project report on working capital

PROJECT REPORT

ON

WORkiNg CaPiTal aNd COsT Of gOOds sOld

A Report Submitted In Partial Fulfilment of the Requirements

For The Award of the Degree of

MasTER Of BUsiNEss adMiNisTRaTiON

Collaborative 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

STUDENTS DECLARATION

I declare that the project titled “WORKING CAPITAL AND COST OF GOODS SOLD” is an
original project done by me and no part of the project is taken from any other project or
materials published or otherwise or submitted earlier to any other college or university.

Student’s Signature

DEEPAK KUMAR

REG.NO-CM2091860012

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AUTHENTICATION CERTIFICATE

This is to certify that the work presented in this dissertation entitled “ON PROJECT” AT
VARIAN (I) PVT.LTD ON THE TOPIC OF WORKING CAPITAL AND COST OF GOODS
SOLD has done by Deepak Kumar Reg.no- CM2091860012 under my guidance is being
submitted to M.S RAMAIAH MANAGEMENT INSTITUTE.

Signature of Project Guide

Dr. H. Muralidharan

M S Ramaiah Management Institute, Bangalore

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ACKNOWLEDGEMENT

It is really a matter of great pleasure to acknowledge the invaluable guidance, enormous assistance
and excellent co-operation extended to me finance department, Varian India Pvt Ltd, Kolkata in
completion of my project.

I express my sincere gratitude to Mr. D. GANGULY (DGM FINANCE), MISS NIMISHA, who
gave me the project guidelines and were a source of constant inspiration and help throughout the
project work.

I extend my special gratitude to our beloved Dean Dr. CS.Thammaiah for inspiring me to take up
this project

I 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 valuable
guidance 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 support
and encouragement to do the best.

I HAVE BEEN IMMENSELY BENEFITTED BY THIS PROJECT.

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CONTENT
Part A: Organizational study

Sl. no Topic Page no.

1 Sectorial analysis 10-14

2 Introduction to VARIAN 15
15
• Company profile
15
• History
• Values 15

• Vision 16
• Mission 16
• Achievement 16

3 Products 17-19

4 VARIAN care program 20

5 Philosophy and human face 20-21

6 Quality policy 21

7 Environment ,health & safety policy 22

8 Organizational structure 23

9 Financial highlights 24-25

10 Swot analysis 26-27

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Part B: Project report

Sl. no Topic Page no

1 Executive summary 29

2 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 32

3 Working capital (Definition) 33-35

4 permanent and temporary working capital 35-36

5 Working capital needs of a business 36-37

6 Working capital cycle 37-41

7 Factor determining the working capital requirement 41-43

8 Consequences of under assessment on working capital 43-44

9 Consequences of over assessment on working capital 44

10 Impact of inflation on working capital requirement 44-45

11 Impact of double shift working capital requirement 45

12 Zero working capital 46

13 Adequate working capital 46-47

14 Working capital leverage 47-48

15 Approaches to working capital finance 48-50

16 Financing working capital 50-51

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17 Committee recommendation of working capital finance 52-54

18 Method for estimating working capital requirement 54-55

19 Inventory management 55-56

20 Objective of inventory management 56-57

21 Inventory management techniques 58-59

22 Receivable management 59-61

23 Receivable collection policy 62

24 Process of receivable management 62

25 Cash management 63

26 Effects of cash deficits 64

27 Cash budget 64-65

28 Method of cash flow budgeting 65-66

29 Cash management model 66-67

30 Analysis and interpretation

• Types of ratio 68

31 Profitability ratio 69-71

32 Activity ratio 72-73

33 Liquidity ratio 74-76

34 Classification of costs 77-79

35 Proforma of cost sheet 79-81

36 Conclusion 82

37 Recommendation 83

38 Bibliography 84

39 Annexure 85-87

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PART A:
ORGANIZATIONAL STUDY

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SECTORIAL ANALYSIS
India’s biotechnology sector is at a crossroads. On the one hand, it must find affordable solutions
to the pressing national needs in agriculture, health and energy, but on the other, it must be
competitive enough to take advantage of the lucrative international markets. The Indian
Government established an independent Department of Biotechnology (DBT) in the Ministry of
Science 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 to
the 11th Five-Year Plan and support to the life sciences sector steadily increased by 16 times in
the same period As a result, a firmer foundation of life sciences and biotechnology has been
created over the years in public-funded institutions, over which a strong edifice of innovation and
enterprise could be built now. Fiscal incentives include relaxed price controls for drugs, subsidies
on capital limits, and tax holidays for R&D spending. Several State Governments (e.g. Andhra
Pradesh, Karnataka, Maharashtra, Himachal Pradesh, Uttar Pradesh, Kerala and Gujarat) have
come 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 have
proactively taken up a number of initiatives in creating trained human resource, institutional
infrastructure (e.g. microbial culture collections, cell and tissue lines, gene banks, laboratory
animals, facilities for oligonucleotide synthesis, etc.) and a strong research base in the country in
areas relating to agriculture and forestry, human health, animal productivity, environmental safety
and industrial production.

Plan Total S&T ( in crore) DBT (in crore)

8th five year plan 9393 406




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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 plan

Figure: From the 8th Five-Year Plan to the 11th Five-Year Plan, government’s total S&T budget
increased 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

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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 67

Bio services 15

Bio agriculture 12

Bio industrial 4

Bio 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
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67%

Figure. Chart showing the segments of biotechnology sector.

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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 410 190
Table: 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 2007-08

Chart: Revenue generated by biotechnology sector in crore.

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COMPANY PROFILE

Varian, Inc. is a leading worldwide supplier of scientific instruments and vacuum technologies for
life science and industrial applications. The company provides complete solutions, including
instruments, vacuum products, laboratory consumable supplies, software, training and support
through its global distribution and support systems. Varian, Inc. employs approximately 3,500
people worldwide and operates manufacturing facilities in North America, Europe and Asia
Pacific. Varian, Inc. had fiscal year 2009 sales of $807 million, and its common stock is traded on
the NASDAQ Global Select Market under the symbol "VARI." It has been opened his company in
Kolkata 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, and
contract manufacturing and has 14 locations in North America, Europe, and the Pacific Rim. The
company caters to the life science, health care, semiconductor processing, and industrial industries
and has over 20,000 customers. Varian's three main business segments include Scientific
Instruments, Electronics Manufacturing, and Vacuum Technologies.

VALUES:-

Our values guide the way we do business–our customers, suppliers and employees see them in
action every day when they work with us. We believe it’s these values that have helped us enable
our customers to excel, and have helped us attract and retain our most valuable asset–our
exceptional people.

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VISION:-

The people of Varian, Inc. enhance customers' success by devising integrated, creative solutions to
their most pressing technological and process requirements. Grounded in an unbending
commitment 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 for
employees while working to achieve the best financial performance in our industry, providing
shareholders with an excellent return on their investment.

MISSION:-

“To be the market leader by providing customer delight through excellent quality, service and
cost-effectiveness in a progressive, innovative and challenging environment. We endeavour to
provide an enriching, rewarding and environment friendly work experience to our employees in an
achievement-based, high- performance culture. We will provide maximum satisfaction to all our
stakeholders”.

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 Week's "50 Best Manufacturing Companies" in
the U.S.
 2006 R&D 100 Award
 2006 Forbes Global High Performer
 2004, 2005 Forbes Platinum 400 list

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PRODUCTS

VARIAN provides leading edge tools and solutions for diverse, high growth applications in life
science and industry.

Scientific Instruments:-
We’re leaders and innovators in creating solutions that solve a wide range of challenges in life
science and industry. In particular, we excel in creating high performance products, often
combining our diverse technologies and capabilities to create new ways to meet the evolving
needs 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&D
and quality control, and in developing everything from disease-resistant crops to cosmetics to
testing drinking water and monitoring quality in the petrochemical industry.

Vacuum Technologies :-
We specialize in listening carefully to customer requirements and developing vacuum systems
tailored to meet each one’s unique needs. We do this by leveraging our broad product range and
our 50 years of fundamental expertise in vacuum technologies. Whether a customer is building a
mass spectrometer or a medical linear accelerator, a system for producing flat panel displays or
coating architectural glass, or experimenting in high-energy, physics experiment, Varian, Inc.
works alongside its customers to solve vacuum challenges.

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Chromatography:-

GC

Flexible solutions, for every application,
From portable Micro-GC to custom
Configurations.

Flash Chromatography

Automated systems improve performance and
Minimize routine tasks to increase productivity

Molecular spectroscopy:-

UV-Vis-NIR

Outstanding performance, flexibility and
Ease of use is what you expect from
The range of Varian spectrophotometers,
From routine to research applications.

FT-IR Imaging

Microscopes and imaging products
For medical, biological and industrial
Applications, with unmatched spatial
Resolution, speed and ease of use.

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Application-based consumables:-Application-Based

Drug Testing and Screening

Varian offers a range of USP-compliant
Dissolution vessels, paddles, and baskets,
All serialized for traceability.

Biotech Particles

Highly reproducible, functionalized
Magnetic, latex and custom particles for
Biotech applications, and solid phase synthesis supports.

Vacuum Technologies for Science and Industry

Primary Vacuum Dry Scroll Pumps

Consistent performance in a reliable,
dry vacuum in a small, economical
Package.

Vacuum Control

Precise, user-friendly mass
Spectrometer and ion pump leak
Detectors are available with wireless
Remote capability.

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Varian Care Program

The Varian Care Program adds value to your business by ensuring ongoing productivity. Whether
you 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 and
service possible. Our dedicated field support representatives and specialists take pride in their
work and are committed to ensuring you get the most from your investment. Our goal is to help
you increase your productivity, maximize your uptime and achieve the highest return possible on
your investment. Our experienced and highly qualified support organization is strategically
located throughout the world to ensure rapid response.

Philosophy & Human Face

Optimum utilization of knowledge:

The Group understand and values the power of knowledge and information .Thus, each employee
is encouraged to garner and utilize his knowledge data to optimum for intrinsic development and
orientation.

Solving problem with the 'Heart':

Emotions are strongly considered. Emotional approach is effective as rational for resolving
problems. The key is to understand the people and their reaction to increase tolerance towards
them.

Playing the Devil's Advocate:

Using a negative point of view and playing the Devil's advocate in all aspects of decision-making
help to eliminate the week points and make the plan more robust and fool proof. Negative thinking
to 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.

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Be Positive:

Optimism keeps one float. Positive thinking generates positive energy that can convert an adverse
situation into striking opportunity.

Out-of-the box thinking

Creativity fuels innovations. Thinking out of the box can result in key insights that can yield
excellent results.

Managing and control

It is the duty of people at the helm of affairs to impart a guideline when things are not clear. They
must encourage creative thinking for a solution-oriented approach and have back–up plans for
adverse situations ready.

Quality Policy

VARIAN INDIA PVT LTD is committed to delight customer by implementing Total Quality
Management (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.

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Environment, Health and Safety Policy

Varian India Pvt Ltd, Kolkata engaged in manufacturing and supply of aggregates and
components is committed to improved Environment, Health and Safety performance continually
through:

 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 R's:
 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.

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Organisational structure:-

Chairman & Managing
Director

Director 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

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FINANCIAL HIGHLIGHTS:-

Sales($ in 772.8 834.7 920.6 1012.5 806.7
mn*)

year 2005 2006 2007 2008 2009

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Profit($ in 1.34 2.17 2.05 1.59 3.67
Mn*)

year 2005 2006 2007 2008 2009

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SWOT ANLYSIS

Strengths: -

 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.

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PART B:
PROJECT REPORT

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EXECUTIVE SUMMARY
VARIAN INDIA PVT LTD is leading scientific instrument and vacuum technology manufacturer
and 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 entities
in the country. The company has spread its wings to reach its customers more effectively by
setting up five branches in India. (Kolkata, Chennai, Mumbai, New Delhi, Bangalore)

Working capital (abbreviated WC) is a financial metric which represents operating liquidity
available to a business, organization, or other entity, including governmental entity. Along with
fixed 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 of
working capital that is commonly used in valuation techniques such as DCFs (Discounted cash
flows). 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

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RESEARCH DESIGN
Statement of the problem

Working capital management is concerned with the problem arise in attempting to manage the
current assets, current liabilities and interrelation between both. It operational goal is to manage
the smooth functioning of day-to- day operation of an organization.

Objective of the Study

The 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.

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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.

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Sampling Design

Type of sampling: Systematic sampling to the employees

Sample size: 6

Area of sampling: Finance Dept. Varian India Pvt Ltd.

Sample collection Technique: Personal Interview

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Working Capital :-

Definition of working capital

The Capital required to run the day-to-day operation of an organization is known as Working
Capital. It can be either gross working capital or net working Capital. Gross working capital
means the total of the all current assets whereas Net working capital means the difference between
the total Current assets and Current liabilities.

WORKING CAPITAL = CURRENT ASSETS – CURRENT LIABILITIES

Current assets are those assets which will be converted in to cash within the current accounting
period or within the next year as a result of the ordinary operation of the business. They are cash
or 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 goods
The value represented by these assets circulates among several items. Cash is to buy raw
materials, 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. The
collections of accounts receivable bring cash into the firm. The cycle starts again

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Cash

Inventories

Receivables

Current liabilities are the debts of the firms that have to be paid during the current accounting
period 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 .The
magnitude 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 needs
enough cash to pay wages and salaries as they fall due and to pay creditors if it to keep its
workforce and ensure its supplies.

Maintaining adequate working capital is not just important in the short –term. Sufficient liquidity
must 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 as
they fall due.

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Therefore, when businesses make investment decisions they must not only consider the financial
outlay involved with acquiring the new machine or the new building ,etc, but must also take
account 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 the
firm’s scale of operations tends to imply a need for greater levels of cash.

Permanent and Temporary Working Capital

Considering 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 during
of the year.

A firm will finance its seasonal and current fluctuation business operation through short-term debt
financing. For example, in Peak season, more raw material to be purchased, more manufacturing
expenses to be incurred, more funds will be locked in debtors balance etc. In such times excess
requirement of working capital will be financed from short –term financing sources.

The permanent components current assets which are required throughout the year will generally
be financed from long-term debt and equity. Tandon Committee has referred to this types of
working capital as ‘Core Current Assets’.

Core current Assets are those required by the firm to ensure of operations which represents the
minimum 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 of
current assets will be financed by the long –term sources and any fluctuation etc. This minimum
level of current assets will be financed by long term sources and any fluctuation over the level of

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the current assets will be financed by the short-term financing. Sometimes core current assets are
also referred to as ‘Hard core working capital’

Temporary short term

Current Financing

assets

Rs. Long term

=

Debt
+
Equity
Capital Fixed assets

0 Time

The management of working capital is concern with maximising the return to shareholder within
the accepted risk constraints carried by the participants in the company.

WORKING CAPITAL NEEDS OF A BUSINESS

Different industries have different optimum working capital profiles, reflecting their method of
doing 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.

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• 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 Cycle

Introduction

The working capital cycle can be define as:

The period of time, which elapses between the point at which cash begins to be expended on the
production of a product and the collection of cash from customer?

Cash is used to buy raw material and other stores, so cash is converted into raw material and stores
inventory. Then the raw material and stores are issued to the production department. Wages are
paid 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 the
course of time these customer pay cash for the goods purchase by them. ‘Cash’ is retrieved and the
cycle is completed. Thus, working capital cycle consists of four stage.

• The raw material and stores inventory stage
• The work-in-progress stage

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• The finished goods inventory stage
• The receivable.
• The diagram below illustrates the working capital cycle for a manufacturing firm.
Work-In- progress

Raw material stock Finished goods stock

Wages & overheads sales

Trade creditors Trade debtors

Selling expenses

Cash

Taxation Shareholders

Fixed assets loan Creditors

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Lease payment

The upper portion of the diagram above shows in a simplified from the chain of a events in a
manufacturing firm. Each of the boxes in the upper part of the diagram can be seen as a tank
through which funds flow. These tanks, which are concerned with day-to-day activities, have
funds 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

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• Interest obligation will have to be met be the business.
Unlike movement in the working capital items, most of this ‘non- working capital’ cash
transaction is not every day events. Some of them are annual events (e.g. tax payments, lease
payment, dividends, interest and possibly, fixed assets purchase and sales). Others (e.g. new
equity and loan finance and redemption of old equity and loan finance would typically be rarer
events.

Working capital cycle involves conversions and rotation of various constituents/components of the
working capital. Initially ‘cash ‘converted into raw materials.

Subsequently ,with the usages of fixed assets resulting in value additions ,the raw material get
converted into work in process and then into finished goods. When sold on credit, the finished
goods assume the form of debtors who give the business cash on due date. Thus, ‘cash’ assumes
its original form against at the end of one such working capital cycle but in the course it passes
through various other forms of current assets too. This is how various components of current
assets keep on changing their forms due to value addition.

As a result, they rotate and business operation continues. Thus, the working capital cycle involves
rotation of various constituents of the working capital.

While managing the working capital, two characteristics of current assets should be kept in mind
viz.

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 a
particular form of current assets for a short period. The life span of current assets depends upon
the time required in the activities of procurement, production, sales and collection and degree of
synchronisation among them. A very short life span of current assets results into swift
transformation into other form of current assets for a running business. These characteristics have
certain implication-

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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 Requirement

The is not set of universally applicable rules to ascertain working capital needs of a business
organisation. 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

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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

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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 WORKING
CAPITAL.

 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.

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 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 to
offer too liberal credit terms to buyers and very poor recovery system and cash management. It
may make management complacent leading to its inefficiency.

Over-investment in working capital in makes capital less productive and reduces return on
investment. Working capital is very essential for success of a business and, therefore, needs
efficient management and control. Each of the components of the working capital needs proper
management to optimise profit.

IMPACT OF INFLATION ON WORKING CAPITAL REQUIREMENT.

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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 of
inflation 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.

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Zero working capital

The idea is to have zero working capital i.e. at all times the current assets shall equal the current
liabilities. Excess investment in current assets is avoided and firm meets its current liabilities out
of the matching current assets.

As current assets ratio 1 and the quick ratio below 1, there may be apprehension about the
liquidity, but if all current assets are performing and are accounted at their realisable values, these
fears are misplaced. The firm saves opportunity cost on excess investment current assets and as
bank cash credit limits are linked to the inventory levels, interest costs are also saved. There would
be self-imposed financial discipline on the firm to manage their activities within their current
liabilities and current assets and there may not be tendency to over borrow or divert funds.

Adequate Working Capital

Working capital is the lifeblood of the organization. Without working capital, the functioning of
an organization will come to a halt. No business can run successfully without adequate amount of
working capital. The main advantages of adequate working capital are as follows:-

Solvency of the business

Adequate working capital helps in smooth running of the business. The generates revenue and
maintains the solvency of the organization.

Goodwill

Sufficient working capital helps to makes prompt payments to the creditors, which maintain the
goodwill of the organization.

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Easy Loan

Organizations having adequate working capital are viewed by the banks as good candidates to
offer the loan facilities.

Cash Discounts

Companies can make use of the discount facilities that come along with the repayment of the
credit.

Regular supply of Raw Material

Adequate working capital helps to make regular payment to the supplier.

Regular payment of Salaries

It helps to make regular payments of salaries to the employees, thereby keeping their moral high.

Working Capital Leverage

One of the important objectives of the working capital management is by maintaining the
optimum levels of the investment in current assets and reducing the level of current liabilities, the
company can minimise the investment in working capital thereby improvement in Return on
Capital employed is achieved. The term working capital leverage refers to the impact of level of
working capital on company’s profitability. The working capital management should improve the
productivity of investment in current assets and ultimately it will increase the return on capital
employed. Higher levels of investment in current assets than is actually required mean increase in
the cost of interest charges on the short-term loans and working capital finance raised from banks
etc, and will result in lower return on capital employed and vice versa. Working capital leverage
measures the responsiveness of ROCE for charges in current assets. It is measured by applying the
following formula.

Working Capital leverage = C. A

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T.A – C.A

Where,

C.A = Current assets

T.A = Total assets (i.e., Net fixed assets + Current assets)

C.A = Change in Current assets

Approaches to working Capital Finance

Every organization requires financing its working capital requirement. Generally, there are two
source of finance. One is long- term source and the other is short-term source. Long term is
considered less risky as the period is high and the amount repayment period is high and the
amount of interest is low. The short-term sources are considered risky as they have to be repaying
within 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.

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Secular Growth

Rs.

Long-Term

Financing

Seasonal

Variations Investment Marketable securities

Time

2. 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

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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.

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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

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It is advisable to finance a portion of current assets from the promoters’ funds. They are long term
funds and therefore do not require immediate repayment. These funds increase the liquidity of the
business.

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


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(-) 25% of above from




Borrowing)


Third Method


(-) Core Current assets :- *****

From long-term source

Real current assets

(-) 25% of above from




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Borrowing)


*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 may
be taken as a base for determining the working capital.

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2. Regression analysis method :-
it is a useful statistical technique applied for forecasting working capital requirements. It helps in
making working capital requirement projection after establishing the average relationship between
sales and working capital and its various components in the past years. The method of least square
is 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.

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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.

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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 liquidity
The excessive level of inventories consumes funds of the firm, which cannot be use for any other
purpose, and thus, it involves an insurance, recording and inspection increase in proportion to the
volume of inventory. These costs will impair the firm’s profitability further. Excessive inventories
carried for long period increase chances of loss of liquidity. It may not be possible to sell
inventories in time and full value. Raw materials are generally difficult to sell as the holding
period increases. There are exceptional circumstances where it may pay to the company to hold
stock of raw materials. This is possible under the conditions of inflation and scarcity. Another
danger of carrying inventory is the physical deterioration of inventories in storage.

An effective inventory management should in case of certain goods of raw material, deterioration
occurs 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 production
interruption; similarly, if finished goods are not sufficient to meet the demand of customer
regularly, they may shift to competitors, which will amount to a permanent loss to the firm. The
aim of inventory management, thus, should be to avoid excessive and inadequate levels of
inventories 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

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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

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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 Ratio
Receivables Management

Given a choice, every business would prefer selling its produce on cash basis. However due to
factors like trade policies, prevailing marketing conditions etc., businesses are compelled to sell
their goods on credit. In certain circumstances, business may deliberately extend credit as a
strategy 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 and
effective management as it to cost such as:

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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 day

Each business should project expected sales and expected investment in receivables based on
various factors, which influence the working capital requirement. Form this it would be
possible to find out the average credit days using the above given formula. A business should
continuously try to monitor the credit days and see that the average credit offered to clients is
not crossing the budgeted period. Otherwise, the requirement of investment in the working
capital would increase and, as a result, activities may get squeezed. This may lead to cash crisis.

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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’s

Character- relates to the customer’s willingness to pay

Capacity- 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

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A firm establish its own credit policy for proper management of debtors, otherwise it will lead
more outstanding balance in debtors account and the risk of bad debts will also arise.

Receivable collection policy

Sometimes a customer fails to pay on the due date. The following procedure will help in
efficient 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 resort

Process of Receivables Management

The 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.

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 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 firm
Following 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.

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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 Deficits

The 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 Budget

Cash budget incorporates estimate of future inflow and outflows of cash over a projected short
period, which may usually be a year, a half or a quarter year. Effective cash management is
facilitated 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:

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(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.

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Method of cash flow budgeting

Cash flow budget is a detailed budget of income and cash expenditure incorporating both
revenue 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

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vice-versa. The Banmol’s model find a correct balance by combining holding cost and
transaction cost so as to minimise the total cost of holding cash. Baumol’s model assumes
that the rate of cash usage is constant and known with certainty. The optimal level of C is
found 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

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ANALYSIS AND INTERPRETATION

TYPES OF RATIO:-

There are a number of types of ratio of interest to the various stakeholders of a business. The main
classification of ratio is as follows:

Profitability Ratios:

Measure the relationship between gross/net profit and sales, assets and capital employed. These
are sometimes referred as performance ratios.

Activity Ratio:-

These measure how efficiently an organization uses its resources. These are sometimes referred as
assets utilization ratios.

Liquidity Ratio:

These measure the short-term and long term financial stability of the firm by examining the
relationship between assets and liabilities. These are sometime called as solvency ratios.

Investment Ratios:

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This group of ratio is concerned with analysing the return for shareholder. These examine the
relationship between the member of share issued, dividend paid , value of the shares, and company
profits. 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 therefore
concerned 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 are
essential but it would be wrong to assume that every action initiated by management of a company
should 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 ultimate
output of a company and it will have no future if it fails to make sufficient profits. Therefore, the
financial 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 ratios

1. Profitability in relation to sales
2. Profitability in relation to investment

o Net profit ratio
o Operating profit ratio
o Return on Investment

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NET PROFIT RATIO:

Net profit is obtained when operating expenses, interest and taxes are subtracted from the gross
profit. The net profit margin is measured by dividing profit after tax or net profit by sales.

NET PROFIT RATIO= NET PROFIT
SALES/INCOME FROM SERVICES

Year Net Profit After Tax Income From Services Ratio
2005-2006 18,259,580 55,550,649 0.33
2006-2007 40,586,359 96,654,902 0.42

Interpretation:

The net profit ratio is the overall measure of the firm’s ability to turn each rupee of income
from services in net profit. If the net margin is inadequate the firm will fail to achieve return on
shareholder’s funds. High net profit ratio will help the firm service in the fall of income from
services, rise in cost of production or declining demand. The net profit is increased because the
income from services is increased. The increment resulted a slight increase in 2007 ratio compared
with the year 2006.

OPERATING PROFIT RATIO:

OPERATING EXPENSE RATIO= OPERATING PROFIT
SALES/INCOME FROM SERVICES.

Year Operating Profit Income From Services Ratio
2005-2006 31,586,718 55,550,649 0.57

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2006-2007 67,192,677 96,654,902 0.70

Interpretation:

The operating profit ratio is used to measure the relationship between net profits and sales of a
firm. Depending on the concept, it will decide. The operating profit ratio is increased compared
with the last year. The earnings are increased due to the increase in the income from services
because of Operations & Maintenance fee. So, the ratio is increased slightly compared with the
previous year

RETURN 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 FUND

Year Profit After Tax Share Holders Fund Ratio
2005-2006 18,259,580 56,473,652 0.32
2006-2007 40,586,359 97,060,013 0.42

Interpretation:

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This is the ratio between net profits and shareholders’ funds. The ratio is generally calculated as
percentage multiplying with 100.
The net profit is increased due to the increase in the income from services
ant the shareholders funds are increased because of reserve & surplus. So, the ratio is increased in
the current year

ACTIVITY RATIOS:

Funds of creditors and owners are invested in various assets to generate sales and profits. The
better the management of assets, the larger is an amount of sales. Activity ratios are employed to
evaluate the efficiency with which the firm manages and utilizes its assets these ratios are also
called turnover ratios because they indicate the speed with which assets are being converted or
turned over into sales. Activity ratios, thus, involve a relationship between sales and assets. A
proper balance between sales and assets generally reflects that assets are managed well.

• Fixed assets turnover ratio
• Capital turnover ratio
• Working Capital turnover ratio

FIXED ASSETS TURNOVER RATIO:

NET ASSETS TURNOVER RATIO= SALES/ INCOME FROM SERVICES
NET FIXED ASSETS

Year Income From Services Net Fixed Assets Ratio
2005-2006 55,550,649 15,056,993 3.69
2006-2007 96,654,902 14,163,034 6.82

Interpretation:

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Fixed assets are used in the business for producing the goods to be sold. This ratio shows the
firm’s ability in generating sales from all financial resources committed to total assets. The ratio
indicates the account of one rupee investment in fixed assets. The income from services is
increased in the current year due to the increase in the Operations & Maintenance fee due to the
increase in extra invoice and the net fixed assets are reduced because of the increased charge of
depreciation. Finally, that affected a huge increase in the ratio compared with the previous year’s
ratio

CAPITAL TURN OVER RATIO:

CTO = SALES OR INCOME FROM SERVICES/CAPITAL EMPLOYED

Year Income From Services Capital Employed Ratio
2005-2006 55,550,649 56,473,652 0.98
2006-2007 96,654,902 97,060,013 1.00

Interpretation:

This is another ratio to judge the efficiency and effectiveness of the company like profitability
ratio.
The income from services is greaterly increased compared with the previous year and the total
capital employed includes capital and reserves & surplus. Due to huge increase in the net profit
the capital employed is also increased along with income from services. Both are effected in the
increment of the ratio of current year.

WORKING CAPITAL TURNOVER RATIO:

WCT RATIO = SALES OR INCOME FROM SERVICES/NET WORKING CAPITAL

Year Income From Services Working Capital Ratio
2005-2006 55,550,649 44,211,009 1.26
2006-2007 96,654,902 85,375,407 1.13

Interpretation:

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. Income from services is greatly increased due to the extra invoice for Operations & Maintenance
fee and the working capital is also increased greater due to the increase in from services because
the huge increase in current assets. The income from services is raised and the current assets are
also raised together resulted in the decrease of the ratio of 2007 compared with 2006

LIQUIDITY RATIOS:

Liquidity ratios measure the firm ability to meet current obligations. It is extremely essential for a
firm to be able to meet its obligations as they become due liquidity ratio's measure. The ability of
the firm to meet its current obligations. In fact analysis is of liquidity needs in the preparation of
cash budgets and cash and funds flow statements, but liquidity ratios by establishing a relationship
between 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 have
excess liquidity. The failure of the company to meet its obligations due to the lack of sufficient
liquidity will result in poor credit worthiness, loss of creditors’ confidence or even in legal tangles
resulting in the closure of company. A very high degree of liquidity is also bad, idle assets earn
nothing. The firm's funds will be unnecessarily tied up to current assets. Therefore, it is
necessary to strike a proper balance between high liquidity and lack of liquidity.

• Current ratio
• Quick ratio
• Absolute liquidity ratio

CURRENT RATIO:-

Current ratio is dividing current assets by current liabilities. Current assets all cash and other
items, which can be encashed within one year duration. Current liabilities include an obligations
making within duration of the year. Current ratio is a measure of a firm’s short term solvency. It
indicates the availability of the current assets in rupees for every one rupee of current liability.

Year Current Assets Current Liabilities Ratio

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2005-2006 91,328,208 47,117,199 1.94

2006-2007 115,642,068 30,266,661 3.82

Interpretation:

As a rule, the current ratio with 2:1 (or) more is considered as satisfactory position of the firm.
When compared with 2006, there is an increase in the provision for tax, because the debtors are
raised and for that the provision is created.
. In the year 2006, the cash and bank balance is reduced because that is used for
payment of dividends. In the year 2007, the loans and advances include majorly the advances to
employees and deposits to government. The loans and advances reduced because the employees
set off their claims. The other current assets include the interest attained from the deposits. The
deposits reduced due to the declaration of dividends. So the other current assets decreased. The
huge increase in sundry debtors resulted an increase in the ratio, which is above the benchmark
level of 2:1 which shows the comfortable position of the firm

QUICK RATIO:

It establishes a relationship between quick or liquid assets and liabilities. An asset is liquid if it
can be immediately converted into cash. As cash is the quickest asset and other assets are
relatively quick and liquid.

QUICK RATIO = CURRENT ASSETS-INVENTORIES/CURRENT LIABILITIES

Year Quick Assets Current Liabilities Ratio
2005-2006 91,328,208 47,117,199 1.9

2006-2007 115,642,068 30,266,661 3.82

Interpretation:

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Quick assets are those assets which can be converted into cash within a short period of time, say to
six months. So, here the sundry debtors which are with the long period does not include in the
quick assets.

Compare with 2006, the Quick ratio is increased because the sundry debtors are
increased due to the increase in the corporate tax and for that the provision created is also
increased. So, the ratio is also increased with the 2006.

ABSOLUTE LIQUIDITY RATIO:

ALR = ABSOLUTE LIQUID ASSETS
CURRENT LIABILITIES

Year Absolute Liquid assets Current Liabilities Ratio

2005-2006 51,690,326 47,117,199 1.09

2006-2007 34,043,520 30,266,661 1.13

Interpretation:

The current assets which are ready in the form of cash are considered as absolute liquid assets.
Here, the cash and bank balance is absolute liquid assets.

In the year 2006, the cash and bank balance is decreased due to decrease in the
deposits and the current liabilities are also reduced because of the payment of dividend. That
causes a slight increase in the current year’s ratio.

74 | P a g e

project report on working capital

project report on working capital

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