A Project on Working Capital Management by Alok, PGDM, IPE, Hyderabad.


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Working Capital Management at Rajapushpa Properties Pvt Ltd, a privately owned real-estate firm with projects around Hyderabad's IT corridor and financial district.
1. Financial ratio analysis
2. Trend analysis of the components of working capital
3. Forecasting working capital requirement
4. Calulation of the cash conversion cycle, DSO, DPO

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A Project on Working Capital Management by Alok, PGDM, IPE, Hyderabad.

  1. 1. CHAPTER ONE Working Capital Management 1
  2. 2. Introduction 1.1.Working Capital Management Working capital is the capital available for conducting the day-to-day operations of an organization; normally the excess of current assets over current liabilities. Working capital management is the management of all aspects of both current assets and current liabilities, to minimize the risk of insolvency while maximizing the return on assets. 1.2. Concepts of Working Capital 1. Gross Working Capital (GWC) GWC refers to the firm’s total investment in current assets. Current assets (CA) are the assets, which can be converted into cash within an accounting year (or operating cycle), and include cash, short-term securities, debtors, (Accounts receivable or book debts) bills receivable and stock (inventory). Gross working capital focuses on a. Optimization of investment in current b. Financing of current assets 2. Net Working Capital (NWC) Net working capital is the difference between the current assets and current liabilities. Current liabilities (CL) are those claims of outsiders, which are expected to mature for payment within an accounting year, and include creditors (accounts payable), bills payable, and outstanding expenses. Net working capital can be positive or negative. When current assets exceed current liabilities net working capital is positive and vice versa. Positive NWC = CA > CL Negative NWC = CA < CL Working Capital Management 2
  3. 3. Net working capital focuses on a. Liquidity position of the firm b. Judicious mix of short-term and long-term financing 1.3. Operating Cycle Operating cycle is the time duration required to convert sales after the conversion of resources into inventories, into cash. The operating cycle of a manufacturing company involves three phases: 1. Acquisition of resources 2. Manufacture of the product 3. Sale of the product These phases of operating cycle create cash flows among which cash inflows are mostly uncertain whereas cash outflows are relatively certain. The firm needs to hold cash to purchase the raw materials, pay for labour, as these payments involve day-to-day transactions, real estate firm needs to maintain liquidity. The length of operating cycle for a real estate firm extends beyond a year. Fig (i) Operating cycle of a manufacturing firm Gross operating cycle (GOC) = Inventory conversion period (ICP) + Debtors conversion period (DCP) ICP= Raw material conversion period (RMCP) + Work-in progress conversion period (WIPCP) + Finished good conversion period (FGCP) Working Capital Management 3
  4. 4. 1.3.1. Inventory conversion period (ICP) Inventory conversion period gives the length of time inventory is held between purchase and sale. It is calculated as: In some cases, a more detailed breakdown of inventory may be required. Inventory holding periods can be calculated for each type of inventory: raw materials, work-in-progress and finished goods. 1.3.2. Raw Material Conversion Period It is the average time taken to convert material into work-in progress. It depends on raw material consumption per day and raw material inventory. Calculated as: 1.3.3. Work-In-Progress Conversion Period It is the average time taken to complete semi-finished work or work-in-progress. It is the length of time goods spend in production. Calculated as: Working Capital Management 4
  5. 5. 1.3.4. Finished Goods Conversion Period It is the average time taken to sell the finished goods. It is the length of time finished goods are held between completion or purchase and sale. Calculated as: For all inventory period ratios, a low ratio is usually seen as a sign of good working capital management. Generally, it is very expensive to hold inventory and thus minimum inventory holding usually points to good practice. 1.3.5. Debtors (Receivables) Conversion Period It is the average time taken time to convert debtors into cash. Calculated as Generally shorter credit periods are seen as financially sensible but the length will also depend upon the nature of the business. 1.3.6. Creditors (Payables) Deferral Period (CDP) CDP is the average time taken by the firm in paying its suppliers. Calculated as Working Capital Management 5
  6. 6. Generally, increasing payables days suggests advantage is being taken of available credit but there are risks: • losing supplier goodwill • losing prompt payment discounts • Suppliers increasing the price to compensate 1.4. Working Capital Liquidity Ratios Two key measures, the current ratio and the quick ratio, are used to assess short-term liquidity. Generally, a higher ratio indicates better liquidity. Current Ratio Measures how much of the total current assets are financed by current liabilities. A measure of 2:1 means that current liabilities can be paid twice over out of existing current assets. Quick (Acid Test) Ratio The quick or acid test ratio measures how well current liabilities are covered by liquid assets. This ratio is particularly useful where inventory-holding periods are long. Calculated as A measure of 1:1 means that the company is able to meet existing liabilities if they all fall due at once. Working Capital Turnover Ratio One final ratio that relates to working capital is the working capital turnover ratio Calculated as Working Capital Management 6
  7. 7. This ratio measures how efficiently management is utilising its investment in working capital to generate sales and can be useful when assessing whether a company is overtrading. It must be interpreted in the light of the other ratios used. Return on Assets (ROA) Return on Assets is used to analyse the effect of working capital management on profitability. Calculated as: Return on Assets = Profit After Tax/Average Total Asset ROA gives an idea as to how efficient management is at using its assets to generate earnings. The higher the ROA number, the better, because the company is earning more money on less investment. Trend Analysis In financial analysis, the direction of changes over a period of years is of crucial importance. Time series or trend analysis of ratios indicates the direction of change. This kind of analysis is particularly applicable to the items of profit and loss account. 1.5. Working Capital Investment Levels The level of working capital required (the financial position statement figure) is affected by the following factors: • The nature of the business • Uncertainty in supplier deliveries • The overall level of activity of the business • The company's credit policy • The credit policy of suppliers • The length of the operating cycle Working Capital Management 7
  8. 8. The working capital ratios can be used to predict the levels of investment required. This is done by re-arranging the formulas. Calculated as: 1.6. Cash Conversion/Net Operating Cycle Net operating cycle is the difference between gross operating cycle and payables deferral period. Fig (ii) Cash Conversion Cycle Working Capital Management 8
  9. 9. 1.7. Permanent and Variable Working Capital a) Permanent or fixed capital is the minimum level of required current assets. Depending on the changes in production and sales, there is need for working capital, over and above the permanent working capital. b) Fluctuating or variable working capital is the extra working capital needed, over and above the permanent working capital to support the changing production and sales activities of the firm. Variable working capital is required to meet the temporary liquidity needs of the firm. Fig (iii) Permanent and Temporary Working Capital Working Capital Management 9
  10. 10. 1.7.1. Balanced Working Capital Position The firm should maintain good working capital, both inadequate and excessive working capital are dangerous for the firm’s well-being as they could impair the firm’s profitability due to production interruptions and inefficiencies and sales disruptions. Fig (iv) Management of Working Capital Excessive working capital leads to • It results in unnecessary accumulation of inventories thereby increases the chances of inventory mishandling, waste, theft and losses • It is an indication of defective credit policy and slack in collection period. Consequently, higher incidence of bad debts results, which adversely affects profits • Negligent excessive working capital makes management negligent which degenerates into managerial inefficiency • Tendencies of accumulating inventories tend to make speculative profits grow. This may tend to make dividend policy liberal and difficult to cope with in future, when the firm is unable to make speculative profits Working Capital Management 10
  11. 11. Inadequate working capital leads to • It stagnates growth. It becomes difficult for the firm to undertake profitable projects for the firm to undertake profitable projects for non-availability of working capital funds • It becomes difficult to implement operating plans and achieve the firm’s profit target • Operating inefficiencies creep in when it becomes difficult even to meet day-today commitments • Fixed assets are not efficiently utilised for the lack of working capital funds. Thus, the firm’s profitability would deteriorate • Paucity of working capital funds render the firm unable to avail attractive credit opportunities etc. • The firm loses its reputation when it is not in a position to honour its short-term obligations. As a result, the firm faces tight credit terms 1.8. Determinants of Working Capital A firm’s working capital can be determined by the following 1. Nature of Business Working capital requirements of a firm are basically influenced by the nature of its business. Retail stores have a need for large sum of money to be invested in working capital. Construction firms need to invest substantially in working capital and a nominal amount in fixed assets. 2. Market and Demand Conditions The working capital needs of a firm are related to its sales though it is difficult to determine the relationship between sales and working capital needs, necessary planning of working capital has to be done to determine levels of current assets to be employed for future sales. Sales forecasts determine the level of production, which in turn determines the level of current assets. Sales forecasts are based on swings in market conditions. An upward swing in the economy will create demand thereby an increase in sales, which calls for an increased deployment of funds in current assets. In such a situation, firms resort to substantial borrowing whereas the scenario for a downward swing in the market is opposite. The demand Working Capital Management 11
  12. 12. for short-term borrowings during the downward swing, to fuel the working capital requirements goes down. 3. Technology and Manufacturing Policy The manufacturing cycle comprises the purchase and use of raw materials and the production of finished goods. Longer the manufacturing cycle, larger will be the firm’s working capital requirements. An extended manufacturing time span means a larger tie-up of funds in inventories. Thus, if there are alternative technologies of manufacturing a product, the technological process with the shortest manufacturing cycle may be chosen. Once a manufacturing technology has been selected, it should be ensured that manufacturing cycle is completed within the specified period. This needs proper planning and coordination at all levels of activity. Any delay in manufacturing process will result in accumulation of work-in-process and wastage of time. In order to minimise the investment in working capital, some firms, have a policy of asking for advance payments from their customers. 4. Credit Policy The credit policy of a firm affects the working capital by influencing the level of debtors. The credit terms granted to the customers depend upon the norms of the industry to which the firm belongs. 5. Availability of Credit from Suppliers The working capital requirements of a firm are also affected by credit terms granted by its suppliers. A firm will need less working capital, if liberal credit terms are available to it from the suppliers. Supplier’s credit finances the firm’s inventories and reduces the cash conversion cycle. In the absence of supplier’s credit, the firm will have to borrow funds from a bank. Availability of credit at reasonable cost from banks is crucial. It influences the working capital policy of a firm. A firm without the supplier’s credit, but which can get bank credit easily on favourable conditions will be able to finance its inventories and debtors without much difficulty. 6. Operating Efficiency The operating efficiency of the firm relates to the optimum utilization of all its resources at minimum costs. Operating efficiency can be achieved by controlling operating costs and Working Capital Management 12
  13. 13. utilization of current and fixed assets thereby improving the use of working capital and accelerating the pace of cash conversion cycle. Efficient and effective usage of firm’s labour and other resources decreases the pressure on working capital. 7. Price Level Changes The increasing shifts in price level make the functions of financial manager difficult. She should anticipate the effect of price level changes on working capital requirements of the firm. Generally, rising price levels will require a firm to maintain higher amount of working capital. Same level of current assets will need increased investment when price levels are increasing. Companies, which can revise their product prices immediately in line with increased input costs, will not face a severe working capital problem. 1.9. Issues in Working Capital Management Working capital management refers to the administration of all components of working capital – Cash, Marketable securities, Debtors, Stock, and Creditors. The financial manager must determine the levels and composition of current assets. He must see that right sources are tapped to finance current assets, and that current liabilities are paid in time. There are many aspects of working capital management, which make it an important function of a finance manager: • Time- Working Capital Management requires much of the financial manager’s time • Investment- Working capital represents a large portion of the total investment in assets • Criticality- Working Capital Management has a great significance for all firms but it is very critical for small firms • Growth- The need for working capital is directly related to the firm’s growth Empirical observations show that financial managers have to spend much of their time to the daily internal operations, relating to current assets and current liabilities of the firms. As the largest portion of the financial manager’s valuable time is devoted to working capital problems, it is necessary to manage working capital in the best possible way to get the maximum benefit. Working Capital Management 13
  14. 14. Working Capital Management is critical for all firms, especially for small firms. A small firm may not have much investment in fixed assets, but it has to investment in current assets. Small firms in India face a severe problem of collecting their debts. Further, the role of current liabilities in financing current assets is far more significant in case of small firms, as, unlike large firms they face difficulties in raising finances. There is a direct relationship between a firm’s growth and its working capital needs. As the sales grow, the firm needs to invest more in inventories and debtors. These needs become very frequent and fast when the sales grow continuously. The finance manager should be aware of such needs and finance them quickly. Continuous growth in sales may also require additional investment in fixed assets. It may, thus, we concluded that all precautions should be taken for the effective and efficient management of working capital. The finance manager should pay particular attention to the levels of current assets and the financing of current assets. To decide the levels and financing of current assets, the risk return implications must be evaluated. 1.9.1. Current Assets to Fixed Assets Ratio A financial manager should determine the optimal level of current assets so that the wealth of stakeholders is maximized. A firm needs fixed and current assets to support a particular level of output. However, to support the same level of output, the firm can have different levels of current assets. As the firms output and sales increase, the need for current assets increases. Generally, current assets do not increase in direct proportion to output; current assets may increase at a decreasing rate with output. This relationship is based upon the notion that it takes a greater proportion of investment in current assets when only a few units of output are produced, than it does later on, when the firm can use its current assets more efficiently. The level of current assets can be measured by relating current assets to fixed assets. Dividing current assets by fixed assets gives CA/FA ratio. Assuming a constant level of fixed assets, a higher CA/FA ratio indicates a conservative current assets policy and a lower CA/FA ratio means an aggressive current assets policy, assuming other factors constant. A conservative policy implies greater liquidity and lower risk while an aggressive policy indicates higher risk and poor liquidity. Moderate current assets policy falls in the middle of conservative and Working Capital Management 14
  15. 15. aggressive policies. The current assets policy of most firms may fall between these two extreme policies. 1.9.2. Liquidity vs. Profitability: Risk-Return Trade-Off Fig (v) The balancing act: Profitability vs. Liquidity The firm would make just enough investment in current assets if it were possible to estimate working capital needs exactly. The perfect certainty, current assets holding should be at the minimum level. A larger investment in current assets under certainty would mean a low rate of return on investment for the firm, as excess investment in current assets would not earn enough return. A smaller investment in current assets, on the other hand, would mean interrupted production and sales, because of frequent stock outa and inability to pay creditors. As it is not possible to estimate working capital needs accurately, the firm must decide about levels of current assets to be carried. Given a firm’s technology and production policy, sales and demand conditions, operating efficiency etc., its capital assets holding will depend upon its working capital policy. These policies involve risk-return trade-offs. A conservative policy means lower return and risk, while an aggressive policy produces higher return and risk. Working Capital Management 15
  16. 16. The two important aims of the working capital management are: profitability and solvency. Solvency, used in the technical sense refers to the firm’s continuous ability to meet maturing obligations. Lenders and creditors expect prompt settlements of their claims as and when due. To ensure solvency, the firm should be very liquid, which means larger current assets holdings. If the firm maintains a relatively large investment in current assets, it will have no difficulty in paying claims of creditors when they become due and will be able to fill all sales orders and ensure smooth production. Thus, a liquid firm has less risk of insolvency; that is, it will hardly experience a cash shortage or a stock out situation. However, there is a cost associated with maintaining a sound liquidity position. A considerable amount of firm’s funds will be tied up in current assets, and to the extent, this investment is idle, the firm’s profitability will suffer. To have higher profitability, the firm may sacrifice solvency and maintain a relatively low level of current assets. When the firm does so, its profitability will improve as fewer funds are tied up in idle current assets, but its solvency would be threatened and would be exposed to greater risk of cash shortage and stock outs. 1.9.3. The Cost Trade-off A different way of looking onto the risk-return trade-off is in terms of the cost of maintaining a particular level of current assets. There are two types of costs involved: cost of liquidity and cost of illiquidity. If the firm’s level of current assets is very high, it has excessive liquidity. Its return on assets will be low, as funds tied up in idle cash, stocks earn nothing, and high levels of debtors reduce profitability. Thus, the cost of liquidity increases with the level of current assets. The cost of illiquidity is the cost of holding insufficient current assets. The firm will not be in a position to honour its obligations if it carries too little cash. This may force the firm to borrow at high rates of interest. This will also adversely affect the creditworthiness of the firm and it will face difficulties in obtaining funds in the future. All this may force the firm into insolvency. Similarly, the low level of stocks will result in loss of sales and customers may shift to competitors. Also, low level of debtors may be due to tight credit policy, which Working Capital Management 16
  17. 17. would impair sales further. Thus, the low level of current assets involves costs that increase as this level falls. In determining the optimum level of current assets, the firm should balance the profitabilitysolvency tangle by minimising total costs- cost of liquidity and cost of illiquidity. Fig (iv) Cost Trade-off It is indicated in the figure that with the level of current assets the cost of liquidity increases while the cost of illiquidity decreases and vice versa. The firm should maintain the current assets at the level where the sum of these two costs is minimized. The minimum cost point indicates the optimum level of current assets. Working Capital Management 17
  18. 18. Inventory High Levels Low Levels Benefit: Benefit: • Happy customers • Low storage costs • Few • Less risk of obsolescence production delays (always have needed parts on hand) Cost: Cost: • Expensive • Shortages • High storage costs • Dissatisfied customers • Risk of obsolescence Cash High Levels Low Levels Benefit: Benefit: • • Reduces risk Cost: • Reduces financing costs Cost: Increases financing costs • Increases risk Table (i) Inventory and cash Working Capital Management 18
  19. 19. Accounts Receivable High Levels (favorable credit terms) Low Levels (unfavorable terms) Benefit: Cost: • Happy customers • Dissatisfied customers • High sales • Lower Sales Cost: Benefit: • Expensive • High collection costs • • Increases financing costs Less expensive Accounts Payable and Accruals High Levels Low Levels Benefit: Benefit: • • Reduces need for external finance-- Happy suppliers/employees using a spontaneous financing source Cost: • Cost: Unhappy suppliers • Not using a spontaneous financing source Table (ii) Accounts Receivable, Accounts Payable, and Accruals Working Capital Management 19
  20. 20. 1.10. Estimating Working Capital Needs The most appropriate method of calculating the working capital needs of a firm is the concept of operating cycle. However, a number of other methods may be used to determine working capital needs in practice. Three approaches which have been successfully applied in practice: 1. Current assets holding period To estimate working capital requirements based on average holding period of current assets and relating them to costs based on the company’s experience in the previous years. This method is essentially based on the operating cycle concept. The calculations are based on the following assumptions: Method 1: Inventory: one month’s supply of each of raw material, semi-finished goods and finished material. Debtors: one month’s sales Operating cash: one month’s total cost This method gives details of the working capital items. This approach is subject to error if markets are seasonal. 2. Ratio of sales To estimate working capital requirements as a ratio of sales based on the assumption that current assets change with sales. The calculations are based on the following assumptions: Method 2: 25-35% of annual sales This method has a limited reliability. Its accuracy is dependent upon the accuracy of sales estimates. 3. Ratio of fixed investment Working capital requirements are estimated as a percentage of fixed investment. The calculations are based on the following assumptions: Method 3: 10-20% of fixed capital investment This method relates working capital to investment. If estimate of investment is inaccurate, this method is not generally used in practice to estimate working capital needs. Working Capital Management 20
  21. 21. A number of factors will govern the choice of methods of estimating working capital. Factors such as seasonal variations in operations, accuracy of sales forecasts, investment cost and variability in sales price would generally be considered. The production cycle and credit and collection policy of the firm would have an impact on working capital requirements. Therefore, they should be given due weightage in projecting working capital requirements. 1.11. Policies for Financing Current Assets A firm can adopt different financing policies vis-à-vis current assets. Three types of financing may be distinguished as 1. Long Term Financing The sources of long-term financing include ordinary share capital, preference share capital, debentures, long-term borrowings from financial institutions and reserves and surpluses (retained earnings). 2. Short Term Financing Short-term financing is obtained for a period less than one year. It is arranged in advance from banks and other suppliers of short term finance in the money market. Short-term finances include working capital funds from banks, public deposits, commercial paper, factoring of receivables etc. 3. Spontaneous Financing Spontaneous financing refers to the automatic sources of short-term funds arising in the normal course of a business. Trade (suppliers), credit, and outstanding expenses are examples of spontaneous financing. There is no explicit cost of spontaneous financing. A firm is expected to utilise these sources of finances fully. The real choice of financing current assets, once the spontaneous sources of financing have been fully utilised, is between the long term and short-term sources of finances. Depending on the long term and short term financing, the approach followed by a company may be referred to as • Matching Approach • Conservative Approach • Aggressive Approach Working Capital Management 21
  22. 22. 1. Matching Approach The firm can adopt a financial plan, which matches the expected life of assets with the expected of the source of funds raised to finance assets. Thus, a ten-year loan may be raised to finance a plant with an expected life of ten years; stock of goods to be sold in thirty days may be financed with a thirty-day commercial paper or a bank loan. The justification for the exact matching is that, since the purpose of financing is to pay for assets, the source of financing and the assets should be relinquished simultaneously. Using long term financing for short-term assets is expensive, as funds will not be utilised for the full period. Similarly, financing long-term assets with short-term financing is costly as well as inconvenient, as arrangements for the new short-term financing will have to be made on a continuing basis. Fig (vii) Financing under matching plan When the firm follows a matching approach (hedging approach), long-term financing will be used to finance fixed assets and permanent current assets and short-term financing to finance temporary or variable current assets are financed with short-term funds and as their level increases, the level of short-term financing also increases. Under a matching plan, no shortterm financing will be used if the firm has a fixed current assets need only. 2. Conservative Approach A firm in practice may adopt a conservative approach in financing its current and fixed assets. The financing policy of the firm is said to be conservative when it depends more on long-term funds for financing needs. Under a conservative plan, the firm finances its permanent assets and a part of temporary current assets with long-term financing. In the Working Capital Management 22
  23. 23. periods when the firm has no need for temporary current assets, the idle long-term funds can be invested in the tradable securities to conserve liquidity. The conservative plan relies heavily on long-term financing and, therefore, the firm has less risk of facing the problem of shortage of funds. 3. Aggressive Approach A firm may be aggressive in financing its assets. An aggressive policy is said to be followed by the firm when it uses more short-term financing than warranted by the matching plan. Under an aggressive policy, the firm finances a part of its permanent current assets with short-term financing. The relatively large use of short-term financing makes the firm more risky. Working Capital Management 23
  24. 24. Fig (ix) Aggressive financing 1.12. Short-term financing Vs. Long-term financing A firm should decide whether it should use short-term financing. If short-term financing has to be used, the firm must determine its portion in total financing. This decision of the firm will be guided by the risk return trade-off. Short-term financing may be preferred over longterm financing for two reasons i) The cost advantage and ii) Flexibility Nevertheless, short-term financing is more risky than long-term financing. 1.12.1. Cost Short-term financing should generally be less costly than long-term financing. It has been found in developed countries, like USA, that the rate of interest is related to the maturity of debt. The relationship between the maturity of debt and its cost is called the term structure of interest rates. The curve, relating to the maturity of debts and interest rates, is called the yield curve. The yield curve may assume any shape, but it is generally upward sloping. Working Capital Management 24
  25. 25. Fig (x) Yield Curve The justification for higher cost of long-term financing can be found in the Liquidity Preference Theory. This theory says that since lenders are risk averse, and risk generally increases with the length of lending time, most lenders would prefer to make short-term loans. The only way to induce these lenders to lend for longer periods is to offer them higher rates of interests. The cost of financing has an impact on the firm’s return. Both short-term and long-term financing have a leveraging effect on stakeholders return. However, the short-term financing ought to cost less than long-term financing; therefore, it gives relatively higher return to stakeholders. 1.12.2. Flexibility It is relatively easy to refund short-term funds when the need for funds diminishes. Longterm funds such as debenture loan or preference capital cannot be refunded before time. Thus, if a firm anticipates that its requirements for funds will diminish in near future, it would choose short-term funds. 1.12.3. Risk Although short-term financing may involve less cost, it is more risky than long-term financing. If the firm uses short-term financing to finance its current assets, it runs the risk of renewing borrowings repeatedly. This is particularly so in the case of permanent current assets, here permanent current assets refer to minimum level of current assets that a firm should always maintain. If the firm finances its permanent current assets with short-term debt, it will have to raise new short-term funds as debt matures. This continued financing Working Capital Management 25
  26. 26. exposes the firm to certain risks. It may be difficult for the firm to borrow during stringent credit periods. In such times, the firm may be unable to raise any funds. Consequently, its operating activities may be disrupted. In order to avoid failure, the firm may have to borrow at most inconvenient terms. These problems are much less when the firm finances with longterm funds. There is less risk of failure when the long-term financing is used. Working Capital Management 26
  27. 27. CHAPTER TWO Working Capital Management 27
  28. 28. DESIGN OF STUDY 2.1. Introduction Working capital is the capital available to meet the day-to-day operations, and depending on the industry, it could be a relatively high percentage of the total assets of the organization. Cash flow is the lifeblood of firms, and efficient working capital management is the key to achieving healthy cash flow. Firms with weak working capital management strategies give up flexibility and potentially a competitive advantage. Efficient utilization of the firm’s resources, as it relates to working capital management, means that managers should find effective and efficient ways to deal with the cash available for the day-to-day operations in order to achieve the optimum impact. Good working capital management leads to increased cash flows, and thus leads to lesser need to depend on external financing; therefore, the probability of default is minimised. A key factor in the working capital management is the cash conversion cycle. Cash conversion cycle is defined as, the time lag between the purchasing of raw materials and the collection of cash from the sale of goods. The longer the lag, the greater the investment in working capital, and thus the financing needs of the firm will be greater. Interest expense will be also higher, which leads to higher default risk and lower profitability. Working capital fluctuations in a huge multi-national company may not adversely affect its day to day functioning and funding could be readily available. Whereas for small and medium enterprises availability of funds could be difficult and even if the funds are available in the form of debt it could be a burden as the firm has to bear the interest charges. Indian medium sized firm with its core competence being real estate will have to hold a stringent policy for working capital management as greater operational efficiency will lead to higher profits especially when the most important raw materials- steel and cement’s prices are showing an upward trend in the times of inflation and economic uncertainty. Working Capital Management 28
  29. 29. 2.2. Review of Previous Literature • A study by Melita Stephanou Charitou, Maria Elfani, Petros Lois, University of Nicosia, Cyprus(Dec 2010) titled “The Effect Of Working Capital Management On Firm’s Profitability: Empirical Evidence From An Emerging Market” indicated that the cash conversion cycle and all its major components; namely, days in inventory, days sales outstanding and creditors payment period, are associated with firm’s profitability. • Chatterjee, S. (2012). The impact of working capital on the profitability: Evidence from the Indian firms. This research has analyzed the impact of working capital on the profitability for a sample of 100 Indian companies listed in the Bombay Stock Exchange for a period of 2 years from 2010-2011. The results depict that, there is a strong negative association between the components of the working capital management and the profitability ratios of the Indian firms which indicates that, as the cash conversion cycle increases it would tend to reduce the profitability of the company, and the managers might increase the shareholder’s value by shortening this cash conversion cycle to a minimum level. It is also observed that the negative association also persists between the liquidity and the profitability of the Indian firms. Nevertheless, there is a positive relationship between the size and the profitability of the firm. This indicates that, as the size of the firm increases the profitability of the firm also increases. Finally a negative relationship is observed between the debt and profitability of the Indian firms. • Appuhami, B. A. R. (2008). The impact of firms' capital expenditure on working capital management: An empirical study across industries in Thailand. International Management Review, 4(1), 8-21. The empirical research found that firms' capital expenditure has a significant impact on working capital management. The study also found that the firms' operating cash flow, which was recognized as a control variable, has a significant relationship with working capital management. • Mary E. Barth, Donald P. Cram and Karen K. Nelson, Accruals and the Prediction of Future Cash Flows, The Accounting Review , Vol. 76, No. 1 (Jan., 2001), pp. 2758. Separate analysis of the change in accounts receivable, change in accounts payable, change in inventory, and other cash management related variables increased Working Capital Management 29
  30. 30. the sample firms' ability to predict future cash flows. In fact, these variables were more successful than several lags of aggregate earnings in predicting future cash flows. • Amarjit Gill , Nahum Biger , Neil Mathur (2010), The Relationship Between Working Capital Management And Profitability: Evidence From The United States. A sample of 88 American firms listed on New York Stock Exchange for a period of 3 years from 2005 to 2007 was selected. It has found a statistically significant relationship between the cash conversion cycle and profitability, measured through gross operating profit. It follows that managers can create profits for their companies by handling correctly the cash conversion cycle and by keeping accounts receivables at an optimal level. 2.3. Case for the present study To analyse the working capital policy of the company over the years to understand the efficiency of working capital utilization 2.4. Statement of the problem In order to complete the present and future projects, to streamline cash flows and remain profitable, Rajapushpa Properties should manage its working capital efficiently. The raw materials such as steel and cement are extremely important in real estate projects not to mention, labour’s role, and the costs of these inputs have skyrocketed in the recent times. Real estate companies need to be thoroughly efficient in project management to stick to the promised delivery dates by finishing projects on time through proper management of funds and inventory levels. Buyers play an important role too; there need to be enough cash with the buyers to invest in home. Real estate sales are dependent on the rates of interest on home loans. Many such factors affect the sales of a real estate firm. However, the company can hedge itself against possible price rises or economic slumps through efficient management of working capital. The study analyses the working capital management practices of the company over the past three years. Working Capital Management 30
  31. 31. 2.5. The Objectives of the project study • To analyse various working capital ratios for last three years starting from 2010 to 2013. • Analysis of Current Asset and Current Liabilities • To estimate Working Capital requirement 2.6. The Research method followed The objective of the study is to analyse the Working Capital position of the company for the past three years from 2010 to 2013. The major sources of data were secondary data i.e. annual financial reports etc. • The position of the working capital has been analysed through various Working Capital ratios with the help of data available in the financial statement of the past three years. • An analysis of the various items of current asset and current liabilities for past three years has been done. 2.7. Scope of the study The study is confined to the organization, to suggest means of improvements in the existing system. 2.8. Collection of data Secondary Sources Balance sheet of Rajapushpa Properties Pvt. Ltd. for the year 2010-11 Balance sheet of Rajapushpa Properties Pvt. Ltd. for the year 2011-12 Balance sheet of Rajapushpa Properties Pvt. Ltd. for the year 2012-13 Primary Source of data includes personal discussion with the finance manager and the director of the company. 2.9. Tools for Analysis of the data Microsoft Excel was used all through the project for the financial analysis of data and to create graphs. Working Capital Management 31
  32. 32. 2.10. Geographical Area The area covered under the study is Hyderabad. All projects of Rajapushpa Properties are located in and around Hyderabad. 2.11. Period of study or Period covered under study The period of study was limited to two months during May and June 2013. During this period all the required data was collected through secondary sources and analysed with the help of financial tools of analysis. The data from past three years’ balance sheet has been analysed. 2.12. Limitations of the study • The period covered under this study is three years. • This analysis is based on secondary data like annual reports and company’s Balance Sheet. The scope of the study is limited to that extent. • The time available to carry out this study was limited to two month Working Capital Management 32
  33. 33. CHAPTER THREE Working Capital Management 33
  34. 34. Industry Overview And Company Profile 3.1. Global Real Estate Industry The global real estate market continues to move forward, and better-than-expected results in the final quarter of 2012 demonstrate renewed impetus in the investment market. Supply is largely under control and, with shortages of high-quality space, rental spikes could appear in some markets later in the year and into 2014. Greatest upside potential is offered by U.S. markets, while austerity measures will constrain recovery across parts of Europe. Many developed economies ended 2012 close to or in recession and a rapid turnaround is not expected in early 2013. Even if the positive trends are upheld, rates of growth in 2013 as a whole will remain well below historic norms. The lingering concern for governments in the developed world will be how to foster a self-sustaining revival. In 2009-2010 these economies appeared to be emerging from their deep trough and hopes were high of a return to more normal expansion. However, demand evaporated in 2011 as the crisis in the Eurozone and tighter policy conditions halted the recovery in its tracks. 3.2. Real Estate in India Real estate plays a crucial role in the Indian economy. It is the second largest employer after agriculture and, slated to grow at 30% over the next decade. The Indian real estate market size is expected to touch $180 billion by 2020. The housing sector alone contributes to 5-6% of the country’s GDP. Retail, hospitality and commercial real estate are also growing significantly, providing the much-needed infrastructure for India’s growing needs. According to a study by ICRA (Investment Information and Credit Rating Agency of India Limited), the construction industry ranks 3rd among the 14 major sectors in terms of direct, indirect and induced effects in all sectors of the economy. A unit increase in construction expenditure generates five times the income, having a multiplier effect across the board. With backward and forward linkages to over 250 ancillary industries, the positive effects of real estate growth spread everywhere. Truly, real estate is a growth engine for India’s economy. Working Capital Management 34
  35. 35. Responding to an increasingly well-informed consumer and keeping in mind the globalization of the Indian business outlook, real estate developers have also shifted gears and accepted fresh challenges. The most marked change has been the shift from family owned businesses to professionally managed ones. Developers, in meeting the growing need for managing multiple projects across cities, are investing in centralized processes to source material and organize manpower and hiring qualified professionals in areas like project management, architecture and engineering. The growing flow of foreign direct investment (FDI) into Indian real estate is encouraging increased transparency. Developers, in order to attract funding, have revamped their accounting and management systems to meet due diligence standards. Customers have also benefited from a hassle-free accounting system. The modern real estate developer is keenly informed about market trends, basing his information on market research and rich experience. Young business leaders, armed with management degrees and international exposure, have also added value to this positive trend. Real estate developers play a leading role in the industry, bridging the gap between construction ability and the customer’s need. Developers offer value in terms of design, cost, functionality and location. They work hard to absorb international trends, analyze the customers’ expectations and deliver quality realty products based on their experience. In India, real estate developers fulfill a critical need for infrastructure to serve a growing economy in areas like housing, office space, retail and entertainment, among others. 3.3. Real Estate in Hyderabad Hyderabad is the capital and largest city of the Indian state of Andhra Pradesh. It occupies 650 square kilometers. The city is located on the banks of the Musi River on the Deccan Plateau. The population of the city is 6.8 million and that of its metropolitan area is 7.75 million, making it India's fourth most populous city and sixth most populous urban agglomeration. The Hyderabad Municipal Corporation was expanded in 2007 to form the Greater Hyderabad Municipal Corporation. Working Capital Management 35
  36. 36. Nehru Outer Ring Road or ORR is a 158 kilometer, 8-lane ring road expressway encircling the city of Hyderabad. It is being built by HMDA at a cost of INR 6,696 crores with an assistance of INR 3,123 crores from Japan International Cooperation Agency. The expressway is designed for speeds up to 120 kmph. A large part, 124 kms of the 158-km was opened in December 2012. It provides an easy connectivity between NH 9, NH 7, NH 4 and state highways leading to Vikarabad, Srisailam and Nagarjunasagar. The road aims to improve connectivity and decongest the traffic flow on the existing major arterials between the outer suburbs of Greater Hyderabad. The current status of the ORR is as given below: Completed segments • Gachibowli to Shamshabad (22 Kilometers)-November 2008 • Shamshabad to Pedda Amberpet (38 kilometers)-2010 • Narsingi to Patancheru (23.7 kilometers)-June 2011 • Patancheru to Shamirpet(38 kilometers)-December 2012 • Shamirpet to Pedda Amberpet (33 kilometers)-June 2013 The realty markets in Hyderabad, which witnessed a prolonged slump due to global recession coupled with the prevailing political uncertainty, is today in a gradual phase of recovery. Weak sentiments had dented the markets for over three years, leading to an over-supply situation across the city. New launches by prominent builders along the IT/ITES corridor, during the last two-quarters have received a good response, indicating a cautious optimism prevailing in the markets. The peripheral regions of Hyderabad contain large chunks of developable land, available at affordable prices. The development of the Outer Ring Road(ORR), The Metro Rail and the prevailing MMTS network will help improve connectivity and reduce travel time to various parts of the city. The regions surrounding the 158-km Nehru Outer Ring Road is yet to witness inclusive growth. A healthy mix of commercial and residential development along this region would aid in the development of this belt as a future growth-corridor. Similarly the presence of land banks surrounding the International Airport at Shamshabad and along the eastern corridor indicates the prospects for the growth of the city over the next decade. Working Capital Management 36
  37. 37. 3.4. Corporate Profile Rajapushpa Properties Pvt. Ltd. Rajapushpa Properties Pvt. Ltd. is an Hyderabad-based real-estate company, founded by Mr. J.C. Reddy, as an family owned entity in the year 2009. Rajapushpa Properties Pvt. Ltd. has a turnover of ₹504848000 for the financial year ending 31st March 2013. Rajapushpa’s first residential project was, a 237 flats gated residential apartments in Attapur, Hyderabad. Subsequent projects are located in Kokapet and Tellapur. The corporate office of Rajapushpa Properties is located at 4th Floor, Plot No. 34, Silicon Valley, Madhapur, Hyderabad – 500 081 Management Directors: P. Jaya Chandra Reddy P. Mahender Reddy P. Sreenivas Reddy Finance Manager: M. Durga Prasad Marketing Manager: Sujith Projects Lifestyle City Lifestyle city is a 150 acre project of 362 villas with areas ranging from 330 sq. yds. to 938 sq. yds. in three independent communities at Tellapur, Hyderabad. Open Skies Open Skies is a gated community of forty-eight villas at Kokapet near Financial District. Cannon Dale Cannon Dale is a gated community of thirty-seven triplex villas located near financial district adjacent to Narsingi junction on outer ring road. Working Capital Management 37
  38. 38. The Retreat Retreat is a gated community of two and three-bedroom luxury apartments laid out in two blocks and twelve towering floors each. This project is spread in an area of 2 acres and located adjacent to the outer ring road near Kokapet. Silicon Ridge It is Rajapushpa’s first residential real estate project. Silicon Ridge is a gated community of two and three-bedroom apartments laid out in eleven blocks and has 237 residencies, located in Attapur, Hyderabad. Working Capital Management 38
  39. 39. CHAPTER FOUR Working Capital Management 39
  40. 40. Analysis of Data 4.1. Current Ratio The current ratio of a company is a quick way to look at its current assets and current liabilities. Current Ratio Year 2010-2011 2011-2012 2012-2013 Current Assets ₹ 180,983,473 ₹ 431,840,922 ₹ 665,071,309 Current Liabilities ₹ 44,790,160 ₹ 146,689,863 ₹ 446,929,793 Current Ratio 4.0 2.9 1.5 Table (iii) Current Ratio Current Ratio 4.5 4.0 4.0 3.5 2.9 3.0 2.5 2.0 1.5 1.5 Current Ratio 1.0 0.5 0.0 2010-2011 2011-2012 2012-2013 Fig (xi) Current Ratio Inference • During the year 2012-2013, the current ratio has gone below the assumed normal value of 2:1. An exponential increase in current liabilities is the reason for the current ratio to fall to 1.5. • The current ratio during the year 2010-11 was 4:1, which is above the assumed value of 2:1. The following year i.e. 2011-12 the current ratio has decreased to 2.9:1. For Working Capital Management 40
  41. 41. the year 2012-13, the value fell to 1.5:1. Current liabilities increased due to the advances received during the year 2012-13 by the company from customers. As long as the company can deliver, the product for the advances received there is no need to worry about the decrease in current ratio during 2012-13. 4.2. Quick Ratio Quick ratio gives the cash position of the firm more accurately by removing the value of the inventories from the current assets. Year Current Assets Current Liabilities Inventories Quick Ratio ₹ ₹ ₹ Quick Ratio (Acid Test) 2010-2011 2011-2012 180,983,473 ₹ 431,840,922 44,790,160 ₹ 146,689,863 142,499,590 ₹ 269,786,686 0.86 1.10 ₹ ₹ ₹ 2012-2013 665,071,309 446,929,793 495,410,892 0.38 Table (iv) Quick Ratio Quick Ratio 1.10 1.20 1.00 0.86 0.80 0.60 0.38 0.40 Quick Ratio 0.20 0.00 2010-2011 2011-2012 2012-2013 Fig (xii) Quick ratio Inference • The quick ratio has shown a downward trend. It was near the ideal value of 1:1 during the year 2011-2012. • During the year 2010-2011, the value of quick ratio was 0.86:1 is fairly near the ideal value. Working Capital Management 41
  42. 42. • As most part of the current assets are inventories, during the year 2012-2013, the value of quick ratio has fallen to 0.38. • The company’s quick ratio values have remained fairly above the required levels of 1:1, except for the year 2012-13. Reason being increase in current liabilities due to advances received from customers at the same time inventories have increased considerably due to work in progress. It is suggested to keep the quick ratio at an optimal level of 1:1, as difficulty to meet the short term obligations may affect solvency of the company. 4.3. Cash ratio Cash ratio is the ratio of cash and cash equivalents of a company to its current liabilities. It is an extreme liquidity ratio since only cash and cash equivalents are compared with the current liabilities. It measures the ability of a business to repay its current liabilities by only using its cash and cash equivalents and nothing else. YEAR ₹ ₹ Cash And Cash Equivalents Current Liabilities Cash Ratio Cash Ratio 2010-2011 8,745,559 44,790,160 0.195 ₹ ₹ 2011-2012 18,038,813 146,689,863 0.123 ₹ ₹ 2012-2013 35,232,474 446,929,793 0.079 Table (v) Cash Ratio Cash Ratio 0.250 0.200 0.195 0.150 0.123 Cash Ratio 0.100 0.079 0.050 0.000 2010-2011 2011-2012 2012-2013 Fig (xiii) Cash Ratio Working Capital Management 42
  43. 43. Inference • The cash ratio for the year 2012-13 was 0.079. It means the company is carrying small amounts of cash 8% (approximately) for the year 2012-13. • In the year 2010-11 the ratio was 0.195. • The cash ratio of the company has been 0.195, 0.063, and 0.079 for the years 201011, 2011-12, 2012-13 respectively. Low values of cash ratio indicate that firm cannot meet all of its current liabilities with the cash available immediately, but the reserve borrowing power of the firm may come in handy during such times. 4.4. Return on Assets (ROA) ROA gives an idea as to how efficiently management is using company assets to generate profit. Return on Assets Year 2010-11 2011-12 2012-13 Net Income ₹ ₹ 6,927,000 ₹ 21,771,000 Total Assets ₹ 229,150,969 ₹ 494,214,067 ₹ 788,826,884 6,882,000 Return on Assets 0.0300 0.0140 0.0276 Table (vi) Return on Assets Return on Assets 0.0350 0.0300 0.0300 0.0276 0.0250 0.0200 0.0140 0.0150 Return on Assets 0.0100 0.0050 0.0000 2010-11 2011-12 2012-13 Fig (xiv) Return on assets Working Capital Management 43
  44. 44. Inference • Return on assets has shown a no consistent trend. • During the year 2011-12 the increase in total assets lead to decrease in RoA. • The return on assets ratio shows the relative performance of the company over the years. Return on assets ratio has shown a downward trend from 0.03 in the year 201011 to 0.014 in the year 2011-12 this can be attributed to the increase in total assets while the net income has more or less remained at 2010-11 levels. Again, in the year 2012-13 it has shown an upward trend and increased to 0.0276. This positive trend has to continue for better efficiency. 4.5. Working Capital Turnover Ratio The ratio measures the effective utilization of working capital. It establishes the relationship between cost of sales and working capital. Working Capital Turnover Ratio 2010-2011 2011-2012 ₹ 132,590,997 ₹ 199,217,000 ₹ 180,983,473 ₹ 431,840,922 ₹ 44,790,160 ₹ 146,689,863 ₹ 136,193,313 ₹ 285,151,059 0.97 0.70 Year Sales Revenue Current Assets Current Liabilities Net Working Capital Working Capital Turnover ₹ ₹ ₹ ₹ 2012-2013 500,751,854 665,071,309 446,929,793 218,141,516 2.30 Table (vii) Working Capital Turnover Ratio Working Capital Turnover 2.50 2.30 2.00 1.50 Working Capital Turnover 0.97 1.00 0.70 0.50 0.00 2010-2011 2011-2012 2012-2013 Fig (xv) Working Capital Turnover Ratio Working Capital Management 44
  45. 45. ₹ 600,000,000 ₹ 500,000,000 Net Working Capital ₹ 400,000,000 ₹ 300,000,000 ₹ 200,000,000 Sales Revenue ₹ 100,000,000 ₹2010-2011 2011-2012 2012-2013 Fig (xvi) Net Working Capital Vs. Sales Revenue Inference • The working capital turnover ratio has increased to 2.30 in the year 2012-2013 from 0.70 during the year 2011-2012. • During the year 2012-13, the working capital turnover ratio has reached its peak value of 2.30 for the company indicating an improved working capital performance. • The sudden jump in ratio is due to the increase in sales during 2012-13. • Net working capital has reduced during the year 2012-13 due to increase in current liabilities. • Working capital turnover ratio values say that in the year 2010-11, Rajapushpa Properties was making only ₹ 0.85 in sales for every ₹ 1 used to fund operations, and in the year 2011-12 it was, making mere ₹ 0.70 in sales on every ₹ 1 spent on operations during the year. In the year 2012-13, though the company earned a good ₹ 2.30 sales revenue for every ₹ 1 spent on operations. Working Capital Management 45
  46. 46. 4.6. Inventory Conversion Period Inventory conversion period Year 2010-2011 2011-2012 2012-2013 COGS* ₹ 102,975,416 ₹ 165,281,562 ₹ 412,605,311 Inventories ₹ 142,499,590 ₹ 269,768,686 ₹ 495,410,892 Days/year 365 365 365 Inventory conversion period 505 596 438 *COGS – Cost of Goods Sold Table (viii) Inventory Conversion Period Inventory conversion period 700 596 600 505 500 438 400 300 Inventory conversion period 200 100 0 2010-2011 2011-2012 2012-2013 Fig (xvii) Inventory Conversion Period Inference • Inventory conversion period has decreased to 438 days during the year 2012-13. • The inventory conversion period has decreased due to increase in sales during the year 2012-13. • The inventory conversion period (ICP) has touched a peak of 596 days during the year 2011-12 as the work in progress has increased considerably. During the year 2012-13 ICP decreased to 438 days. The downtrend in ICP observed in the year 2012-13 is due to increased sales during the year. Working Capital Management 46
  47. 47. 4.7. Receivables Collection Period Receivables collection period Year 2010-2011 2011-2012 ₹ 132,590,997 Sales 2012-2013 ₹ 199,217,000 ₹ 500,751,854 ₹ 4,008,963 Receivables collection period ₹ 94,628,622 365 365 11 Days/year ₹ 83,040,650 365 Accounts Receivables 152 69 Table (ix) Receivables collection period Receivables collection period 200 152 150 100 Receivables collection period 69 50 11 0 2010-2011 2011-2012 2012-2013 Fig (xviii) Receivables collection period Inference • Receivables collection period has increased to 152 days during the year 2011-12. • There has been a sudden increase in the trade receivables during the year 2011-12. • The company could bring down the receivables collection period to 69 days during 2012-13, thanks to the sales revenue during the year. • Receivables collection period (RCP) has peaked during the year 2011-12 to 152 days from a mere 11 days during 2010-11. In the following year i.e. 2012-13 RCP came down to 69 days. This downtrend should be encouraged for higher profitability. Working Capital Management 47
  48. 48. 4.8. Payables Deferral Period Payables deferral period Year 2010-2011 ₹ 165,281,562 ₹ 412,605,311 ₹ 16,643,581 ₹ 26,177,273 ₹ 60,010,782 365 365 365 59 Accounts Payable 2012-2013 ₹ 102,975,416 COGS 2011-2012 58 53 Days/year Payables deferral period Table (x) Payables Deferral Period Payables Deferral Period 60 59 58 58 56 53 54 Payables deferral period 52 50 2010-2011 2011-2012 2012-2013 Fig (xix) Payables Deferral Period Inference • The payables deferral period has decreased to 53 days in 2012-13 from 59 days in 2010-11. • The payables deferral period has remained more or less consistent. • The firm should aim to increase the payables deferral period to the maximum extent possible. • Payables deferral period (PDP) has shown a near consistent trend over the past three years. That said the company should exploit the opportunities to increase the PDP to permissible extent without losing the credibility with creditors. Working Capital Management 48
  49. 49. 4.9. Cash Conversion Cycle Cash conversion cycle represents the time (in days), a company takes to convert resource inputs into cash flows. Cash Conversion Cycle |Year 2010-2011 2011-2012 2012-2013 Sales ₹ 132,590,997 ₹ 199,217,000 ₹ 500,751,854 COGS ₹ 102,975,416 ₹ 165,281,562 ₹ 412,605,311 Inventories ₹ 142,499,590 ₹ 269,768,686 ₹ 495,410,892 ₹ 4,008,963 ₹ 83,040,650 ₹ 94,628,622 ₹ 16,643,581 ₹ 26,177,273 ₹ 60,010,782 Days/year 365 365 365 Inventory conversion period 505 596 438 Receivables collection period 11 152 69 Payables deferral period 59 58 53 457 690 454 Accounts Receivables Accounts Payable Cash conversion cycle (CCC) Table (xi) Cash Conversion Cycle Cash Conversion Cycle (CCC) 800 690 700 600 500 457 454 400 Cash conversion cycle (CCC) 300 200 100 0 2010-2011 2011-2012 2012-2013 Fig (xx) Cash Conversion Cycle Working Capital Management 49
  50. 50. Inference • The length of the time to convert resources into cash flows has been more or less consistent except during the year 2011-12. • The spike in the cash conversion cycle during the year 2011-12, can be attributed to an increase in receivables collection period and inventory conversion period. • Payables deferral period has been more or less consistent over the years. • Receivables collection period has spiked to 152 days in the year 2011-12. • Empirical studies show that Cash conversion cycle (CCC) is inversely related to profitability. In the year 2011-12, the CCC was 690 days in the previous year and in the following year, it has remained more or less same at 457 and 454 respectively. Rajapushpa properties can improve profitability by further decreasing the length of CCC. 4.10. Sales It indicates the amount realized from product or service sold through the normal operations of the company during the year. Sales Year 2010-2011 2011-2012 2012-2013 Sales ₹ 132,590,997 ₹ 199,217,000 ₹ 500,751,854 Table (xii) Sales Working Capital Management 50
  51. 51. Sales ₹ 600,000,000 ₹ 500,751,854 ₹ 500,000,000 ₹ 400,000,000 ₹ 300,000,000 ₹ 200,000,000 Sales ₹ 199,217,000 ₹ 132,590,997 ₹ 100,000,000 ₹0 2010-2011 2011-2012 2012-2013 Fig (xxi) Sales Inference • A consistent increase in the sales over past three years has been witnessed. • A remarkable sales growth of about 151.36% has been observed in the sales during the year 2012-13 over the year 2011-12. • The increase in sales revenue can be attributed to completion of projects. • The sales revenue of Rajapushpa Properties has shown a consistent increasing trend all through 2010 to 2013. This upward trend is a positive sign to sustain this in the long run and to improve on it the company can adopt better working capital management practices. Working Capital Management 51
  52. 52. 4.11. Changes in Working Capital Changes In Working Capital 2010-11 Current Assets (a)Current investments (b)Inventories (c )Trade receivables (d)cash and cash equivalents (e )Short-term loans and advances (f)Other current assets Total Current Liabilities (a)Short-term borrowings (b)Trade payables (c )Other current liabilities (d)Short-term provisions Total 2011-12 Increase ₹142,499,590 ₹ 4,008,963 ₹ 8,745,559 ₹269,768,686 ₹ 83,040,650 ₹ 18,038,813 ₹127,269,096 ₹79,031,687 ₹ 9,293,254 ₹ 25,729,361 ₹ 60,992,773 ₹35,263,412 ₹180,983,473 ₹431,840,922 ₹ 26,177,273 ₹117,818,746 ₹ 2,693,843 ₹ 146,689,863 ₹136,148,313 Working Capital(WC) Change in WC ₹0 ₹ 16,643,581 ₹ 24,591,894 ₹ 3,554,685 ₹ 44,790,160 Decrease ₹ 250,857,449 ₹285,151,059 ₹ ₹ 9,533,692 93,226,852 ₹ 102,760,544 ₹ 860,842 ₹ 860,842 ₹ 149,002,746 2011-12 2012-13 Increase ₹269,768,686 ₹ 83,040,650 ₹ 18,038,813 ₹495,410,892 ₹ 94,628,622 ₹ 35,232,474 ₹ ₹ ₹ ₹ 60,992,773 ₹ 39,799,321 ₹431,840,922 ₹665,071,309 Current Liabilities (a)Short-term borrowings (b)Trade payables ₹ 26,177,273 ₹ 52,536,248 ₹ 60,010,782 ₹ 33,833,509 (c )Other current liabilities (d)Short-term provisions ₹117,818,746 ₹ 2,693,843 ₹323,790,449 ₹ 10,592,313 ₹ ₹ 205,971,703 7,898,470 Total ₹146,689,863 ₹446,929,793 ₹ 247,703,682 Working Capital(WC) Change in WC ₹285,151,059 Decrease ₹218,141,516 Current Assets (a)Current investments (b)Inventories (c )Trade receivables (d)cash and cash equivalents (e )Short-term loans and advances (f)Other current assets 225,642,206 11,587,972 17,193,661 ₹ ₹ 254,423,839 21,193,452 ₹ 21,193,452 ₹ 52,536,248 ₹ 52,536,248 ₹ 67,009,543 Table (xiii) Changes in Working Capital Working Capital Management 52
  53. 53. Inference • Working capital has increased considerably during the year 2011-12, the result of which can be seen from the sales during next year. • During the year, 2012-13 current liabilities have increased drastically leading to an decrease in working capital over the previous year (2011-12). 4.12. Trend Analysis Time series or trend analysis of ratios indicates the direction of change. The procedure followed is to assign the number 100 to items of the base year and to calculate the percentage changes in each item of other years in relation to base year. This procedure may be called as trend percentage method. Trend Analysis YEAR 2010-2011 2011-2012 2012-2013 Sales ₹ 132,590,997 ₹ 199,217,000 ₹ 500,751,854 EBITDA ₹ 15,042,000 ₹ 16,367,000 ₹ 56,800,000 PAT ₹ 6,992,000 ₹ 6,927,000 ₹ 21,771,000 Current Assets ₹ 180,983,473 ₹ 431,840,922 ₹ 665,071,309 Current Liabilities ₹ 44,790,160 ₹ 146,689,863 ₹ 446,929,793 Gross fixed Assets ₹ 29,908,029 ₹ 33,388,506 ₹ 49,564,354 Net Fixed Assets ₹ 26,327,829 ₹ 32,452,869 ₹ 48,145,444 Total assets ₹ 229,150,969 ₹ 494,214,067 ₹ 788,826,884 Net Worth ₹ 38,113,251 ₹ 41,215,242 ₹ 100,601,010 Table (xiv) Trend Analysis Working Capital Management 53
  54. 54. YEAR Sales EBITDA PAT Current Assets Current Liabilities Gross fixed Assets Net Fixed Assets Total assets Net Worth Trend Analysis: Trend-Percentage Method 2010-2011 2011-2012 100% 150% 100% 109% 100% 99% 100% 239% 100% 328% 100% 112% 100% 123% 100% 216% 100% 108% 2012-2013 378% 378% 311% 367% 998% 166% 183% 344% 264% Table (xv) Trend Analysis: Trend-Percentage Method Inference • Trend analysis has shown that the total assets have grown faster than the net worth, it is an indication that the company has been relying on outsider’s money. The growth in sales and EBITDA has come to same level by year 2012-13. The growth in PAT has not kept up with the growth in sales from the base year 2010-11. Currents assets and current liabilities have not moved together. The exponential growth in the current liabilities is attributed to increase in advances from customers, which is likely to be converted into sales in the coming year. 4.13. Working Capital Estimation Estimation Method Raw Material: One month’s supply (Raw Material consumed/12) Semi-Finished Material: Raw Material per month + One- half of normal conversion cost Finished Material: One month’s supply (Total Product Cost/12) Total Inventory Needs: Raw material + Semi-finished material + finished material Debtors: One month’s total revenue (Total Revenue/12) Operating Cash: Total Product Cost/12 Total Working Capital required= Total Inventory Needs + Debtors + Operating Cash Working Capital Management 54
  55. 55. Year 2010-11 2011-12 2012-13 Consumed ₹ 35,588,142 ₹ 121,417,575 ₹ 405,353,782 Operating Expenses ₹ 84,378,110 ₹ 65,611,437 ₹ 42,674,767 Total Expenses ₹ 119,966,252 ₹ 187,029,012 ₹ 448,028,549 Depreciation ₹ ₹ ₹ Total Product Cost ₹ 121,881,697 ₹ 187,915,349 ₹ 449,412,949 Annual Revenue ₹ 135,122,825 ₹ 203,445,198 ₹ 504,848,388 Raw Material 1,915,445 886,337 1,384,400 Table (xvii) Parameters considered for Working Capital Estimation Estimation of Working Capital using Current Assets Holding Period Year 2010-11 2011-12 2012-13 Consumed ₹ 35,588,142 ₹ 121,417,575 ₹ 405,353,782 RMC/Month ₹ 2,965,679 ₹ 10,118,131 ₹ 33,779,482 Semi-Finished Material ₹ 5,729,176 ₹ 11,686,485 ₹ 38,991,258 Finished Material ₹ 10,156,808 ₹ 15,659,612 ₹ 37,451,079 Total Inventory Needs ₹ 18,851,663 ₹ 37,464,229 ₹ 110,221,819 Debtors ₹ 11,260,235 ₹ 16,953,767 ₹ 42,070,699 Operating Cash ₹ 1,263,048 ₹ ₹ 2013-14 Raw Material 1,368,016 ₹ 31,374,946 Estimated WC 4,734,987 ₹ 55,786,011 ₹157,027,505 Table (xvii) Working Capital (WC) Estimation Inference • Estimated working capital needs for the year 2013-14 is ₹ 157,027,505 based on the current assets holding period method • The method fairly relies on non-cash items in estimation of working capital Working Capital Management 55
  56. 56. CHAPTER FIVE Working Capital Management 56
  57. 57. CONCLUSION AND RECOMMENDATIONS Conclusion The company’s cash flows are positive and the company is making profits. The profitability and solvency of the company are intact. The firm is in stages of growth where it is going to witness economies of scale. As the turnover and scales of operations, increase the firm needs to manage its working capital requirements through a proper policy. The two primary concerns firms have regarding receivables are the lost cash flows arising from bad debts and from administrative costs. Standardization of the procedures in debtors and inventory management to decrease the length of cash conversion cycle will go a long way in increasing the profitability of the company. Recommendations • Improving collection practices, inventory controls, and trade credit practices are beneficial for the company, the firm's lenders, and their investors. • The current liabilities have been increasing at an exponential rate during the years analysed, an effort should be made to keep the current liabilities under check and to improve the levels of current assets. • The period between bookings and handing over of homes should be shortest, the company can use the funds in construction of new projects, and at the same time, cost of debt too is reduced. • The working capital estimation method used in this study can be applied with needed modifications to suite the company’s needs and a mechanism to address the working capital needs can be put in place. • The cash conversion cycle and its components can be used as indicators of performance of the administration. Working Capital Management 57
  58. 58. References 1. The Impact of Working Capital on the Profitability: Evidence from the Indian Firms Chatterjee, Saswata. SSRN Working Paper Series, Aug 2012. http://search.proquest.com/business/docview/1323893939/13F9986416064E37D0/6?a ccountid=131549 2. The Impact of Firms' Capital Expenditure on Working Capital Management: An Empirical Study across Industries in Thailand Appuhami, B A Ranjith. International Management Review 4.1 (2008): 8-21. http://search.proquest.com/business/docview/195578526/13F9986416064E37D0/3?ac countid=131549 3. Melita Stephanou Charitou, Maria Elfani, Petros Lois, University of Nicosia, Cyprus(Dec 2010)- titled “The Effect Of Working Capital Management On Firm’s Profitability: Empirical Evidence From An Emerging Market” 4. Accruals and the Prediction of Future Cash Flows, Mary E. Barth, Donald P. Cram and Karen K. Nelson, The Accounting Review , Vol. 76, No. 1 (Jan., 2001), pp. 27-58, Published by: American Accounting Association,Article Stable URL: http://www.jstor.org/stable/3068843 http://www.jstor.org/stable/3068843?seq=1&uid=3738256&uid=2&uid=4&sid=2110 2507846991 5. www.joneslanglasalle.com 6. I M Pandey (2010), Financial Management, Tenth Edition , Vikas Publishing House Pvt. Ltd. 7. Eugene F. Brigham, Michael C. Ehrhardt, Financial Management: Theory and Practice, Cengage Learning. 8. Hrishikes Bhattacharya (2009), Working Capital Management: Strategies and Techniques, PHI Learning Pvt. Ltd. 9. Lorenzo Preve, Virginia Sarria-Allende(2010), Working Capital Management, Financial Management Association Survey and Synthesis Series, Oxford University Press. 10. Kaplan Schweser CFA 2013 Level 1 Study Notes, Book 3 Working Capital Management 58
  59. 59. Annexure Profit & Loss Statement Year 2010-11 2011-12 2012-13 Operations ₹ 132,590,997 ₹ 199,217,000 ₹ 500,751,854 Other income ₹ ₹ ₹ Total Revenue (I) ₹ 135,122,825 ₹ 203,445,198 ₹ 504,848,388 ₹ 35,588,142 ₹ 121,417,575 ₹ 405,353,782 ₹ 66,323,939 ₹ 37,640,487 ₹ 125,082,630 ₹ 1,063,335 ₹ 6,241,500 ₹ -117,849,101 expenses ₹ 4,928,597 ₹ 8,041,945 ₹ 16,907,670 Finance costs ₹ 2,690,511 ₹ 5,420,037 ₹ 22,940,201 ₹ 12,062,239 ₹ 13,687,505 ₹ 18,533,568 ₹ 1,915,445 ₹ 935,637 ₹ 1,418,910 Income Revenue from 2,531,828 4,228,198 4,096,534 Expenses Raw material consumed Construction expenses (Increase)/decrease in stock Employee benefit Administrative expenses Depreciation and amortization Working Capital Management 59
  60. 60. expenses Provisions and writeoffs Total Expenses(II) ₹ 124,572,208 ₹ 193,384,686 ₹ 472,387,661 ₹ 10,550,617 ₹ 10,060,512 ₹ 32,460,727 ₹ 3,554,685 ₹ 102,693,843 ₹ 10,592,313 ₹ 114,390 ₹ 439,364 ₹ 98,376 ₹ 6,114,470 ₹ 3,825,314 ₹ 10,000,000 (Loss)/Profit before tax (III)= (I)-(II) Tax Expenses Current tax Deferred tax liability(asset) (Excess)/Short provision of tax relating to earlier years Total Tax Expense(IV) ₹ 9,783,545 ₹ 6,958,521 ₹ 20,690,689 ₹ 767,072 ₹ 3,110,991 ₹ 11,770,038 ₹ 767,072 ₹ 3,110,991 ₹ 11,770,038 (Loss)/ Profit for the year (III)-(IV) Less/Add: Prior period expenditure Balance Carried to Balance Sheet Table (xviii) Profit & Loss Statement Working Capital Management 60
  61. 61. Balance Sheet Year 2010-11 2011-12 2012-13 I EQUITY AND LIABILITIES (1) Shareholder's funds (a) Share Capital (b)Reserves and surplus ₹ 32,384,270 ₹ 32,384,270 ₹ 80,000,000 ₹ 5,728,981 ₹ 8,830,972 ₹ 20,601,010 (c )Money received against share warrants ₹ 38,113,251 (2) Share application money pending allotment ₹ 41,215,242 ₹100,601,010 ₹ 76,003,326 ₹ 94,403,326 ₹107,880,557 ₹ 69,397,842 ₹ 68,375,043 ₹132,031,394 (3)Non-current liabilities (a)Long-term borrowings (b)Deferred tax liabilities (Net) ₹ 114,390 ₹ 553,754 ₹ 652,130 (c )Other long term liabilities ₹ 732,000 ₹ 732,000 ₹ 732,000 ₹ 3,390,820 (d)Long term provisions ₹ 70,244,232 ₹ 73,051,617 ₹133,415,524 (4)Current liabilities (a)Short-term borrowings ₹ 0 ₹138,854,019 (b)Trade payables ₹ 16,643,581 (c )Other current liabilities ₹ 24,591,894 ₹117,818,746 ₹323,790,449 (d)Short-term provisions ₹ 3,554,685 ₹ 26,177,273 ₹ 52,536,248 ₹ 2,693,843 ₹ 60,010,782 ₹ 10,592,313 ₹ 44,790,160 ₹285,543,882 ₹446,929,793 TOTAL ₹229,150,969 ₹494,214,066 ₹788,826,884 II ASSETS (1)Non-current assets Working Capital Management 61
  62. 62. (a)Fixed assets ₹ 26,327,829 ₹ 32,452,896 ₹ 48,145,444 ₹ 2,500,000 ₹ 2,500,000 ₹ 2,500,000 ₹ 18,945,267 ₹ 27,075,175 ₹ 72,799,540 ₹ 394,400 Tangible assets ₹ 345,100 ₹ 310,590 Capital Work in Progress Intangible assets under development (b)Non-current investments (c )Deferred tax assets(net) (d)Long term loans and advances (e )Other non-current assets ₹ 48,167,496 ₹ 62,373,144 ₹123,755,574 (2)Current assets (a)Current investments ₹142,499,590 ₹269,768,686 ₹495,410,892 (b)Inventories (c )Trade receivables ₹ 4,008,963 ₹ 83,040,650 ₹ 94,628,622 (d)cash and cash equivalents ₹ 8,745,559 ₹ 18,038,813 ₹ 35,232,474 ₹ 25,729,361 ₹ 60,992,773 ₹ 39,799,321 (e )Short-term loans and advances (f)Other current assets ₹180,983,473 ₹431,840,922 ₹665,071,309 TOTAL ₹229,150,969 ₹494,214,066 ₹788,826,884 Table (xix) Balance Sheet Working Capital Management 62