capital means the difference betweenthe total Current assets and Current liabilities.WORKING CAPITAL = CURRENT ASSETS – CURRENT LIABILITIESCurrent assets are those assets which will be converted in to cash within the current accountingperiod or within the next year as a result of the ordinary operation of the business. They are cashor near cash resources. These include:  Cash and Bank balances  Receivables  Pre-Paid expenses  Short-term advances  Temporary advance  Inventory  Raw materials, stores and spares  Work-in-Progress  Finished goodsThe value represented by these assets circulates among several items. Cash is to buy rawmaterials, to pay wages to meet others manufacturing expenses. Finished goods are produced.These are held as inventories. When these are sold, accounts receivables are created. Thecollections of accounts receivable bring cash into the firm. The cycle starts again 31 | P a g e
  32. 32. Cash Inventories ReceivablesCurrent liabilities are the debts of the firms that have to be paid during the current accountingperiod or within the a year. These include:  Creditors for goods purchased  Outstanding expenses i.e., expenses due but not paid  Short-term borrowings  Advances received against sales  Taxes and Dividends payable  Other liabilities maturing within a year.Working capital is also known as circulating capital, fluctuating capital and revolving capital .Themagnitude and composition keep on changing continuously in the course of business.Every business needs adequate liquid resources in order to maintain day-to-day cash flow. It needsenough cash to pay wages and salaries as they fall due and to pay creditors if it to keep itsworkforce and ensure its supplies.Maintaining adequate working capital is not just important in the short –term. Sufficient liquiditymust be maintained in order to ensure the survival of the business in the long-term as well.Even a profitable business may fail if it does not have adequate cash flow to meet its liabilities asthey fall due. 32 | P a g e
  33. 33. Therefore, when businesses make investment decisions they must not only consider the financialoutlay involved with acquiring the new machine or the new building ,etc, but must also takeaccount of the additional current assets that are usually involved with any expansion of activity.Increased production increases need to hold more stock of raw material and work-in-progress.Increased sales usually mean that the level of debtors will increase. A general increase in thefirm’s scale of operations tends to imply a need for greater levels of cash.Permanent and Temporary Working CapitalConsidering times as the basis of classification, there are two types of working capital viz,‘Permanent and Temporary working capital.Permanent working capital represents the assets required on continuing basis over the entire year,whereas temporary working capital represents additional assets required at different times duringof the year.A firm will finance its seasonal and current fluctuation business operation through short-term debtfinancing. For example, in Peak season, more raw material to be purchased, more manufacturingexpenses to be incurred, more funds will be locked in debtors balance etc. In such times excessrequirement of working capital will be financed from short –term financing sources.The permanent components current assets which are required throughout the year will generallybe financed from long-term debt and equity. Tandon Committee has referred to this types ofworking capital as ‘Core Current Assets’.Core current Assets are those required by the firm to ensure of operations which represents theminimum levels of various items of current assets viz., stock of raw material, stock of work-in-process, stock of finished goods, debtors balance, cash and bank etc. This minimum level ofcurrent assets will be financed by the long –term sources and any fluctuation etc. This minimumlevel of current assets will be financed by long term sources and any fluctuation over the level of 33 | P a g e
  34. 34. the current assets will be financed by the short-term financing. Sometimes core current assets arealso referred to as ‘Hard core working capital’ Temporary short term Current Financing assets Rs. Long term=Debt + Equity Capital Fixed assets 0 TimeThe management of working capital is concern with maximising the return to shareholder withinthe accepted risk constraints carried by the participants in the company. WORKING CAPITAL NEEDS OF A BUSINESSDifferent industries have different optimum working capital profiles, reflecting their method ofdoing business and what they are selling. • Business with a lot of cash sales and few credit sales should have minimal trade debtors. Supermarkets are good examples of such businesses. 34 | P a g e
  35. 35. • Business that exists to trade in completed products will only have finished goods in stock. Compared this with manufactures who will also have to maintain stock of raw material and work-in-progress. • Some finished goods, notably foodstuffs, have to be sold within a limited period because of their perishable nature. • Larger companies may be able to use their bargaining strength as customers to obtain more favourable, extended credit terms from suppliers. By contrast, smaller companies, particularly those that have recently started trading (and do not have a record of accomplishment of credit worthiness) may be required to pay their suppliers immediately. • Some business will receive their monies at certain times of the year, although they my incur expenses thought the year at a consistent level. This is often known as “seasonality” of the cash flow. For example, travel agents have peak sales in the weeks immediately following Christmas.Working Capital CycleIntroductionThe working capital cycle can be define as:The period of time, which elapses between the point at which cash begins to be expended on theproduction of a product and the collection of cash from customer?Cash is used to buy raw material and other stores, so cash is converted into raw material and storesinventory. Then the raw material and stores are issued to the production department. Wages arepaid and other expenses are incurred in the process and work-in-process comes into existence.Work –in-process becomes finished goods. Finished goods are sold to customer on credit. In thecourse of time these customer pay cash for the goods purchase by them. ‘Cash’ is retrieved and thecycle is completed. Thus, working capital cycle consists of four stage. • The raw material and stores inventory stage • The work-in-progress stage 35 | P a g e
  36. 36. • The finished goods inventory stage • The receivable. • The diagram below illustrates the working capital cycle for a manufacturing firm. Work-In- progressRaw material stock Finished goods stock Wages & overheads sales Trade creditors Trade debtors Selling expenses Cash Taxation Shareholders Fixed assets loan Creditors 36 | P a g e
  37. 37. Lease paymentThe upper portion of the diagram above shows in a simplified from the chain of a events in amanufacturing firm. Each of the boxes in the upper part of the diagram can be seen as a tankthrough which funds flow. These tanks, which are concerned with day-to-day activities, havefunds constantly following into and out of them. • The chain starts with the firm buying raw material on credit. • In due course, this stock to be used in production ,work will be carried out on the stock, and it will become part of the firm’s work in progress( WIP) • Work will continue on the WIP until it eventually emerges as the finished product. • As production progresses, labour costs and overheads will need to be met. • Of course, at some stage trade creditors will need to be paid • When the finished goods are sold on credit, debtors are increased • They will eventually pay, so that cash will be injected into the firm Each of the areas –stocks (raw material, work in progress and finished goods), trade debtors, cash (positive or negative) and trade creditors-can be viewed as tanks into and from which funds flow. Working capital is clearly not the only aspect of a business that affects the amount of cash: • The business will have to make payments to government for taxation • Fixed assets will be purchased and sold • Lesser of fixed assets will be paid their rent. • Shareholders (existing or new) may provide new funds in the form of cash. • Some shares may be redeemed for cash. • Dividends may be paid. • Long –term loan creditors (existing or new) may provide loan finance ,loan will need to be repaid from time to time , and 37 | P a g e
  38. 38. • Interest obligation will have to be met be the business.Unlike movement in the working capital items, most of this ‘non- working capital’ cashtransaction is not every day events. Some of them are annual events (e.g. tax payments, leasepayment, dividends, interest and possibly, fixed assets purchase and sales). Others (e.g. newequity and loan finance and redemption of old equity and loan finance would typically be rarerevents.Working capital cycle involves conversions and rotation of various constituents/components of theworking capital. Initially ‘cash ‘converted into raw materials.Subsequently ,with the usages of fixed assets resulting in value additions ,the raw material getconverted into work in process and then into finished goods. When sold on credit, the finishedgoods assume the form of debtors who give the business cash on due date. Thus, ‘cash’ assumesits original form against at the end of one such working capital cycle but in the course it passesthrough various other forms of current assets too. This is how various components of currentassets keep on changing their forms due to value addition.As a result, they rotate and business operation continues. Thus, the working capital cycle involvesrotation of various constituents of the working capital.While managing the working capital, two characteristics of current assets should be kept in mindviz. 1. Short life span 2. Swift transformation into other form of current assets.Each constituent of current assets has comparatively very short life span. Investment remains in aparticular form of current assets for a short period. The life span of current assets depends uponthe time required in the activities of procurement, production, sales and collection and degree ofsynchronisation among them. A very short life span of current assets results into swifttransformation into other form of current assets for a running business. These characteristics havecertain implication- 38 | P a g e
  39. 39. i. Decision regarding management of the working capital has to be taken frequently and on a repeat basis. ii. The various components of the working capital are closely related and mismanagement of any one component adversely affects the other components too. iii. The difference between the present value and the book value of profit is not significant. The working capital has the following components, which are in several form of current assets: 1. Stock of cash 2. Stock of raw material 3. Stock of finished goods 4. Value of debtors 5. Miscellaneous current assets like short term investment loans & advances.Factors Determining the working Capital RequirementThe is not set of universally applicable rules to ascertain working capital needs of a businessorganisation. The factors which influence the need level are discussed below.  Nature of Enterprise:- The nature and the working capital requirement of an enterprise are interlinked. While a manufacturing industry has a long cycle of operation of the working capital, the same would be short in an enterprise involved in providing service. The amount required also varies as per the nature; an enterprise involved in production would required more working capital than a service sector enterprise.  Manufacturing / Production Policy: Each enterprise in the manufacturing sectors has its own production policy, some follow the policy of uniform production even if the demand varies from time to time, and others may follow the principle of ‘demand-based production’ in which production is based on 39 | P a g e
  40. 40. the demand during that particular phase of time. Accordingly, the working capital requirement varies for both of them. Operation: The requirement of working capital fluctuates for seasonal business. The working capital needs of such businesses may increase considerably during the busy season and decrease during the slack season. Ice creams and cold drinks have great demand during summers; while winter the sales are negligible. Market Condition:- If there is high competition in the chosen product category, then one shall need to offer sops like credit, immediate delivery of goods etc, for which the working capital requirement will be high. Otherwise, if there is no competition or less competition in the market then the working capital requirement will be low. Availability of Raw material:- If raw material is readily then one need not maintain a large stock of the same, thereby reducing the working capital investment in raw material stock. On the other hand, if raw material is not readily available then a large inventory/ stock needs to be maintained, thereby calling for substantial investment in the same. Growth and Expansion:- Growth and expansion in the volume of business result in enhancement of the working capital requirement. As business grows and expands, it needs a larger amount of working capital. Normally the need for increased working capital funds precedes growth in business activities. Manufacturing Cycle :- The manufacturing cycle starts with the purchase of raw material and is completed with the production of finished goods. If the manufacturing cycle involves a longer period, the need for working capital would be more. At times, business needs to estimate the 40 | P a g e
  41. 41. requirement of working capital in advance for proper control and management. The factor discussed above influence the quantum of working capital in the business. The assessment of working capital requirement is made keeping these factors in view. Each constituent of working capital retains its form for a certain period and that holding period is determined by the factors discussed above. So for correct assessment of the working capital cycle requirement, the duration at various stages of the working capital estimated. Thereafter, proper value is assigned to the respective current assets, depending on its level of completion. Each constituent of the working capital is valued on the basis of valuation enumerated above for the holding period estimated. The total of all such valuation becomes the total estimated working capital requirement. The assessment of the working capital should be accurate even in the case of small and micro enterprise where business operation is not very large. We know that working capital has a very close relationship with day-to-day operation of a business. Negligence in proper assessment of the working capital, therefore, cans affect the day-to day operation severely. It may lead to cash crisis and ultimately to liquidation. An inaccurate assessment of the working capital may cause either under- assessment or over assessment of the working capital and both of them are dangerous.CONSEQUENCES OF UNDER ASSESSMENT ON THE WORKINGCAPITAL.  Due to lack of funds, payment of salaries may become irregular.  Inadequate working capital may lead to non-payment of creditors’ amount in time.  It will not allow the organization to produce the demanded number of items.  Growth may by stunted. It may become difficult for the enterprise to undertake profitable project due to non-availability of working capital.  Implementation of operating plans may become difficult and consequently the profit goals may be achieved.  Cash crisis may emerge due to paucity of working funds. 41 | P a g e
  42. 42.  Optimum capacity utilisation of fixed assets may not achieved due to non – availability of the working capital.  The business may fail to honour its commitment in time, thereby adversely affecting its credibility. This situation may lead to business closure.  The business may be compelled to buy raw material on credit and sell finished goods on cash. In the process it may end up with increasing cost of purchase and reducing selling by offering discounts. Both these situation would affect profitability adversely.  Non-availability of stock due to non- availability of funds may result in production stoppage.  While underassessment of working capital has disastrous implication on business, over assessment of working capital also has its own dangers.CONSEQUENCES OF OVER ASSESSMENT ON WORKING CAPITAL  Idle funds which will earn no profit.  It may lead to unnecessary purchase.  It may allow the change of misuse of funds.  It reduces the overall efficiency of the organization.Excess of working capital may result in unnecessary accumulation of inventory. It may lead tooffer too liberal credit terms to buyers and very poor recovery system and cash management. Itmay make management complacent leading to its inefficiency.Over-investment in working capital in makes capital less productive and reduces return oninvestment. Working capital is very essential for success of a business and, therefore, needsefficient management and control. Each of the components of the working capital needs propermanagement to optimise profit.IMPACT OF INFLATION ON WORKING CAPITAL REQUIREMENT. 42 | P a g e
  43. 43. When the inflation rate is high, it will have its direct impact on the requirement of the working capital as explained below: 1. Inflation will cause to show the turnover figure at higher level even if there is no increase in the quantity of sales. The higher the sales means the sales means the higher level of balance in receivables. 2. Inflation will result in increase of raw material prices and hike in payment for expenses and as a result, increase in balance of trade creditors and creditors for expenses. 3. Increase in valuation of closing stocks result in showing higher profit but without its realisation into cash causing the firm to pay higher tax, dividends and bonus. Thus will lead the firm in serious problem of fund shortage and firm may unable to meet its short-term and long term obligation. 4. Increase in investment is current assets means the increase in requirement of working capital without corresponding increase in sales or profitability of the firm.Keeping in view of the above, the finance manager should be very careful about the impact ofinflation in assessment of working capital requirement and its management.IMPACT OF DOUBLE SHIFT WORKING CAPITAL REQUIREMENT • Working capital in double shift means requirement of raw material will be doubled and other variable expenses will also increase drastically. • With the increase in raw materials requirement and expenses, the raw material inventory and work-in- progress will increase simultaneously the creditors for goods and creditors for expenses balances will also increase. • Increase in production to meet the increased demand which will also increase the stock of finished goods. The increase in sales means increase in debtors balance. • Increase in production will result in increased requirement of working capital. • The fixed expenses will increase with the working capital on double shift basis. 43 | P a g e
  44. 44. Zero working capitalThe idea is to have zero working capital i.e. at all times the current assets shall equal the currentliabilities. Excess investment in current assets is avoided and firm meets its current liabilities outof the matching current assets.As current assets ratio 1 and the quick ratio below 1, there may be apprehension about theliquidity, but if all current assets are performing and are accounted at their realisable values, thesefears are misplaced. The firm saves opportunity cost on excess investment current assets and asbank cash credit limits are linked to the inventory levels, interest costs are also saved. There wouldbe self-imposed financial discipline on the firm to manage their activities within their currentliabilities and current assets and there may not be tendency to over borrow or divert funds.Adequate Working CapitalWorking capital is the lifeblood of the organization. Without working capital, the functioning ofan organization will come to a halt. No business can run successfully without adequate amount ofworking capital. The main advantages of adequate working capital are as follows:-Solvency of the businessAdequate working capital helps in smooth running of the business. The generates revenue andmaintains the solvency of the organization.GoodwillSufficient working capital helps to makes prompt payments to the creditors, which maintain thegoodwill of the organization. 44 | P a g e
  45. 45. Easy LoanOrganizations having adequate working capital are viewed by the banks as good candidates tooffer the loan facilities.Cash DiscountsCompanies can make use of the discount facilities that come along with the repayment of thecredit.Regular supply of Raw MaterialAdequate working capital helps to make regular payment to the supplier.Regular payment of SalariesIt helps to make regular payments of salaries to the employees, thereby keeping their moral high.Working Capital LeverageOne of the important objectives of the working capital management is by maintaining theoptimum levels of the investment in current assets and reducing the level of current liabilities, thecompany can minimise the investment in working capital thereby improvement in Return onCapital employed is achieved. The term working capital leverage refers to the impact of level ofworking capital on company’s profitability. The working capital management should improve theproductivity of investment in current assets and ultimately it will increase the return on capitalemployed. Higher levels of investment in current assets than is actually required mean increase inthe cost of interest charges on the short-term loans and working capital finance raised from banksetc, and will result in lower return on capital employed and vice versa. Working capital leveragemeasures the responsiveness of ROCE for charges in current assets. It is measured by applying thefollowing formula.Working Capital leverage = C. A 45 | P a g e
  46. 46. T.A – C.AWhere, C.A = Current assets T.A = Total assets (i.e., Net fixed assets + Current assets) C.A = Change in Current assetsApproaches to working Capital FinanceEvery organization requires financing its working capital requirement. Generally, there are twosource of finance. One is long- term source and the other is short-term source. Long term isconsidered less risky as the period is high and the amount repayment period is high and theamount of interest is low. The short-term sources are considered risky as they have to be repayingwithin a very short period and the interest rate is very high. 1. Conservative working capital Approach A conservative approach suggests carrying high levels of current assets in relation to sales. Surplus current assets enable the firm to absorb sudden variations in sales, production plans and procurement time without disrupting production plans. Additionally, the higher liquidity levels reduce the risk of insolvency. But lower risk translates into lower return. Larger investment in current assets leads to higher interest and carrying costs and encouragement for inefficient. But conservative policy will enable the firm to absorb day to day business risk. Under this approach long –term financings covers more than the total requirement for working capital. The excess cash is invested in short term marketable securities and in need, theses securities are sold off in the market to meet the urgent requirement of working capital. 46 | P a g e
  47. 47. Secular GrowthRs. Long-Term Financing Seasonal Variations Investment Marketable securities Time2. Aggressive working capital Approach Under the approach current assets are maintained just to meet the current liabilities without keeping any cushion for the variation in working capital needs. The core working capitals financed by long-term sources of capital and seasonal variations are met through short- term borrowings. Adoption of this strategy will minimise the investment in net working capital and ultimately it lower the cost of financing working capital. The main drawback of 47 | P a g e
  48. 48. this approach is that it necessitates frequent financing and also increase risk as the vulnerable to sudden shocks.Rs. Seasonal Variation Short term Financing Secular growth Long- term Financing Time 3. Matching working Capital approach Under this approaches, manager undertake only the required amount of risk. The fixed portion of working capital is financed from long-tem sources. Here the source of financing is matched with the components of working capital. 48 | P a g e
  49. 49. Financing working capital Now let us understand the means to finance the working capital. Working capital or current assets are those assets, which unlike fixed assets change their form rapidly. Due to this nature, they need to be finance through short-term funds is also called current liabilities. The following are the also called current liabilities. The following are the major sources of raising short-term funds.1. Supplier’s Credit At times, business gets raw material on credit from the suppliers. The cost of raw material is paid after some time, i.e. upon completion of the credit period. Thus without having an outflow of cash the business is in position to use raw material and continue the activities. The credit given by the suppliers of raw material is for a short period and is considered current liabilities. These funds should be used for creating current assets like stock of raw material, work in process, finished goods, etc. A. Bank Loan This is a major source for raising short-term funds. Banks extend loans to business to help them create necessary current assets so as to achieve the required business level. The loans are available for creating the following current assets. • Stock of raw materials • Stock of work in process • Stock of finished goods • Debtors. Banks give short-term loans against these assets, keeping some security margin. The advances given by banks against current assets are short term in nature and banks have the right to ask for immediate repayment if they consider doing so. Thus, bank loans for creation of current assets are also current liabilities. B. Promoter’s Fund 49 | P a g e
  50. 50. It is advisable to finance a portion of current assets from the promoters’ funds. They are long termfunds and therefore do not require immediate repayment. These funds increase the liquidity of thebusiness.Committee Recommendation for working capital finance. 1. Tandon committee recommendation The committee has three method of working out the maximum amount that a unit may expect from the bank. The extent of bank finance will be more in the first method, less in the second method and least in the third method. First Method:- Total Current assets :- ***** (-) Current Liabilities :- ***** (Other than long-term Borrowing) 25% of above from Long-term sources :- ****** Balance MPBF :- ***** MPBF: - Maximum Permissible Bank Finance Second Method Total Current assets :- ***** 50 | P a g e
  51. 51. (-) 25% of above from Long-term sources :- ******(-) Current Liabilities :- *****(Other than long-term Borrowing)Balance MPBF :- *****Third MethodTotal Current assets :- *****(-) Core Current assets :- *****From long-term source Real current assets(-) 25% of above from Long-term sources :- ******(-) Current Liabilities :- *****(Other than long-term 51 | P a g e
  52. 52. Borrowing) Balance MPBF :- ***** *MPBF – Maximum Bank Finance 2. Chore Committee recommendation. 3. Vaz Committee recommendation. 4. Nayak Committee recommendation:- • To give preference to village industries, tiny industries and other small scale units . • For the credit requirement of village industries ,tiny industries and other SSI units up to aggregate funds based working capital credit limits up to Rs. 50 lacs from banking system, the norms for inventory and receivable as also the method of lending as per Tandon Committee will not apply . instead ,for such units the working capital limit will be computed at 20% of their projected annual turnover (for both new as well as existing units) .These SSI units will be required to bring in 5% of their annual turnover as margin money. In other words 25% of the output value should be computed as working capital requirement ,of which at least 4/5th should be provide by banking sectors, the remaining 1/5th representing borrower’s contribution towards margin money for the working capital. Method for estimating working capital requirement. There are three methods for estimating the working capital requirement of a firm:1. Percentage of Sales Method:-It is traditional and simple method of determining the level of working capital and its components.In the method, working capital is determined on the basis of past experience. If , over the years,the relationship between sales and working capital is found to be stable ,then this relationship maybe taken as a base for determining the working capital. 52 | P a g e
  53. 53. 2. Regression analysis method :-it is a useful statistical technique applied for forecasting working capital requirements. It helps inmaking working capital requirement projection after establishing the average relationship betweensales and working capital and its various components in the past years. The method of least squareis used in this regard.3. Operating cycle method:- The following methods are used in operating cycle approach: • Total operating cycle Duration Approach Working capital requirement is estimated using the following formula Estimated cost of goods sold x Operating Cycle + desired cash 365 balance • Estimated working capital Estimated cost of goods sold x Operating Cycle + desired cash 360 balance • Individual component approach Detailed estimation is made using the individual component of the operating cycle. Inventory Management Introduction: Inventory includes all types of stocks. For effective working capital management, inventory needs to be managed effectively. The level of inventory should be such that the total cost of ordering and holding cost inventory is the least. Simultaneously, stock out costs should also be minimised. Business, therefore, should fix the minimum safety stock level, re-order level and ordering quantity so that the inventory cost is reduced and its management becomes efficient. 53 | P a g e
  54. 54. Every organisation required to maintain inventory for smooth running of its activities. The investment in inventories constitutes the major proportion of the current assets. Therefore, it is essential to have proper control and management of inventories. The purpose of inventory management is to insure availability of material in right quality, in right time and at right place. Purpose of Following Inventory i. Transaction Motive:- In order to have smooth and continuous operation, the organizations maintain inventory. ii. Precautionary Motive :- In order to satisfy the fluctuating demands and supply as well as some emergency like strikes, etc., inventory is maintained.iii. Speculative Motive :- In order to take advantage of the price changes, organizations sometimes maintain inventory to make profit. Objective of Inventory Management: In the context of inventory management, the firm can face the problem of meeting two conflicting needs: • To maintain a large size of inventories of raw material and work-in-progress for efficient and smooth production and of finished goods for uninterrupted sales operation. • To maintain a minimum investment in inventory to maximize profitability. Both excessive and inadequate inventories are not desirable. These are two danger points, which the firm should avoid. The objective of inventory management should be to determine and maintain optimum level of inventory investment. The optimum level of inventory will lie between the two –danger points of excessive and inadequate inventories. 54 | P a g e
  55. 55. The firm should always avoid a situation of over investment and under investment in inventories. The major dangers of over investment are: • Unnecessary tie up of the firm’s funds • Excessive carrying cost • Risk of liquidityThe excessive level of inventories consumes funds of the firm, which cannot be use for any otherpurpose, and thus, it involves an insurance, recording and inspection increase in proportion to thevolume of inventory. These costs will impair the firm’s profitability further. Excessive inventoriescarried for long period increase chances of loss of liquidity. It may not be possible to sellinventories in time and full value. Raw materials are generally difficult to sell as the holdingperiod increases. There are exceptional circumstances where it may pay to the company to holdstock of raw materials. This is possible under the conditions of inflation and scarcity. Anotherdanger of carrying inventory is the physical deterioration of inventories in storage.An effective inventory management should in case of certain goods of raw material, deteriorationoccurs with the passage of time, or it may be due to mishandling and improper shortage facilities.Maintaining an inadequate level of inventories is also dangerous. The consequences of under-investment in inventories are: a. Production hold-ups, and b. Failure to meet delivery commitments.Inadequate raw material and work-in-progress inventories will result in frequent productioninterruption; similarly, if finished goods are not sufficient to meet the demand of customerregularly, they may shift to competitors, which will amount to a permanent loss to the firm. Theaim of inventory management, thus, should be to avoid excessive and inadequate levels ofinventories and to maintain sufficient inventory for the smooth and sales operation effort should. ⇒ Ensure a continuous supply of raw material to facilitate uninterrupted production. ⇒ Maintain sufficient stock of raw material in period of short supply and anticipate price 55 | P a g e
  56. 56. changes. ⇒ Maintain sufficient finished goods inventory for smooth sales operation and efficient customer service. ⇒ Control investment in inventories and keep it at an optimum level.Inventory Management Techniques:  Economic Order Quantity- EOQ = (2AB) 2 (CS) 2 Where, EOQ = Economic Order Quantity. A = Annual Consumption B = Buying cost per order C = Cost per unit S = Storage and other inventory carrying cost  Fixation of Inventory Levels- The following levels of inventory are fixed for efficient management of inventory:  Re-Order Level: - Re-order level is the level of the stock availability when a new order should be raised. Re-Order level= Maximum usage X Maximum lead time  Minimum Stock Level: - Minimum stock level is the lower limit which the stock of any stock items should not normally be allowed to fall. Their level is also called safety stock or buffer stock level 56 | P a g e
  57. 57. Minimum stock Level = Re-order level – (Average or Normal Usage X average lead time)  Maximum Stock Level: - Maximum stock levels represent the upper limit beyond which the quantity of any item is not normally allowed to rise. Maximum level = Re-order level + EOQ – (Minimum usage X Minimum lead time)  Danger level: - Danger level of stock is fixed below the minimum stock level and if stock reaches below this level. Danger Level = Average consumption X Lead time emergency Period.  VED Analysis ( Vital, Essential, & Desirable)  FNSD Analysis ( Fast moving items, Normal moving items, Slow moving items & Dead stock)  Pareto Analysis ( 80 : 20 Rule)  ABC Analysis  Two Bin system  Perpetual Inventory system  Continuous stock taking  Periodic stock taking system  Input-Output Ratio  Stock Turnover RatioReceivables ManagementGiven a choice, every business would prefer selling its produce on cash basis. However due tofactors like trade policies, prevailing marketing conditions etc., businesses are compelled to selltheir goods on credit. In certain circumstances, business may deliberately extend credit as astrategy of increasing sales. Extending credit means creating current assets in the form of‘Debtors’ or Accounts Receivable. Investment in this type of current assets needs proper andeffective management as it to cost such as: 57 | P a g e
  58. 58. a. Carrying cost – This cost includes the interest on capital blocked in the debtors balance the administration costs associated with the credit decision making and controlling of debtors balances, cost of keeping the records of credit sales and payment ,cost of collection of payments from customers , opportunity cost of cost of capital that can be employed elsewhere than in debtors balances. b. Default risk:- There are also costs associated with the risk of default a certain portion of debtors will never pay, and will become ‘Bad debts’ which has to be written off of the profits of the firm. Thus the objective of any management policy pertaining to account receivable would be ensure that the benefit arising due to the receivables are more than the cost incurred for receivable and the gap between benefit and cost increases profit. An effective control of receivables helps a great deal in properly managing it. Each business should, therefore ,try to find out average credit extended to its client using the below given formula. Average credit = Total amount of receivables Extended (in days) Average credit sales per dayEach business should project expected sales and expected investment in receivables based onvarious factors, which influence the working capital requirement. Form this it would bepossible to find out the average credit days using the above given formula. A business shouldcontinuously try to monitor the credit days and see that the average credit offered to clients isnot crossing the budgeted period. Otherwise, the requirement of investment in the workingcapital would increase and, as a result, activities may get squeezed. This may lead to cash crisis. 58 | P a g e
  59. 59. Cash discount Cash discounts are offered by the seller to the customer to encourage early payment. This is to encourage payment before the end of the credit period –cash discounts are cost to the seller and benefit to the buyer. Credit Rating Customer For credit rating customer the following information will be collected and processed, depending upon which the individual limits and the term will be fixed to each individual credit limits and the terms will be fixed each individual customer. • The experience of sales force • Financial statement of the customer • Bank checking • Company’s own experience • Statistical data available with credit rating agencies. The credit manager should check the following five C’sCharacter- relates to the customer’s willingness to payCapacity- The customer should have ability to pay his dues.Capital- The customer should have sufficient funds to pay the dues.Collateral- The security available with the customer in paying the debt.Condition- The economic position of the customer.Credit Policy 59 | P a g e
  60. 60. A firm establish its own credit policy for proper management of debtors, otherwise it will leadmore outstanding balance in debtors account and the risk of bad debts will also arise.Receivable collection policySometimes a customer fails to pay on the due date. The following procedure will help inefficient collection of overdue debtors.  A reminder  A personal letter  Several telephone calls  Personal visit of salesman  A telegram  A visit from salesman responsible to customer  A reminder to the sales person that commission is based on cash received not invoice sales.  Restriction of credit.  Use of collection agencies.  Legal action : as a resortProcess of Receivables ManagementThe Following process will help in efficient management of the receivable.  Take the opinion of the sales force and internal staff  Frame the credit terms for the customer if credit is sanctioned.  Established the initial creditworthiness.  Check the credit before the despatch of consignment.  Close monitoring of the credit terms and customer compliance. 60 | P a g e
  61. 61.  Develop the report for internal appraisal of the customer. Cash Management Cash represent the liquid form of assets in an organization. A business should also maintain adequate amount of cash to met its obligation . any shortage of cash will leads to disruption of operation. If excess cash is maintained then it does not earn any profit for the organisation . so maintaining adequate amount of cash , cash management is an important function of the organization. Cash is required to meet the business obligation and it is unproductive when it is not used. The following are the various aspects of cash management: a) Cash inflow and outflow b) Cash flow within the firm c) Cash balance held by the firmFollowing are the tools used by the organization: a) Cash Planning it is the technique to plan and control the use of cash. A projected cash flow statement is prepared showing the future payment and receipts of cash b) Cash forecast and budgeting: Cash budget is the most important tool in the hands of an organization to manage cash. It can be prepared on a daily basis, weekly basis or monthly basis. A cash budget typically shows the receipt of cash and the payment of cash during a future period. At the end, cash budget shows the cash balance for the period. Either it can be deficit or surplus cash balance. 61 | P a g e
  62. 62. Cash is the liquid current assets. It is of vital importance to the daily operation of business. While the proportion of assets helps in the form of cash is very small, its efficient management is crucial to the solvency of the business. Therefore, planing cash and controlling its use are very important tasks. Cash budgeting is a useful device for this purpose.Effects of cash DeficitsThe cash balance shortage can result in the making of sub-optimal investment decision and sub-optimal financing decisions:  Sub –optimal investment decision : These decision would includes the disposal of profitable lines of division, inability profitable investment project , failure to maintain an adequate level of working capital.  Sub –optimal financing decision: These decisions would include the taking out of very expensive loans and being granted overdraft facilities subject to restrictive convents which could include personal guarantees from directors, restrictions on investment, and restriction on additional finance.Cash BudgetCash budget incorporates estimate of future inflow and outflows of cash over a projected shortperiod, which may usually be a year, a half or a quarter year. Effective cash management isfacilitated if the cash budget is further broken down into month, week or even on daily basis.There are two component of cash budget: (1) Cash Inflows and (2) Cash outflows The main sources for these flows are given hereunder: Cash inflow: 62 | P a g e
  63. 63. (a) Cash sales (b) Cash received from debtors (c) Cash received from loans, deposit ,etc. (d) Cash receipt of the revenue income (e) Cash received from sale of investment or assets. Cash Outflows: (a) Cash purchase (b) Cash payment to creditors (c) Cash payment for other revenue expenditure (d) Cash payment for assets creation (e) Cash payment for withdrawals, taxes (f) Repayment of loan, etc.In preparation of cash flow budgets the following points are considered :  Credit period allowed to debtors  Credit period allowed by creditors to the company for good and services.  Payments of dividends, taxation and capital expenditure etc., and the month when cash payments are expected to be made.  Non- consideration of transaction which have no impact on cash flow e.g Deprecation.  The bank overdraft limits allowed.  Dealing with the surplus cash e.g putting in marketable securities.  Dealing with the cash deficit.  Trends of sales.  Period of debt payment.  Raising long-term funds during the course of cash budget etc. 63 | P a g e
  64. 64. Method of cash flow budgetingCash flow budget is a detailed budget of income and cash expenditure incorporating bothrevenue and capital items. The cash flow budget can be prepared in the following ways : 1. Receipts and payment method : In this method all the expected receipt and payment for budget period are considered . all the cash inflow and out flow of all functional budget including capital expenditure budget are considered . accruals and adjustments in account will not affect the cash budget. 2. Adjusted Income Method: In the method the annual cash flow are calculated by adjusted the sales revenues and cost figures for delays in receipts and payment and eliminating non-cash items such as deprecation. 3. Adjusted Balance sheet method: in this method, the budgeted balance sheet is predicted by expressing each type of asset and short-term liabilities as percentage of the expected sales. Cash Management Models The following method are useful in management of cash.  Baumol’s Model:- Baumol’s (1952) suggested that cash may be managed in the same way as any other inventory and that the inventory model reasonably reflect the cost- volume relationship as well as the cash flows. In the model, the carrying cost of holding cash-namely the interest forgone on marketable securities is balance against the fixed cost of transferring marketable securities to each, or 64 | P a g e
  65. 65. vice-versa. The Banmol’s model find a correct balance by combining holding cost andtransaction cost so as to minimise the total cost of holding cash. Baumol’s model assumesthat the rate of cash usage is constant and known with certainty. The optimal level of C isfound to be : C = (2BT)2 (I)2 Where, C = optimal transaction size B = fixed cost per transaction T = Estimed cash payment during the period I = interest on marketable securities p.a Limitation  This model can be applied only when the payment position can be reasonably  Degree of uncertainty is high in predicting the cash flow transaction  The model merely suggest only the optimal balance under a set of assumption.  Miller-Orr –Model:The Miller –Orr-model (1966) specifies the following two control limit. H - Upper control Limit O - Lower control Limit Z - The return point for cash balance 65 | P a g e
  66. 66. ANALYSIS AND INTERPRETATIONTYPES OF RATIO:-There are a number of types of ratio of interest to the various stakeholders of a business. The mainclassification of ratio is as follows:Profitability Ratios:Measure the relationship between gross/net profit and sales, assets and capital employed. Theseare sometimes referred as performance ratios.Activity Ratio:-These measure how efficiently an organization uses its resources. These are sometimes referred asassets utilization ratios.Liquidity Ratio:These measure the short-term and long term financial stability of the firm by examining therelationship between assets and liabilities. These are sometime called as solvency ratios.Investment Ratios: 66 | P a g e
  67. 67. This group of ratio is concerned with analysing the return for shareholder. These examine therelationship between the member of share issued, dividend paid , value of the shares, and companyprofits. For obvious reasons these are quite often categorized as shareholder ratios.Gearing :Examines the relationship between internal sources and external sources of finance. It is thereforeconcerned with the long-term financial position of the company.Profitability Ratios:A company should earn profits to survive and grow over a long period of time. Profits areessential but it would be wrong to assume that every action initiated by management of a companyshould be aimed at maximizing profits, irrespective of social consequences.Profit is the difference between revenues and expenses over a period of time. Profit is the ultimateoutput of a company and it will have no future if it fails to make sufficient profits. Therefore, thefinancial manager should continuously evaluate the efficiency of the company in terms of profits.The profitability ratios are calculated to measure the operating efficiency of the company.Generally, there are two types of profitability ratios1. Profitability in relation to sales2. Profitability in relation to investment o Net profit ratio o Operating profit ratio o Return on Investment 67 | P a g e
  68. 68. NET PROFIT RATIO:Net profit is obtained when operating expenses, interest and taxes are subtracted from the grossprofit. The net profit margin is measured by dividing profit after tax or net profit by sales. NET PROFIT RATIO= NET PROFIT SALES/INCOME FROM SERVICESYear Net Profit After Tax Income From Services Ratio2005-2006 18,259,580 55,550,649 0.332006-2007 40,586,359 96,654,902 0.42Interpretation: The net profit ratio is the overall measure of the firm’s ability to turn each rupee of incomefrom services in net profit. If the net margin is inadequate the firm will fail to achieve return onshareholder’s funds. High net profit ratio will help the firm service in the fall of income fromservices, rise in cost of production or declining demand. The net profit is increased because theincome from services is increased. The increment resulted a slight increase in 2007 ratio comparedwith the year 2006.OPERATING PROFIT RATIO: OPERATING EXPENSE RATIO= OPERATING PROFIT SALES/INCOME FROM SERVICES.Year Operating Profit Income From Services Ratio2005-2006 31,586,718 55,550,649 0.57 68 | P a g e
  69. 69. 2006-2007 67,192,677 96,654,902 0.70Interpretation:The operating profit ratio is used to measure the relationship between net profits and sales of afirm. Depending on the concept, it will decide. The operating profit ratio is increased comparedwith the last year. The earnings are increased due to the increase in the income from servicesbecause of Operations & Maintenance fee. So, the ratio is increased slightly compared with theprevious yearRETURN ON INVESTMENT: It is an index of profitability of business and is obtained by comparing net profit with capital employed. The ratio is normally expressed in the percentage. The term capital employed includes share capital, reserves and surplus, long term loans such a debentures. ROI = PAT / SHARE HOLDERS FUNDYear Profit After Tax Share Holders Fund Ratio2005-2006 18,259,580 56,473,652 0.322006-2007 40,586,359 97,060,013 0.42Interpretation: 69 | P a g e
  70. 70. This is the ratio between net profits and shareholders’ funds. The ratio is generally calculated aspercentage multiplying with 100. The net profit is increased due to the increase in the income from servicesant the shareholders funds are increased because of reserve & surplus. So, the ratio is increased inthe current yearACTIVITY RATIOS:Funds of creditors and owners are invested in various assets to generate sales and profits. Thebetter the management of assets, the larger is an amount of sales. Activity ratios are employed toevaluate the efficiency with which the firm manages and utilizes its assets these ratios are alsocalled turnover ratios because they indicate the speed with which assets are being converted orturned over into sales. Activity ratios, thus, involve a relationship between sales and assets. Aproper balance between sales and assets generally reflects that assets are managed well. • Fixed assets turnover ratio • Capital turnover ratio • Working Capital turnover ratioFIXED ASSETS TURNOVER RATIO:NET ASSETS TURNOVER RATIO= SALES/ INCOME FROM SERVICES NET FIXED ASSETSYear Income From Services Net Fixed Assets Ratio2005-2006 55,550,649 15,056,993 3.692006-2007 96,654,902 14,163,034 6.82Interpretation: 70 | P a g e
  71. 71. Fixed assets are used in the business for producing the goods to be sold. This ratio shows thefirm’s ability in generating sales from all financial resources committed to total assets. The ratioindicates the account of one rupee investment in fixed assets. The income from services isincreased in the current year due to the increase in the Operations & Maintenance fee due to theincrease in extra invoice and the net fixed assets are reduced because of the increased charge ofdepreciation. Finally, that affected a huge increase in the ratio compared with the previous year’sratioCAPITAL TURN OVER RATIO:CTO = SALES OR INCOME FROM SERVICES/CAPITAL EMPLOYEDYear Income From Services Capital Employed Ratio2005-2006 55,550,649 56,473,652 0.982006-2007 96,654,902 97,060,013 1.00Interpretation:This is another ratio to judge the efficiency and effectiveness of the company like profitabilityratio.The income from services is greaterly increased compared with the previous year and the totalcapital employed includes capital and reserves & surplus. Due to huge increase in the net profitthe capital employed is also increased along with income from services. Both are effected in theincrement of the ratio of current year.WORKING CAPITAL TURNOVER RATIO:WCT RATIO = SALES OR INCOME FROM SERVICES/NET WORKING CAPITALYear Income From Services Working Capital Ratio2005-2006 55,550,649 44,211,009 1.262006-2007 96,654,902 85,375,407 1.13Interpretation: 71 | P a g e
  72. 72. . Income from services is greatly increased due to the extra invoice for Operations & Maintenancefee and the working capital is also increased greater due to the increase in from services becausethe huge increase in current assets. The income from services is raised and the current assets arealso raised together resulted in the decrease of the ratio of 2007 compared with 2006LIQUIDITY RATIOS:Liquidity ratios measure the firm ability to meet current obligations. It is extremely essential for afirm to be able to meet its obligations as they become due liquidity ratios measure. The ability ofthe firm to meet its current obligations. In fact analysis is of liquidity needs in the preparation ofcash budgets and cash and funds flow statements, but liquidity ratios by establishing a relationshipbetween cash and other current assets to current obligations provide a quick measure of liquidity.A firm should ensure that it does not suffer from lack of liquidity and also that it does not haveexcess liquidity. The failure of the company to meet its obligations due to the lack of sufficientliquidity will result in poor credit worthiness, loss of creditors’ confidence or even in legal tanglesresulting in the closure of company. A very high degree of liquidity is also bad, idle assets earnnothing. The firms funds will be unnecessarily tied up to current assets. Therefore, it isnecessary to strike a proper balance between high liquidity and lack of liquidity. • Current ratio • Quick ratio • Absolute liquidity ratioCURRENT RATIO:- Current ratio is dividing current assets by current liabilities. Current assets all cash and otheritems, which can be encashed within one year duration. Current liabilities include an obligationsmaking within duration of the year. Current ratio is a measure of a firm’s short term solvency. Itindicates the availability of the current assets in rupees for every one rupee of current liability.Year Current Assets Current Liabilities Ratio 72 | P a g e