working capital management

WORKING CAPITAL MANAGEMENT
CHAPTER – 1
INTRODUCTION OF WORKING CAPITAL
Working capital is the employment of current assets and current liabilities in
such a way as to increase short-term liquidity. Working capital management is a
significant fact of financial management due to the fact that it plays a crucial role in
keeping the wheels of business enterprise running. Working capital management is
concerned with the short-term financial decisions, which have been comparatively
neglected in the literature of finance. Shortage of funds for working capital has
caused many businesses to fail. Lack of efficient and effective utilization of working
capital leads to low rate of returns on capital employed or even compels to sustain
loses. The need for skilled working capital has become greater in recent years.
A firm usually invests a part of its permanent capital in fixed assets and keeps
a part of it for working capital, for example meeting day-to-day requirements. The
requirement of working capital varies from firm to firm, depending on the nature of
business, production policy, market conditions, seasonality of operation, condition of
supply etc. Working capital to a company is like a blood of human body. It is the
most vital ingredient of business. Working capital if carried out effectively and
efficiently and consistently, will assure the health of an organization.
Every organization has to arrange for adequate funds for meeting day-to-day
expenditure, apart from investment from fixed assets. Working capital is the flow of
ready funds necessary for the working of the enterprise. It consists of funds invested
in current asset of that asset, which in the ordinary course of business, can be turned
into cash within a brief period without undergoing reduction in value and without
disruption of organization. Current liabilities are those indented to be paid in ordinary
course of business within a short period of time. Working capital serves the fallowing
purposes: -
1. To meet the cost of inventories, raw materials purchases, work in progress,
finished goods etc.
2. To pay wages and salaries.
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3. To meet overhead cost, factory cost, office and administration cost, taxes,
selling distribution expense, packing, advertisements etc.
FIG 1.1 CIRCULATION OF CURRENT ASSET
CHAPTER – 2
DEFINITION OF WORKING CAPITAL
2
INVENTORIES
CASH
RECEIVABLES

In case of gross working capital, it is the concept that focus attention of two
aspects of current asset management:
1. Optimum investment in current asset.
2. Financing of current assets.
Following definitions of working capital place emphasis on gross working
capital.
1. According to Mead, Mallot & Field. “Working capital means current assets”.
2. According to Bonneville. “Working capital is any acquisition of funds which
increase the current asset, increases working capital, for they are one and the
same.”
3. According to J.S Mills. “The sum of current asset is the working capital of
the firm”.
Now let us look at the definitions of net working capital. It reflects the modern
concept of working capital, which is also most commonly used. According to the new
concept of working capital it refers to the difference between current asset and
current liability. It is the excess of current asset over current liability. Current liabilities
refer to the claims of outsiders, which are expected to mature for payment within an
accounting year. It includes creditors for goods, bills payable, bank overdraft etc. The
concept may be better understood in the fallowing equation: -
WORKING CAPITAL = CURRENT ASSET – CURRENT LIABILITY.
The net working capital (a) indicate the liquidity position of the firm and (b)
suggest the extend to which working capital needs to be financed by permanent
sources of fund. Both the net and gross concept of working capital is the two facets
of working capital management.
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Net working capital may be of the fallowing type:
Positive and quantitive net working capital: - It arises when current asset
exceeds current liability.
Negative or quantities net working capital: - It occurs when current
liabilities are in excess of current asset.
CHAPTER – 3
CLASSIFICATION OF WORKING CAPITAL
Working capital may be classified on the fallowing basis:
1. On the basis of concept:
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I. Gross working capital (represented by the total current asset).
II. Net working capital (excess of current asset over current liabilities).
2. On the basis of periodicity of requirements:
I. Fixed or permanent working capital: It represents that part of capital
permanently locked up in the current asset to carry out the business smoothly.
This investment in current asset increase as the size of business expands.
Examples of such investment are those required to maintain the minimum stock
of raw material, work in progress, finished products, loose tools and
equipments. This arrangement requires minimum cash balance to be kept in
reserve for payment of wages salaries and all other current expenditure
throughout the year. The permanent fixed working capital may again be
subdivided into fallowing:
(A) Regular working capital: It is the minimum amount of liquid capital
required to keep up the circulation of the capital from cash to inventories; to
receivables and again to cash. This includes sufficient minimum cash balance
to discount all bills and to maintain adequate supply of raw material etc.
(B) Reserve margin or cushion working capital: It is the excess capital over
the needs of regular working capital, that should be kept in reserve for
contingencies, that may arise at any time. These contingencies include rising
price, strikes, business decompressions, special operation such as
experiment with new product etc.
II. Variable working capital: Variable working capital changes with the increase or
decrease in the volume of business. It may be subdivided into fallowing: -
{A} Seasonal variable working capital: The working capital required to meet
the seasonal liquidity of business is seasonal variable working capital.
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{B} Special variable working capital: It is that part of variable working capital,
which is required for financing special operation such as extensive marketing
campaigns, experiment with product or methods of production, carrying of
special jobs etc.
CHAPTER – 4
ADEQUACY OF WORKING CAPITAL
Working capital or investment in current asset is a must for meeting the day-
to-day expenditure on salaries, wages rent, advertising etc and for maintaining the
fixed asset. Large-scale capital in fixed asset is often determined by relatively small
amount of current asset. The heart of industry, working capital, if weak the business
cannot prosper and survive, although there may be a large investment of fixed
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assets. Inadequate as well as superfluous working capital is dangerous for the health
of the industry.”Inedequate working capital is disastrous, whereas superfluous
working capital is a criminal waste”. Both situations are unwarranted in a sound
business organization. Adequacy of working capital is the lifeblood and controlling
nerve center of a business.
Some of the uses of adequate working capital are:
1) CASH DISCOUNT: By adequate working capital the business can avail the
advantage of cash discount by paying cash for the purpose of raw material
and merchandise. If proper cash balance is maintained, this will reduce the
cost of production.
2) SENSE OF SECURITY AND CONFIDENCE: Adequate working capital create
a sense of security, confidence and loyalty throughout the business and also
among its consumers, creditors and business associates .The proprietor,
official or manager of a concern are carefree, if they have proper capital
arrangements because they need not worry for the payment of business
expenditure or creditors.
3) SOLVENCY AND CONTINUOUS PRODUCTION: In order to maintain the
solvency of business, it is essential that sufficient amount of funds are
available to make all the payments in time as and when they are due. In the
absence of working capital, production will suffer in the era of cutthroat
competition and business can never flourish in the absence of adequate
working capital.
4) SOUND GOODWILL AND INCREASED DEBT CAPACITY: Promptness of
payment in business creates goodwill and increases the debt capacity of the
firm. If the investors and borrowers are confident that they will get their due
interest and payment of principle in time, a firm can raise funds from market,
purchase goods on credit and borrow short term loans from bank etc.
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5) EASY LOANS FROM THE BANK: An adequate working capital helps the
company to borrow unsecured loans from the bank, because the excess
provides a good security to the unsecured loans. If the business has a good
credit standing and trade reputation, bank favors in granting seasonal loans.
6) DISTRIBUTION OF DIVIDEND: Short of working capital, a company cannot
distribute dividend to its shareholders in spite of sufficient profits. To make up
for the deficiency of working capital, profits are to be retained in business. On
the other hand ample dividend can be declared and distributed to the market
value of share and increase by sufficient working capital.
7) EXPLOITATION OF GOOD OPPORTUNITIES: Good opportunity can be
exploited through adequacy of capital in a concern. For example – A company
may make off seasons purchase, resulting in substantial saving or it can fetch
big supply orders resulting in good profits.
8) MEETING UNSEEN CONTINGENCY: As stock piling of finished goods
becomes necessary, depression shoots up the working demand of capital. If a
company maintain adequate working capital, unseen contingencies such as
financial crisis due to heavy loses, business oscillation etc can easily be
overcome.
9) INCREASE IN EFFICIENCY OF FIXED ASSETS: Proper maintainces and
adequate working capital increase the efficiency of fixed asset of business. It
has been rightly said,” the fate of large scale investment in fixed capital is
often determined by a relatively small amount of current asset.”
10)HIGH MORALE: The provision of adequate working capital improves the
morale of the executive as they get an environment of security, certainty and
confidence, which is a great psychological factor in improving the overall
efficiency of business and of the person who is at the helm of affair in the
company.
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11)INCREASE PRODUCTION EFFICIENCY: A continuous supply of raw
material, research programs, innovation and technical development and
expansion programs are successfully carried out if adequate capital is
maintained in the business. It increases production capacity, which increase
the efficiency and morale of the employees.
CHAPTER – 5
EVILS OF INADEQUATE WORKING CAPITAL
Some of the evils of not having adequate working capital in a business firm or
a company are as fallows:
1) LOSS OF CREDIT WORTHINESS AND GOODWILL: A firm losses its credit
worthiness and goodwill if it fails to honors its current liability. It finds it difficult
to procure the required funds for its business operation on easy terms. This
leads to reduced profitability and production interruption.
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2) NO BENEFIT FROM FAVORABLE OPPORTUNITY: With inadequate working
capital a firm fails to undertake profitable projects. It prevents the firm from
availing the benefit of available opportunity and stagnate its growth.
3) FAILURE TO AVAIL CREDIT OPPORTUNITY: Due to inadequate working
capital a firm fail to avail attractive credit opportunities.
4) OPERATING INEFFICIENCIES: Inadequate working capital leads to
operating inefficiencies, as day-to-day commitment cannot be met.
5) LOW RATE OF RETURN ON FIXED ASSET: Inadequate working capital
leads to a lowering down of rate of returns of fixed asset, as it cannot be
efficiently utilized or maintained due to inadequacy of working capital.
6) INCREASE IN BUSINESS RISKS: Inadequate working capital increases the
business risk of the firm. Unable to discharge its current liability it is liable to
be declared as insolvent. Thus inadequate working capital posses a serious
threat to the working and survival of the firm.
7) CANNOT ACHIEVE PROFIT TARGET: Due to inadequate working capital the
firm cannot achieve its profit target, as it cannot put into operation, its
operating plans due to shortage of working capital.
8) LOW MORALE OF BUSINESS EXECUTIVES: Inadequate working capital
adversely lowers the morale of the firm’s executive, as they do not have an
environment of certainty safety and confidence, which is necessary
psychological factor in improving the overall efficiency of a business firm.
9) WEAKENING OF FINANCIAL CAPACITY: Inadequate working capital
weakens the shock absorbing capacity of the firm, as it cannot meet the
contingencies arising from business fluctuation, financial loses etc.
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CHAPTER – 6
EVILS OF EXCESSIVE WORKING CAPITAL
Now let us look at some of the evils of having excessive or redundant working
capital:
1. IDLE FUNDS: Excessive and redundant working capital implies the presence
of idle funds, which earn no profits for the firm. A firm with excessive working
capital cannot earn proper rate of return on its total investments, as profits are
distributed on the whole of its capital. This brings down the rate of return to
the shareholders. Lower dividend reduce the market value of shares and
causes capital losses to the shareholders.
2. DECLINE IN OPERATING EFFICIENCY: Companies often adopt some
objectionable devices to inflate profits to maintain or increase the rate of
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dividend. Sometimes unearned dividends are paid out of company’s capital to
keep the show of prosperity by window dressing of accounts. In order to make
up the deficiency of reduced earnings, certain provision, such as the provision
for depreciation, repairs and renewals are not made. This leads to decline in
operating efficiency and fall in profits.
3. LOSS OF CONFIDENCE AND GOODWILL: Excessive working capital leads
to lower rate of returns on company’s total investments. Lower dividend leads
to reduction of market value of companies share much less than the book
value. The shareholders losses confidence in the company and the goodwill
or the credit of the company suffers a serious setback. Thus the financial
stability of the company is jeopoderzied.
4. MISAPPLICATION OF FUNDS: Companies with excessive working capital do
not utilize the resources prudently. The company purchases excessive
inventories and fixed assets, which do not add to the profitability and increase
its maintaince cost and losses due to theft, waste and mishandling.
5. EVILS OF OVERCAPITALIZATION: Excessive working capital leads to over
capitalization, which is disastrous to the smooth working and survival of the
company and effect the interest of those associated with the company.
6. INEFFICIENT MANAGEMENT: Excessive working capital indicates that the
management is not interested in expanding the business; otherwise the
excessive capital might have been utilized for this purpose.
7. DESTRUCTION IN TURNOVER RATIO: Superfluous working capital destroys
the control of turnover ratio, which is commonly used in conduct of an efficient
business. It eradicates all other guide and signpost commonly used and
employed in conducting and operating a business.
Thus a company must have working capital adequate to its requirements. It
must neither be excessive or inadequate. While inadequate working capital
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adversely affects the business operation and profitability, excessive working capital
keep it idle and earn no profits.
CHAPTER – 7
Working capital is the money used to make goods and attract sales. The less
working capital is used to attract sale, the higher is it likely to be the return of
investment. Working capital management is about the commercial and financial
aspect of inventory, credit, marketing, royalty and investment policy. The higher the
profit margin, lower is it likely to be the level of working capital tied up in creating and
selling titles. The faster that we create and sell the books the higher is it likely to be
the return on investment.
Now let us look at some of the definitions of working capital management:
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PROF K V SMITH: “Working capital management is concerned with problems
that arise in attempting to manage the current asset, the current liability and
the interrelation that exist between them”.
WESTON AND BRIGHAM: “Working capital management refer to all aspect
of administration of both current asset and current liability”.
JAMES C VAN HORNE: “Current asset, by definition are asset normally
converted into cash within one year. Working capital management is
concerned with the administration of these asset-namely cash and
marketable securities”.
Now let us look at some of the main and important objective of working capital
management:
1. To decide upon the optimum level of investment in various current asset I.e.
determining the size of working capital.
2. By optimizing the investment in current asset and by reducing the level of
current liability, the company can reduce the locking up of funds in working
capital and thereby it can improve the return on capital employed in the
business.
3. To decide upon the optimum mix of short-term funds in relation to long-term
capital.
4. The company should always be in a position to meet its current obligation,
which should be properly supported by current assets available with the firm.
Maintaining excess fund in working capital means locking of funds without any
returns.
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5. To locate appropriate source of short term financing.
6. Maintaining working capital at appropriate levels.
7. Availability of sufficient funds at time of need.
8. The Firm should manage its current asset in such a way that marginal returns
on investment in current asset is not less than the cost of capital employed to
finance the current assets.
CHAPTER – 8
IMPORTANCE OF WORKING CAPITAL MANAGEMENT
According to Husband and Hockery,”the prime object of management is to
make a profit, either or not this is accomplished, depend on the manner in which
working capital is accomplished”. The primary object of working capital is
management is to manage the firm’s current asset and current liability in such a
manner that a satisfactory level of working capital is maintained. The firm may
become insolvent if it cannot maintain a satisfactory level of working capital. Working
capital assist in increasing the profitability of the concern. The working capital
position decide the various policies in the business with receipt to general operation
viz importance of working capital.
Positive correlation between sale and current assets: There is a positive
correlation between the sale of the product of the firm and its current assets.
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Increase in the sale of the product requires a corresponding increase in current
assets. Therefore, the current asset must be managed properly.
Investment in current asset: Generally more than half of the total capacity of
the firm is invested in current assets. Thus less than half of the capital is blocked in
fixed asset. Therefore management of working capital attracts the attention of the
management.
No alternative for current asset: While fixed capital can be acquired on
lease in emergency, there is no alternative for current asset. Investment in current
asset cannot be avoided without substantial losses.
Important for small unit: The management of working capital is more
important for small unit because they do not relay on long term capital market and
have easy access to short term finance source such as trade credit, short term bank
loans etc.
CHAPTER – 9
FACTORS DETERMINING WORKING CAPITAL REQUIREMENTS
Now let us look at the various factors determining the working capital
requirement in a business firm:
(A) Nature of businesses: The amount of working capital is related to the nature of
business. It concerns, where the cost of raw material used in manufacture of a
product is very large in production to its total cost of manufacture, the requirement of
working capital will be very large. For instance a cotton or sugar mills require a large
amount of working capital. On the other hand firms requiring large amount of
investment in fixed asset require less working capital. Public utility concern like
Indian Railways, require a lesser amount of working capital as compared to trading
or manufacturing concern, partly because of cash nature of their business and partly
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because, they are selling service instead of a commodity and there is no need of
maintaining inventories.
(B) Size of business unit: The general principle in this regard is that the bigger the
size of business, the larger will be the amount of working capital required, because
the larger business unit are required to maintain big inventories for the flow of the
business and to spend more in carrying out the business operation smoothly.
(C) Seasonal variation: Strong seasonal variation create special problem of working
capital in controlling the internal financial swings in many companies such as sugar
mills, oil mills, woolen mills etc. These require larger amount of working capital in the
season to purchase the raw material in large quantity and utilize them throughout the
year. They adjust their production schedule and maintain a steady rate of production
in off seasons. Thus they require larger amount of working capital during season.
(D) Time consumed in manufacture: The average time taken in the process of
manufacture is also an important factor in determining the amount of working capital.
The larger the period of manufacture the larger will be the working capital required.
Capital goods industries managed to minimize their investment in working capital by
asking advances from consumers as work proceeds in their orders.
(E) Turnover of circulating capital: Turnover means ratio of annual gross sales to
average working asset. It means the speed with which circulating capital complete its
round, or number of times the amount invested in working asset has been converted
into cash by sale of finished goods and reinvested in working asset during the year.
The faster the sales the larger the turnover. Conversely greater the turnover, larger
the volume of business to be done with given working capital. It require lesser
amount of working capital in spite of larger sale because of great turnover.
(F) Labor intensive versus capital intensive industries: In labor intensive
industries, larger working capital is required because of regular payment of heavy
wage bills and more time taken in completing the manufacturing process. On the
other hand the capital intensive industry requires require lesser amount of working
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capital because of heavy investment in fixed asset and shorter period in many
acquiring processes.
(G) Need to stockpile raw material and finished goods: The industry, where it is
necessary to stockpile the raw material and finished goods increase the amount of
working capital, which is tied up in stock and stores. In some line of business where
the materials are bulky and best purchased in large quantity such as cements,
stockpiling of raw material is very usual and used. In companies where labor strike is
very frequent like public utility concern, stockpiling of raw material is advisable. In
certain industries which are seasonal in nature, finished goods stock have to be in
large quantity which require large working capital.
(H) Terms of purchase and sale: Cash or credit terms of purchase and sale also
affect the amount of working capital .If a company purchase all goods in cash and
sells its finished product on credit, it will require a large amount of working capital
.On the other hand a concern having credit facility and allows no credit to its
customers will require less amount of working capital. Terms and conditions of
purchase and sale are generally governed by prevailing trade practice and by
changing economic conditions.
(I) Conversion of current asset into cash: The need of having cash in hand to
meet the day to day requirement like payment of wage and salary, rent etc has an
important bearing in deciding the adequate amount of working capital. The greater
the cash requirement, higher will be the need of working capital. A company has
ample stock of liquid current asset will require lesser amount of working capital
because it can encash its assets immediately in open market.
(J) Growth and extension of business: Growing concern requires more working
capital than that which is static. It is logical to except larger amount of working capital
in a going concern to meet its growing need of funds and for its expansion programs
through it varies with economic condition and corporate practice.
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(K) Business cycle fluctuation: Business cycle affect the requirement of working
capital At times, when the prices are going up and boom condition prevail, the
management seek to pile up big stock of raw material to have an advantage of lower
price and maintain a big stock of finished goods with an expectation to earn more
profit by selling it at higher price in future. The expansion of business unit caused by
the inflationary condition creates demand for more and more working capital.
Depression involves the locking up of big amount in working capital as the
inventories remain unsolved and book debts uncollected. The reduction in the
volume of business may result in increasing the cash position because of reduction
in inventories and receivable that usually accompanies decline in sale and
shortening in capital expenditure. In such case shortage of working capital develops.
(L) Profit margin and profit appropriation: Some firms enjoy a leading position in
the market due to quality product and good marketing management or monopoly
power in the market and thereby earn huge profits. It contributes towards working
capital, provided it is earned in cash. Cash profit can be found by adjusting the non-
cash item like depreciation, outstanding expense, accumulated losses and expense
written off in net profit. But in practice the whole cash inflows are not considered as
cash available for use as cash is used up to increase the other asset like, book
debts and fixed asset stock etc. In a growing concern working capital requirement
will be estimated on how the cash available is rightfully used. Even if the net profit is
earned in cash, whole of it is not available for working capital purpose. The
contribution towards working capital is effected by the way in which profit are
appropriated and affected by tax action, dividend, depreciation and reserve policy.
(M) Price level changes: The financial manager should predict the effect of price
level changes on working capital requirement of the firm. Rising price level will
require a higher level of working capital to maintain the same level of current asset,
as it will require higher investments. However if companies reverse their product
prices, they will not face a severe working capital problem. Thus the effect of rising
price will be different for different firm depending upon their price policy and its
nature.
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(N) Dividend policies: There is a well-established relationship between dividend
and working capital in companies where successive dividend policy is followed. The
changes in working capital position bring about an adjustment in dividend policy. In
order to maintain an established dividend policy, the management gives due
consideration to its effect on cash requirements. Storage of cash may induce the
management to reduce cash dividend. Strong cash position may justify the cash
dividend, even if earnings are not sufficient to cover the payments. Shortage of cash
is one of the reasons for issue of stock dividend. On the other hand if the company
follow the policy of retention of profit in business, the working capital position will be
quite adequate, alternatively, if the whole of the profit are distributed among the
shareholders, companies working capital position will suffer.
(O) Close coordination between production and distribution policy: This will
reduce the demand of working capital.
(P) An absence of specialization in the distribution of products: This will require
more working capital as such concerns will have to maintain its own marketing
organization.
(Q) If the means of transporting and communication are less developed: More
working capital is required in such areas to store the material and finished goods.
(R) Hazards in a particular business also decide the magnitude of working
capital required.
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CHAPTER – 10
WORKING CAPITAL FINANCING
The main source of working capital financing, namely, trade credit, bank
credit, RBI framework/regulation of bank credit/finance/advances, factoring and
commercial papers will be discussed in this chapter.
1. TRADE CREDIT: Trade credit refers to the credit extended by the suppliers of
goods and service in normal course of transaction/business/sale of the firm.
According to trade practice, cash is not paid immediately for purchase but
after an agreed period of time. There is however, no formal/specific
negotiation of trade credit It is an informal arrangement between buyer and
seller. There is no legal instrument of acknowledgement of debt, which is
granted on an open account basis.
(a) ADVANTAGES: - Trade credit as a source of short-term working
capital finance has certain advantages. It is easily available. Moreover
it is flexible and spontaneous source of finance. The availability and
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magnitude of trade credits is related to the size of operation of a firm in
relation to sales/purchase. If the credit purchase of goods decline,
availability of credit will also decline. Trade credit is also an informal,
spoteganous source of finance. Not requiring negotiation and formal
agreement, trade credit is free from the restriction associated with
formal/negotiated source of finance/credit.
(b) COST: Trade credit does not involve any explicit interest charged.
However there is an implicit cost of trade credit. It depends on trade
credit offered by suppliers of goods. The smaller the difference
between the payment day and the end of the discount period, the
larger is the annual interest/cost of trade credit.
2. BANK CREDITS: It is the primary institutional source of working capital
finance in India. In fact it represent the most important source of financing of
credit asset. It can be provided by banks in five ways
(a) Cash/credit overdrafts: Under cash credits, the bank specifies a
predetermined borrowing/credit limit. The borrowers can draw/borrow
up to the stipulated credit/overdraft limit. Similarly repayment can be
made wherever desired during the period. The interest is determined
on the basis of the running balance/amount actually utilized by
borrower and not on the sanctioned amount.
(b) Loans: Under the arrangement the entire amount of borrowing is
credited to the current account of the borrower .The borrower has to
pay interest on the total amount.
(c) Bills purchased/discounted: -The amount made available under this
arrangement is covered by the cash credit and the overdraft limit.
Before discounting the bill the bank satisfies itself with the credit
worthiness of the drawer and the genuineness of the bill. To
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popularize the scheme, the discounting banker asks the drawer of the
bill (i.e. the seller of the goods) to have his bills accepted by the
drawee bank.
(d) Term loans for working capital: Under this arrangement, banks
advance loans for three to seven years repayable in yearly and half
yearly installments.
(e) Letter of credit: While the other forms of bank credit are direct forms
of financing in which banks provide funds as well as bears risk, letter
of credit is an indirect form of working capital financing and bank
assume only the risk, the credit being provided by the supplier.
MODES OF SECURITY
Banks provide credit on the fallowing modes of security:
1. Hypothecation: Under this mode of security the bank provide credit to
borrowers against the security of movable property, usually inventory of
goods.
2. Pledge: Pledge, as a mode of security is different from hypocatation in
that in the former unlike the later goods, which are offered as security
is transferred to the physical possession of the lender.
3. Lien: The term lien refers to the right of the party to retain goods
belonging to other party until a debt due to him is paid.
4. Mortgage: It is the transfer of legal stock equitable interest in specific
immovable property for securing the payment of debt.
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CHAPTER – 11
RESERVE BANK OF INDIA FRAMEWORK FOR REGULATION OF BANK
CREDIT
Till the mid sixties, the notable feature of bank financing of working capital of
corporate industrial borrowers were (a) easy access/over-reliance, i.e. in excess of
legimate requirement and (b) pre ponderance of cash credit arrangement/device
through which his finance was provided. In order to secure arrangement of a bank
credit with planning priorities and ensures equitable distribution to various sectors of
Indian economy, the RBI initiated several policy measures measure to direct bank
credit to priority sectors and enforce a measure of financial discipline among
industrial borrowers. However the basic character of bank financing and industry
namely, over borrowing and domination of cash credit system did not materially alter.
To reorient bank lending to industry to the two emerging reality of the Indian
economy in terms of the crucial factors of regulating controlling it, the RBI constitute
from time to time a number of expert groups to examine the various aspect of
banking policy relating to industrial financing, the notable being Dehejia committee of
1969,Marathe committee of 1974,Chore committee of 1980 and Marathe committee
of 1984.The recommendation of these groups ( refer to annexure) shaped the
framework/regulation of industrial finance by banks after mid 1970s.After mid 1990
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the framework have been relaxed permitting banks greater flexibility in tune with the
emergence of new banking in the country, focusing on viability and profitability in
contrast with earlier trust on social/development banking .The main element of the
framework and the subsequent relaxation are discussed.
CHAPTER – 12
FIXATION OF NORMS
A notable feature of the framework /regulation to the fixation of norms for bank
lending to industry fall under two category:
1. Inventory and receivable norms: The norms refer to the maximum level
for holding inventory and receivable in each industry. Initially, the
inventory and receivable norms were applied in respect to 15 major
industries accounting for about one half of the industrial advance of the
bank. The norms pertained to (a) raw material including stores and
other item used in the process of manufacture: (b) stocks in process (c)
finished goods and receivables and bills purchased and discounted.
The norms were based on time elements
2. Lending norms: The lending norms are the basic element of the
framework of bank lending to have far-reaching implications. According
to lending norms a part of the current asset should be financed by
trade credit and other current liabilities. The remaining part of the
current asset, termed, as working capital gap should be partly financed
by owner’s funds and long-term borrowing and partly by short-term
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credit. There are three alternative methods for working out the
maximum permissible level of bank borrowing/finance, each
successive method reducing the involvement of short-term bank credit
to support current assets.
CHAPTER –13
HOW “PUBLISHERS” CAN MAKING MORE EFFICIENT USE OF WORKING
CAPITAL
The table below lists items, which influence working capital levels favorably
and adversely for Publishers
Items that reduce working capital
levels
Items that increase working
capital levels
-- Customers who pay promptly
-- Advance payment by customers
-- Long print runs expect where
all the books are required on
publication e.g. schools and
university textbooks.
-- Increased profit margins -- Lower profit margins
-- Inventory which is sold and paid
for quickly by customers and
publication
-- Lower inventory level by reducing
print quantities and working with
printers who will delivery quickly and
produce low print runs economically
-- Slow authors whom deliver late
and whose manuscript require
substantial editing.
-- Holding paper stock unless
market condition demand and the
saving are large
-- Slow schedules for
development of new titles
26

-- Successful promotion that speed
up the rate of sale.
-- Licensing
-- Paying suppliers on completion
with credit
-- Making advance payment to
printers
-- Seasonal sales except where
the publishers print only for the
season
CHAPTER – 14
ASSESSMENT OF WORKING CAPITAL REQUIREMENT IN SEASONAL
INDUSTRY
In the seasonal industries the level of working capital requirement will not be
similar all the year. In times of off-season, the working capital requirements and
therefore, the level of investment in current asset and liability are very low. But
during seasons, the firm requirement of working capital is at peak level. Now let us
look at the sugar industry. The crushing season in the year will remain for five to six
month’s time. During the season the plant is expected to work at full capacity, with
triple shift working and the requirement of stock is very high resulting in increased
sugar stock. The requirement for payment of labor, expense and maintenance is also
very high. There will not be immediate sale of sugar and finished stock inventory will
be much higher.
After the completion of crushing season the plants will stop and only upkeep
and maintenance of plant will be incurred and the level of current asset and the
current liabilities will come down and the working capital requirement will be very
low. For efficient management of working capital the finance manager should be able
to properly estimate the season and off season requirement of working capital. For
this the fallowing precaution are taken:
27

1. Preparation of projected cash flow statement showing the cash flow for peak
season, normal season and off-season requirement.
2. Make proper arrangement with the banks and other source of finance to meet
the short-term need of season
3. Make proper arrangement for meeting contingencies of higher-level
requirements than the projected level of requirement.
4. Proper and careful assessment of working capital requirement for the season
and off-season requirement.
5. Care to be taken to reduce the level of investment in current asset after the
season is completed.
CHAPTER – 15
METHODS OF ESTIMATING WORKING CAPITAL REQUIREMENT
Now let us look at some of the ways used by a business firm in estimating the
working capital requirement:
Operating cycle method: Operating cycle is a period that a business enterprise
takes in converting cash back into cash. It has the fallowing four stages.
(a) The raw material and stores inventory stage.
(b) The semi finished goods or work in progress stage
(c) The finished goods inventory stage.
(d) The accounts receivable and book debt stage.
Each of he above stage is expressed in terms of days of relevant activity.
Each requires a level of investment to support it. The sum of these stage wise
investments will be total amount of working capital of the firm. The fallowing formulae
can be used to express the framework of the operating cycle.
T = (S * C) + W + F + B
Where
T Stands for the total period of operating cycle in number of days
R Stands for the number of days of raw material and stores
28

Consumption requirement held in raw material and store
Inventory
C The number of days of purchase in trade creditors
W The number of days of cost of production held in W.I.P
F The number of days of cost of sales held in finished goods
B The number of days of sale in book debt
The consumption may be made as under:
Average inventory of raw material and stores
R = Average per day of consumption of raw materials and stores
Average trade creditors
C = Average credit purchase per day
Average work in progress
W = Average cost of production per day
Average inventory of finished goods
F = Average cost of sale per day
Average book debts
B = Average sales per day
The average inventory, trade creditors, working progress, finished goods and
book debts can be computed by adding the opening and closing balance at the end
of the year in the respective accounts and dividing the concerned annual figures by
365 or the number of days in a given period.
The operational cycle method of determining working capital requirements
gives only an average figure. In this method the fluctuations in the intervening period
due to seasonal and other factors and their impact on working capital cannot be
judged. Continuous short run detailed forecasting and budgeting exercise are
necessary to identify these impacts.
29

The new concept that is gaining more and more importance in recent years is
this style of working capital method. The operating cycle refer to the average time
elapsed between the acquisition of raw material and the final cash realization.
Cash is used to buy the raw materials and other stores, so cash is converted
into raw materials and stores inventories. Then the raw materials and stores are
issued to the production department. Wages are paid and other expense are
incurred in the process and work in progress comes into existence. Work in progress
becomes finished goods. Finished goods are sold to costumers on credit. In the
course of time these costumers pay cash for the goods purchased by them. Cash is
retrieved and cycle is completed.
The operating cycle of working capital is shown below:
CASH
ACCOUNTS RECEIVABLE
PURCHASE OF RAW MATERIAL
INVENTORY FINISHED GOODS
W.I.P
FIG 15.1 OPERATING CYCLE OF WORKING CAPITAL
Percent of sales method: It assumes that certain balance sheet items vary directly
with sales. Thus the ratio of the given balance sheet item to sales remains constant.
The firms need in terms of percentage of annual sales envisaged in each individual
balance sheet items are expressed in the following three ways:
As number of days of sale
As turnover
As percent of sales
30

Regression analysis method: This is a very useful statical technique of working
capital forecasting which helps in making projection after establishing the
relationship in the past years between sales and working capital and its various
components. This analysis may be carried out through the graphic portrayals or
through mathematical formulae. The relationship between the sales and working
capital of various components may be simple and direct indicating linearly between
the two. It may be complex involving simpler linear regression or simple curvilinear
regression and multiple regression situations. This method is particularly suitable for
long term forecasting.
CHAPTER – 16
WORKING CAPITAL REPORT
A sensible finance manager is always vigilant for avoiding the financial
embarrassment likely to be caused to the firm due to inadequacy of working capital.
He always takes utmost care so as to keep himself well informed of the working
capital position, its present aspect and its future prospects. Working capital report
varies according to the requirement of individual firms and circumstances.
Some of the types of working capital report are:
Inventory report: It gives in detail a comparative analysis of composition of closing
stock of raw material and finished products. It may be prepared weekly, monthly or
quarterly. It brings into light the fact whether working capital is unnecessarily blocked
up in the inventory. Fallowing is an example of monthly inventory report.
Sr no Item Cod
e no
Max
Stock
Limit
Min
Stock
Limit
Order
size
Op
Bal
Receive
d During
The
Month
Issued
during
the
Month
Balance
1 001 *** *** *** *** *** *** *** ***
2 002 *** *** *** *** *** *** *** ***
31

3 003 *** *** *** *** *** *** *** ***
4 004 *** *** *** *** *** *** *** ***
5 005 *** *** *** *** *** *** *** ***
6 006 *** *** *** *** *** *** *** ***
7 007 *** *** *** *** *** *** *** ***
Cash report: It reflects the net liquidity position of the concern. It is prepared on
daily basis. It shows the summary of daily cash receipt, cash disbursements and the
cash balance. Fallowing is the Performa of a cash report.
Receivables report: These help in studying up the efficiency of the collection
policies and the desirability of credit policies. Detailed report may be made to depict
the reserve for bad and doubtful debts position. Some companies prepare aging
report in respect of debtors and receivables. A Performa of receivable report is given
below
Particulars Current
a/c
Letter of
credit a/c
Fixed
deposit
a/c
Cash in
chest
Total Previous
week
A
REVENUE
X *** *** *** *** *** ***
Y *** *** *** *** *** ***
Z *** *** *** *** *** ***
B
CAPITAL
X *** *** *** *** *** ***
Y *** *** *** *** *** ***
Z *** *** *** *** *** ***
TOTAL ****** ****** ****** ****** ****** ******
32

BALANCE AT THE BEGINNING
SUPPLIES
MADE DURING
THE MONTH
REALIZATION MADE
DURING THE MONTH
BACK
RECO
VERY
BAL
ANC
E
SR NO PART
Y
MORE
THAN
1
YEAR
6
MO
NT
HS
LESS
THAN 6
MONTHS
BILLS
REALI
ZED
BILLS
NOT
REALI
ZED
MORE
THAN
1
YEAR
MOR
E
THA
N 6
MON
THS
BEL
OW
6
MTH
S
33

CHAPTER - 17
RECEIVABLES MANAGEMENT
The receivables represent an important component of current asset of a firm.
The purpose of this chapter is to analyze the importance of efficient management of
receivables, within the framework of a firm’s objective of value maximizing. The first
section of this chapter discusses the objective of receivables management. This is
followed by an indebt analysis of three crucial aspect of management of receivables.
Before understanding the objectives of receivables management let us first
understand the two concepts, which forms an important part in receivables
management, namely debtors and creditors.
34

Debtors: Debtors (Accounts Receivable) are customers who have not yet made
payment for goods or services, which the firm has provided. The objective of
debtor management is to minimize the time-lapse between completion of
sales and receipt of payment. The costs of having debtors are:
1. Opportunity costs (cash is not available for other purposes);
2. Bad debts.
Debtor management includes both pre-sale and debt collection strategies.
Pre-sale strategies include:
1. Offering cash discounts for early payment and/or imposing penalties for late
payment;
2. Agreeing payment terms in advance;
3. Requiring cash before delivery;
4. Setting credit limits;
5. Setting criteria for obtaining credit;
6. Billing as early as possible;
7. Requiring deposits and/or progress payments.
Post-sale strategies include:
1. Placing the responsibility for collecting the debt upon the center that made
the sale;
2. Identifying long overdue balances and doubtful debts by regular analytical
reviews;
3. Having an established procedure for late collections, such as
- A reminder;
- a letter;
- cancellation of further credit;
- telephone calls;
35

- use of a collection agency;
- legal action.
Creditors; Creditors (Accounts Payable) are suppliers whose invoices for goods or
services have been processed but who have not yet been paid.
Organizations often regard the amount owing to creditors as a source of free
credit. However, creditor administration systems are expensive and time-
consuming to run. The over-riding concern in this area should be to minimize
costs with simple procedures.
While it is unnecessary to pay accounts before they fall due, it is usually not
worthwhile to delay all payments until the latest possible date. Regular weekly or
fortnightly payment of all due accounts is the simplest technique for creditor
management.
Electronic payments (direct credits) are cheaper than cheque payments,
considering that transaction fees and overheads more than balance the advantage of
delayed presentation. Some suppliers are unenthusiastic to receive payments by this
method, but in view of the significant cost advantage (and the advantages to the
suppliers themselves) departments may wish to encourage suppliers to accept this
option. However, electronic payments are likely to be used in combination with,
rather than as a replacement for, cheque payments.
Objectives of receivables management:
The term receivables are defined as debts owed to the firm by customers
arising from sale of goods or service in the ordinary course of business. When a firm
makes an ordinary sale of goods or service and does not receive payment the firm
grant credit and credits account receivable. Receivables management is also known
as trade credit management and thus, account receivables represent an extension of
credits to customers, allowing them a reasonable period of time in which to pay the
goods received.
36

The sale of goods on credit is an essential part of modern competitive
economic systems. Infact, credit sales and therefore receivables are treated as
marketing tools to aid the sale of goods. The objective of receivable management is
to promote the sale and profits until that point is reached where the return on
investment in further funding receivable is less than the cost of funds raised to
finance that additional credit (i.e.) cost of capital.
Now let us see some costs in receivable management:
1. Collection cost: Collection costs are administrative costs incurred in collecting
the receivables from the customers to whom credit sale have been made.
2. Capital cost: The increased level of account receivable is an investment in
asset. They have to be financed thereby incurring a cost. The cost on the use
of additional capital, to support the credit sale, which alternatively, profitably
employed is therefore a part of the cost of receivables.
3. Delinquency cost: These cost arise out of the failure of customers to meet
their obligation when payment on credit sale becomes dew after the expiry of
credit period. Such cost is called delinquency cost.
4. Default cost: Finally the firm may not be able to recover the overdue because
the inability of the customers to pay. Such that are treated as bad debts and
have to be written off, as they cannot be realized is called default cost.
Benefits:
The benefits are increased sales and anticipated profits because of a more
liberal policy. When firms extend trade credits, that is, invest in receivables; they
intend to increase the sales. The impact of liberal trade credit policy is likely two
take two forms. First it is oriented to sales expansion. In other words a firm may
grant trade credit to increase sale to existing customers. Secondly the firm gives
trade credit to protect its current sales against competitions.
37

Credit policies:
The credit policy of the firm provides a framework to determine (a) whether or
not to extend credit to a costumer (b) how much credit to extend. The credit
policy decision of a firm has two broad dimensions
1. Credit standards
2. Credit analysis
CHAPTER – 18
WORKING CAPITAL RATIO
Working capital ratios indicate the ability of a business concern in meeting its
current obligation as well as its efficiency in managing the current asset in the
generation of sales. These ratios are applied to evaluate the efficiency with which the
firm manages and make use of its current assets. The fallowing three categories of
ratio are used for efficient management of working capital (a) efficiency ratios (b)
Liquidity ratios (c) Structural health ratios.
Efficiency ratio: This ratio is computed by dividing the working capital by
sale. This ratio helps to measure the efficiency of utilization of networking capital. It
signifies for an amount of sale a relative amount of working capital is needed. If any
38

increase in sale is contemplated, working capital should be adequate and thus this
ratio is useful for maintaining adequate level of working capital.
Inventory turnover ratio: This ratio indicate the effectiveness and efficiency
of the inventory management .The formulae is as fallows
INVENTORY TURNOVER RATIO = SALES / CURRENT ASSET
This ratio shows how speedily the inventory is turned into accounts receivable
through sales. The lower the inventory of sales ratio, the more efficiently the
inventory is said to manage and vice versa.
Current assets turnover ratio: This ratio formula is:
CURRENT ASSET TURNOVER RATIO = SALES / CURRENT ASSETS
This ratio indicates the efficiency with which the current asset turn into sales.
The lower the current asset to sales ratio, it implies a more efficient use of funds.
Thus, a high turnover rate indicates reduced lock up of funds in current assets. An
analysis of this ratio over a period of time reflects working capital management of a
firm.
Liquidity ratio: This ratio indicate the extend of soundness of the current
financial position of an undertaking and the degree of safety provided to the
creditors. The higher the current ratio, the larger amount of rupee available, per
rupee for current liability, the more the firms ability to meet current obligation and the
greater safety of funds of short term creditors. The liquidity ratio formulae is
LIQUIDITY RATIO = CURRENT ASSET, LOANS, ADVANCES/ CURRENT
LIABILITY
Current assets are those assets, which can be converted into cash within an
accounting year. Current liability and provisions are those liability that are payable
within a year. A current ratio of 2: 1 indicates a highly solvent position. Banks
consider a current ratio of 1: 3: 1 as minimum acceptable level for providing working
capital finance. The constituents of the current asset are as important as current
asset themselves for evaluation of companies solvency position.
39

Quick ratio: This ratio is a more refined tool to measure the liquidity of an
organization. It is a better test of financial strength than the current ratio, because it
excludes very slow moving inventories and the item of current asset, which cannot
be converted into cash easily. This ratio shows the extend of cushion of protection
provided from the quick assets to the current creditors. A quick ratio of 1: 1 is usually
considered satisfactorily through it is again a rule of the thumb only.
Structural health ratio: This ratio explains the relationship between current
asset and total investment in current asset. A business enterprise should use its
current asset effectively and economically because it is out of the management of
these assets that profits accrue. A business will end up in losses if there is any
lacuna in managing assets to the advantage of business. Investment in fixed assets
being inelastic in nature there is no elbowroom to make an amendment in this
sphere and its impact on profitability remains minimal. This structural ratio can be
indicated as
S.H.R = NET ASSETS / CURRENT ASSET
An analysis of current assets composition enable one to examine in which
components the working capital funds are locked up. Large tie up of funds in
inventories effect profitability of the business adversely owing to carry over cost .in
addition losses are likely to occur by the way of depreciation, decay, obsolesce,
evaporation and so on. Receivable constitute another component of current assets If
the major portion of current assets are made of cash alone the profitability will be
decreased because cash is a non earning asset. If the portion of cash balance is
excessive then it can be said that management is not efficient to employ surplus
cash.
Debtor turnover ratio: This ratio shows the extend of trade credit granted
and the efficiency in the collection of debts and thus it is an indicative of trade credit
management. The lower the debtor to sale ratio the better the trade credit
management and better the quality of debtors. The lower debtor means prompt
payment by customers. An excessive long collection period on the other hand
indicates a very liberal ineffective inefficient credit and collection policy.
DEBTOR TURNOVER RATIO = SALES / DEBTORS
40

Average collection period measures how long it takes to collect amounts from
debtors. The actual collection period can be compared with the stated credit terms of
the company. If it is longer than those terms, this indicate some insufficiency in the
procedure of collecting debts
Bad debts to sale ratio: This ratio indicates the efficiency of the controlled
procedure of the company. The actual ratio is compared with the target of norms to
decide whether or not it is acceptable.
Creditor turnover period: The measurement of creditor turnover period
shows the average time taken to pay for goods and service by the company. In
general the longer the credit period achieved the better, because delay in payments
means that the operation of the company is financed interest free by suppliers funds.
But there will be point beyond which if they are operating in a sellers market, may
harm the company. If too long a period is taken to pay creditors, the credit rating of
the company may suffer, thereby making it more difficult to obtain supplier in future.
CREDIT TURNOVER PERIOD = CREDITORS * 365 / PURCHASES
CHAPTER – 19
WORKING CAPITAL LEVERAGES
One of the important objectives of working capital management is by
maintaining the optimum level of investment in current asset and by reducing the
current liability .The company can minimize the investment in working capital and
thereby improve the return of capital employed. The term working capital leverages
refer to the impact of level of working capital on company’s profitability. The working
capital management should improve the productivity of investment and current asset
and ultimately it will increase the return on capital employed. Higher level of
investment in current asset than is required means increase in the cost of interest
charged on short term loans and working capital finance raised from banks and will
resulting the lover return on capital employed and vice versa. Working capital
leverages measures the responsiveness of ROCE for changes in current asset. It is
measured by applying the fallowing formulae
41

Working capital leverages = C.A / T.A - ‫טּ‬C.A
Where:
C.A = CURRENT ASSET
T.A = TOTAL ASSETS (net fixed asset = current asset )
‫טּ‬C.A = CHANGE IN CURRENT ASSET
IMPACT OF INFLATION ON WORKING CAPITAL REQUIREMENT
When the inflation rate is high, it will have a direct impact on the requirement
of working capital as explained below
1. Inflation will cause the slow turnover figure at higher level even if there is no
increase in the quantity of sale. The higher the sale means the higher level of
balance in receivables.
2. Inflation will result in the increase of raw material price and hike in the
payment for expenses and as a result increase in balance of trade creditors
and creditors for expense.
3. Increase in the valuation of closing stock will result in showing higher profits
but without its realization into cash cause the firm to pay higher tax dividend
and bonus. This will lead the firm in serious problem in fund shortage and the
firm may enable to meet its short term and long-term obligation.
4. Increase in investment in current asset means the increase in the requirement
of working capital without corresponding increase in sale or profitability of a
firm.
Keeping in view of the above stated points the finance manager should be
very careful about the impact of inflation in assessment of working capital
requirement and its management.
42

IMPACT OF DOUBLE SHIFT WORKING ON WORKING CAPITAL REQUIREMENT
If the firm, which is presently running in single shift, plans to go for working in
double shift, the fallowing factors should be considered in assessing the working
capital requirement of the firm.
1. Working in double shift means requirement of raw materials will be doubled
and another variable expense will also increase drastically.
2. With the increase in the raw material requirement and expenses, the raw
material inventory and work in progress will increase simutanunsly. The
creditors for goods and creditors for expense balance will also increase.
3. Increase in production to meet the increased demand, which will also increase
the stock of finished goods. The increase in sales means increase in debtor
balance.
4. Increased in production will result in increased requirement of working capital
5. The fixed expense will increase with the working on double shift basis.
The finance manager should reassess the working capital requirement if the
change is contemplated from single shift operation to double shift operation.
43

CHAPTER – 20
ZERO WORKING CAPITAL
This is one of the newest trends in working capital management. The idea is
to have zero working capital .For e.g. at all times the current asset shall be equal to
current liability. Excess investment in current asset is avoided and firms meet its
current liability out of the matching current asset.
As current ratio is 1 and quick ratio below 1,there may be appreansation
about the liquidity, but if all current assets are performing and are accounted at their
realizable values, these fears are misplaced. The firm saves opportunity cost on
excess investments in current assets and as bank cash credit limit are limits are
linked to inventory levels, interest cost is also sold. There would be a self-imposed
financial disciple on the firm to manage their activity within their current liability and
current asset and there may not be attendance to over borrow or divert funds.
44

Zero working capital also ensures a smooth and uninterrupted working capital
cycle, and it will pressurize the financial manager to improve the quality of current
asset at all times, to keep them 100 percent realizable. There will also be a constant
displacement in current liability and the possibility of having overdue may diminish.
The tendency to postpone current liability payment has to be curbed and working
capital always maintained at zero. Zero working capital will also call for a fine
balancing act in financial management, and the success in this endeavor would get
reflected in healthier bottom lines.
CHAPTER – 21
OVERTRADING
Overtrading arises when a business expands beyond the level of funds
available. Overtrading an attempt to finance a certain volume of production and sales
with inadequate working capital .If the company does not have enough funds of its
own to finance stock and debtors it is forced, if it wish to expand, to borrow from
creditors and from banks on overdraft sooner or later and such expansion financed
completely by funds of others, will lead to a chronic imbalance in the working capital
ratio.
Expansion is advantageous so long as the business has funds available to
finance stock and debtors involved. Overtrading begins at a point where the
business relies on extra trade credit and increased turnover are financed by taking
longer period of credit from suppliers and/or negotiating an extension of overdraft
limits with the banks.
45

Over dependence on outside finance is a sign of weakness, unless the
expansion is curtailed, suppliers may refuse credit beyond certain limit, and the
banks may call for the reduction in overdrafts. If this happens the business may be
insolvent in that it does not have sufficient liquid resource to pay for current operation
or to repay current liability until customers pay for sale made on credit terms, or
unless the stock is sold for a loss for immediate cash payments.
Using the fallowing ratios it will be possible to analyze the situation properly
1. Working capital = current asset: current liability
2. Acid test = quick asset: current liability
3. Stock turnover = stock: cost of sale
4. Debtor’s turnover = debtors: credit purchases
The object of using these ratios is to detect a disorientation of liquidity position
of a firm and increase reliance upon trade creditors and overdraft facilities.
CHAPTER – 22
OVERCAPITALIZATION AND UNDER CAPITALIZATION OF WORKING
CAPITAL
If there are excessive stock, debtors and cash and very few creditors, there
will be an over investment in current asset. The inefficiency of managing working
capital will cause this excessive working capital resulting in lower returns in working
capital employed. and long-term funds will be unnecessarily tied up when they could
be invested to earn profit. This situation is known as overcapitalization of working
capital.
Under capitalization is a situation where a company does not have funds
sufficient to run the normal operation smoothly. This may happen, due to inefficient
working capital or diversion of working capital funds to finance capital items. If the
company faces the situation of undrecapitalization, then it will face difficulty in
meeting current obligation, procurement of raw material, meeting day-to-day running
expense etc. The result will ultimately be reduced profitability, and reduced turnover.
The finance manager must take immediate and proper step to overcome the
46

situation by making arrangements for sufficient working capital. For this purpose he
should prepare the realistic cash flow and fund flow statement of the company.
Some of the symptoms of poor working capital management are:
1. Excessive carriage of inventory over the normal levels required for
business will result in more balance in trade creditors account. More
creditors balance will cause strain on the management in management
of cash.
2. Working capital problem will arise when there is a show down in
collection of debtors.
3. Sometimes capital goods will be purchased from the funds available for
working capital. This will result in the working capital and its impact on
the operation of the company.
4. Unplanned production schedule will cause excessive stock of finished
goods or failure in meeting dispatch shedadule. More funds kept in the
form of cash will not generate any profit for the business.
5. Inefficiency in using potential trade credit require more funds for
financing working capital.
6. Overtrading will cause shortage of working capital and its ultimate
effect is on the operation of the company.
7. Dependence in short term source of finance for financing permanent
working capital causes less profitability and will increase strain on
management in managing working capital.
8. Inefficiency in cash management will cause embezzlement of cash.
47

CHAPTER – 23
INVENTORY MANAGEMENT
Inventories symbolize the second largest asset categories for manufacturing
companies, next only to plant and equipments. The proportion of inventories to total
asset varies between fifteen to thirty percent. Inventories are stocks of the product a
company is manufacturing for sale and component that make up the product. There
are three types of inventories: raw materials, work in progress and finished goods.
Raw materials are materials and components that are inputs in making the final
product. The work in progress, also called stock in progress, refer to goods in
intermediate stage of production. Finished goods consist of the final products that
are ready for sale. While manufacturing firms generally hold all three types of
inventories, distribution firms hold mostly finished goods. As inventory management
has important financial implication, the financial manager has the responsibility to
ensure that the inventory properly monitored and controlled.
The three general motives for holding the inventories are:
1. The transaction motives that emphasis the need to maintain inventories
to facilitate smooth production and sales operation.
48

2. The precautionary motive that necessitates holding of inventories to
guard against the risk of unpredictable change in demand and supply
force and other factors.
3. The speculative motive which influence the decision to increase and
reduce the inventory level to take advantage of price fluctuations.
The objectives of holding inventory are:
1. To maintain a large size of inventory for efficient and smooth
production and sales operation.
2. To maintain a minimum investment in inventories to maximize
profitability.
The objective of inventory management should be to determine and maintain
optimum level of inventory investment. The firm should always avoid a situation of
over investment or under investment in inventories. If there is over investment in
investment then it would result in unnecessary tie up of firm’s funds, loss of profit,
excessive carrying cost and risk of liquidity. Maintaining an inadequate level of
inventories is also dangerous. The consequence of under investment in inventories
will lead to production hold up and failure to meet delivery commitments. The aim of
inventory management thus should be to avoid excessive and inadequate level of
inventories and to maintain sufficient inventories for smooth production and sales
operation. Efforts should be made to place an order at the right time and with the
right source to acquire the right quantity at he right place and quality. An effective
inventory management should:
1. Ensure a continuous supply of materials to facilitate uninterrupted production.
2. Maintain sufficient stock of raw material in periods of short supply and
anticipate price change.
3. Maintain sufficient finished goods inventory for smooth sales operation, and
efficient customer service.
4. Minimize the carrying cost and time.
5. Control investment in inventories and keep it at an optimal level.
ECONOMIC ORDER QUANTITY:
49

There are two basic questions that should be considered in inventory
management namely (a) What should be the size of order? (b) At what level should
the order be placed?
This includes three types of cost:
1. Ordering cost: It relates to purchased items that include expense on
fallowing: requisitioning, preparation of purchase order, expediting,
transport and receiving and placing in storage.
2. Carrying cost: It includes expenses on interest on capital locked up in
inventory, storage, and insurance, obsolesce and taxes. Carrying cost
generally are 25% of the value of inventory held.
3. Storage cost: It arises when inventories are short of requirement for
meeting the need of production or demand of customers. Inventory
shortage may result in high cost, less efficient and uneconomic
production schedules, customer dissatisfaction and loss of sale.
Thus when a firm order in large quantities, in a bid to reduce the total
ordering cost, the average inventory, other things being equal, tends to be high
thereby increasing the carrying costs. In view of such relationship, minimization of
overall inventory management would require a consideration of trade off among
these costs.
For determining Economic Order Quantity formula the fallowing symbols
are used:
U Annual usage/demand
Q Quantity ordered
F Cost per order
C Percent carrying cost
P Price per unit
TC Total cost of ordering and carrying
T.C = U * F * Q * P * C
50

The total cost of ordering and carrying cost is minimized when
Q = √ 2 FU / PC
CHAPTER – 24
MONITORING AND CONTROLLING OF INVENTORIES
This includes the tools of ABC (Always Better Control) analysis, the
various measures for judging the effectiveness of inventories, the concept of just
in time inventory control and the steps that may be taken to maintain control over
inventories.
ABC analysis: In most inventories a small proportion of items account for a
very substantial usage (in terms of monetary value of annual consumption) and a
very large proportion of items account for a very small usage (in terms of
monetary value of annual usage). ABC analysis, based on this empirical reality,
advocates in essence, a selective approach to inventory control, which calls for
greater concentration of efforts on inventory items accounting for the bulk usage
value. This approaches calls for classifying inventories into three broad
categories namely A, B and C categories. Category A represent the most
important items, which generally consist of 15 to 25 % of inventory items and
constitute for 60 –70 % of annual usage value. Category B, represent items of
moderate importance, generally consist of 20 to 30 % of inventory items and
account for 20 to 30 % of annual usage value. Category C represent items of
least importance, generally consisting of forty to sixty percent of inventory items
and accounts for 10 to 15 % of annual usage value.
51

To illustrate the use of ABC analysis, let the information on usage and
price of 20 items used by Control System Limited be
CLASS NUMBER OF
ITEMS
% OF ITEMS % OF
USAGE
VALUES
A 5 25 68.3
B 5 25 21.4
C 10 50 10.2
The procedure for numerical calculation of ABC analysis will be (1) Rank
the items of inventory on the basis of usage value (2) Record the cumulative
usage in value (3) Show the cumulative percent of the usage item. Now a days
many large manufacturers operate on just in time basis whereby all the
components to be assembled on a particular day arrive at the factory early that
morning, no earlier-no later. This helps to minimize manufacturing costs as JIT
stock take up a little space, minimize stock holding and virtually eliminate the risk
of obsolete and damaged stock. Because JIT manufacturers hold stock for a
short time, they are able to conserve substantial cash. IT is a good model to
strive for, as it embraces all the principle of sensible stock management.
The key issue for a business is to identify the fast and slow stock movers
with the objective of establishing optimum stock level for each category and
thereby minimize the cash tied up in stock. Factors to be considered when
determining optimum stock level include (a) what are the projected sales of each
product? (b) How widely available are the raw materials, components etc? (c)
How long does it take for delivery by suppliers? (d) Can you remove slow movers
from your product range without compromising best sellers?
Remember that stock sitting on shelves for long period of time ties up
money that is not working for you. For better stock control a firm should try the
fallowing (a) Review the effectiveness of existing purchases and inventory
system? (b) Know the stock turn for all major item of inventory (c) apply tight
control to significant few items and simplify controls for trivial many. (d) Sell off
52

outdated or slow moving merchandise—It gets more difficult to sell the longer you
keep it. (e) Consider having part of your product outsourced to another
manufacturer rather than making it yourself (f) Review your security procedure to
ensure that no stock “is going out the back door”! Higher than necessary stock
levels tie up cash and cost more in insurance, accommodation costs and interest
charges.
CHAPTER – 25
STRATEGIES IN WORKING CAPITAL MANAGEMENT
At present more finance option are available to the finance manager to see
the operation of his firm go smoothly. Depending on the risks of business
strategies is evolved to manage the working capital.
Conservative working capital strategy: A conservative strategy
suggests carrying high levels of current asset in relation to sales. Surplus current
asset enable the firm to absorb sudden variation in sales, production plans, and
procurement time without destructing production plans. Additionally the higher
liquidity level reduces the risk of insolvency. But lower risk translates into lower
returns. Large investment in current asset lead to higher interest and carrying
cost and encouragement for efficiency. But conservative policy will enable the
firm to absorb day o day risk. It assures continuous flow of operation and
illuminates worry about recurring obligation. Under this strategy, long term
financing covers more than the total requirement of capital. The excess cash is
invested in short-term marketable securities and in need these securities are sold
off in the market to meet the urgent requirement of working capital.
Aggressive working capital strategy: Under this approach current asset
are maintained just to meet the current liability without keeping cushions for the
variation in working capital needs. The companies working capital is financed by
long-term source of capital and seasonal variation are met through short-term
borrowing. Adoption of this strategy will minimize the investment in net working
53

capital and ultimately it lowers the cost financing working capital needs. The main
drawback of this strategy is that it necessitates frequent financing and also
increase, as the firm is variable to sudden shocks.
A conservative current asset financing strategy would go for more long-
term finance, which reduces the risk of uncertainty associated with frequent
refinancing. The price of this strategy is higher financing cost since long-term
rates will normally exceed short-term rates. But when aggressive strategy is
adopted, some time the firm runs into mismatches and defaults. It is a cardinal
principle of corporate finance that long term source and short-term assets should
finance long term asset by a mix of long and short-term source.
Efficient working capital management techniques are those that
compressed operating cycle. The length of operating cycle is equal to the sum of
the length of the inventory period and the receivable period. Just in time inventory
management techniques reduce carrying cost by slashing the time that goods are
parked as inventories. To shorten the receivables period without necessary
reducing the credit period, corporate can offer trade discount for prompt payment.
Rs
SECULAR GROWTH
LONG TERM
FINANCING
SEASONAL INVESTMENT IN
VARIATION MARKETABLE SECURITY
54

Time
FIG 25.1 CONSERVATION WORKING CAPITAL STRATEGY
Rs Seasonal variation
Short term financing
Secular growth Long term financing
Time
FIG 25.2 AGGRESSIVE WORKING CAPITAL STRATEGY
55

CHAPTER – 26
ROLE OF CASH AND BANK IN WORKING CAPITAL MANAGEMENT
Good cash management can have a major impact on overall working capital
management. The key elements of cash management are:
1. Cash forecasting;
2. Balance management;
3. Administration;
4. Internal control.
Cash Forecasting. Good cash management requires regular forecasts. In
order for these to be essentially accurate, they must be based on information
provided by those managers responsible for the amounts and timing of expenditure.
Capital expenditure and operating expenditure must be taken into account. It is also
necessary to collect information about impending cash transactions from other
financial systems, such as creditors and payroll.
Balance Management. Those responsible for balance management must
make decisions about how much cash should at any time be on call in the Bank
Account and how much should be on term deposit at the various terms available.
There are various types of mathematical model that can be used. One type is
analogous to the ERQ inventory model. Linear programming models have been
56

developed for cash management, subject to certain constraints. There are also more
complicated techniques.
Administration. Cash receipts should be processed and banked as quickly
as possible because:
1. They cannot earn interest or reduce overdraft until they are banked;
2. Information about the existence and amounts of cash receipts is
usually not available until they are processed.
Where possible, cash floats (mainly petty cash and advances) should be avoided. If,
on review, the only reason that can be put forward for their existence is that "we've
always had them", they should be discontinued. There may be situations where they
are useful, however. For example, it may be desirable for minor parts of departments
to meet urgent local needs from cash floats rather than local bank accounts.
Internal Control. Cash and cash management is part of a department's
overall internal control system. The main internal cash control is invariably the bank
reconciliation. This provides assurance that the cash balances recorded in the
accounting systems are consistent with the actual bank balances. It requires regular
clearing of reconciling items.
57

CHAPTER – 27
CONCLUSIONS
In conclusion, good management of working capital is part of good financial
management. Effective use of working capital will add to the operational efficiency of
a department; optimal use will help to generate maximum returns.
Ratio analysis discussed in the beginning, can be used to identify working
capital areas, which require closer management. Various techniques and strategies,
discussed above are available for managing specific working capital items.
Debtors, creditors, cash and in some cases inventories are the areas most
likely to be relevant to a firm.
58

CHAPTER –28
ANALYSES 1
GUJARAT AMBUJA CEMENTS L.T.D
Gujarat Ambuja cements was set up in 1986.In the last decade the company
has grown tenfold. With the commencement of commercial production of its 2 mn
tones plant in Chandrapur, Maharashtra, Ambuja will become India’s third largest
cement company with a capacity of 12.5 mn tones and revenue in excess of 2500
crores. Its plants are one of the most efficient in the world with environment
protection measures that are on par with the finest in the developed world.
Ambuja fallows a unique home grown philosophy of giving people the
authority to set their own targets, and the freedom to achieve their goals. This simple
vision has created an environment where there are no limits to excellence, no limits
to efficiency and has proved to be a powerful engine of growth for the company.
Ambuja, believes that an asset is worth only as much as the people who use it. The
people’s efforts to constantly raise efficiency have not only raised the bar at Ambuja,
but across the industry as well. Thus their people continue to achieve ever-high
efficiency and productivity at all their plants.
59

Over 40 % of the production cost of cement is power. Ambuja realized that to
run a profitable company, they need to keep power cost to minimum. So they set up
a captive power plant at a substantially lower cost than the national grid. They
sourced a cheaper and a higher quality coal from South Africa. They also brought
better furnace oil from the Middle East. The result is that today hey are in a position
to sell their excess power to the local government.
Their sea borne bulk cement transportation facility has brought many costal
markets within easy reach. It also made Ambuja India’s largest exporter of cement
consistently for the last five years. As a result Ambuja is the most profitable cement
company in India, and the lowest cost producer of cement in the world. Ambuja has
received the highest quality award – The national quality award and the only current
company to do so. It was also the first to receive ISO 9002 quality certification.
Performance highlights of Gujarat Ambuja cements Ltd for the years
2001 – 2002 and 2002 – 2003
PARTICULARS
2002 – 2003
(Rs in cores)
2001 -2002
(Rs in cores)
Sales 1592 1474
(-) Expenditure 1126 1010
PBDIT 466 464
(-) Depreciation & Amortization 138 129
PBIT/Operating profit 328 335
(-) Interest/Financial charges 97 134
PBT 231 201
(-) Provision for tax 45 14
PAT 186 187
60

STATEMENT SHOWING WORKING CAPITAL OF GUJAART AMBUJA
CEMENT LTD
Particulars
2002 – 2003
Rs in lacks
2001 – 2002
Rs in lacks
CURRENT ASSETS:
Inventories 20837 16143
Sundry debtors 3901 3344
Cash and Bank balance 5072 2861
Other current asset 2371 2435
Loans and advances 15055 15278
TOTAL CURRENT ASSET (A) 47236 40061
CURRENT LIABILITY
Current liability 18821 22060
Provisions 3430 8313
TOTAL CURRENT LIABILITY (B) 22251 30373
NET WORKING CAPITAL (A-B) 24985 9668
Statement indicating short-term ratio:
1. Liquid ratios:
RATIO FORMULAE 2002 - 2003 2001 - 2002
A) Current ratio Current 47236 / 22251 40061 / 30373 =
61

asset/current
liability
=2.12 1.32
B) Quick ratio (Current asset –
inventories) /
current liability
26399 / 22251 =
1.86
23918 / 30373 =
0.79
C) Cash ratio Cash + marketable
securities / current
liability
5072 / 22251 =
0.23
2861 / 30373 =
0.09
2. Turnover ratios:
C) Stores and
consumables
turnover ratio
Cost of goods
sold / Closing
consumables
433.99 / 143.98 =
3.01 days
406.90 / 97.93 =
4.16 days
RATIO FORMULAE 2002 - 2003 2001 - 2002
A) Debtor turnover
ratio
Net credit sales /
Closing debtors
1592 / 39.01 = 1474 / 33 =
Debtor collection
period
365 days / DTR 365 / 40.81 = 9 365 / 44 =14
B) Stock in trade
ratio
Cost of goods
sold / Closing stock
in trade
964.5 / 64.30 = 15 898 / 63 =8
Stock holding
period
365 days STR 365 / 15 = 24 365 / 14 =26
62

Stores and
consumables
holding period
365 / SCTR 365 / 3.01 = 121
days
365 / 4.16 = 87
days
D) Creditor
turnover ratio
Net credit
purchases /
Closing Creditors
464.34 / 112.27 =
4.14 days
461.40 / 167.32 =
2.76 days
Creditors payment
period
365 / CTR 365 / 4.1 = 88 days 365 / 2.76 = 132
days
3. Effect of turn over ratio on working capital:
RATIO 2002 –
2003 (IN
DAYS)
2001 –
2002 (IN
DAYS)
Stock holding period 24 26
(ADD) Stores and consumables holding period 121 87
(ADD) Debtors collection period 9 8
(LESS) Creditors payment period 88 132
Total 66 (11)
4. Profitability ratio:
RATIO FORMULAE 2002 - 2003 2001 - 2002
Gross profit margin
ratio
Gross profit / net
sales
328 / 1592 = 0.21
=21%
335 / 1474 = 0.23 =
23%
ANALYSIS:
WORKING CAPITAL OUTLAY:
63

In the cement business where the production and marketing cycle can be
long, working capital funds a number of activity: the purchase of raw materials,
making advances, availing cash discount on the total billing, maintaining an inventory
on production spares, sustaining the production cycle without interruption and
sustaining all the usual function within the organization.
Working capital accounted for 7.8 percent of the companies total capital
employed in 2002 – 2003.The total quantum of working capital was rs 24985 lac in
2002-2003 compared to 9688 lacks in 2001-2002,a 157.9% increase. The
company’s turnover to working capital ratio increased from 6.6 times in 2001-2002 to
15.7 times in 2002-2003.
LIQUIDITY RATIOS:
It implies the firm’s ability to pay its debts in a short run. It involves the
relationship between the current asset and current liability. In case of Gujarat
Ambuja Cements, the net working capital was Rs 9688 lacks in 2001-2002 has
increased to Rs 24985 lacks in the year 2002-2003.It means that the liquidity
position of the firm has increased. This is mainly due to increase in inventory holding
and cash balances.
The current ratio implies the firm’s ability to meet its current obligation. In
2001-2002 the current ratio was 1.32,which is now increased to 2.12 in 2002-
2003,which means that the company has current asset, which are 2.12 times the
current liability. This shows that the overall liquidity position of the company has seen
an improvement over the previous year. The increase in current ratio in over the
earlier period can be attributed towards an increase in inventory holdings and also a
noticeable rise in cash holdings over the earlier period. This if further affraimed by
quick ratio, which has shown a significant rise from 0.79 in 2001-2002 to 1.86 in
2002-2003.In fact the quick ratio has more than doubled over the previous year.
Thus, the company has managed to generate adequate cash surplus to meet its
growing business needs. Besides they have also built up good stock levels of coal
and other packing materials, probably to take advantage of low price prevailing in the
market.
64

SUNDRY DEBTORS:
Sundry debtors stood at 3901 lacks in 2002-2003,compared with Rs 3344
lacks in 2001-2002,a 16.66 percent increase. Sales have increased by 9.34 percent
in 2002-2003,and average collection period has more or less remained steady from
8 days in 2002 to nine days in 2003.This indicates that the company has succeeded
in achieving growth in sales and at the same time, efficiently collected its receivables
from the marketplace, as in the previous year. Credit worthiness was appraised on a
periodic basis.
INVENTORIES:
Inventories increased from Rs 16143 lacks in 2001-2002 to Rs 20837 lacks in
2002-2003,a 29% increase over the previous year primarily due to the increase in
stock of coal and packing material. Goods and consumables holding period
increased from 87 days to 121 days As a result the total inventory-holding period
also increased from days in 2001 –2002 to 145 days in 2002-2003.
SUNDRY CREDITORS:
The sundry creditors decreased from 16732 lacks in 2001-2002 to Rs 11226
lacks in 2002-2003,a 32.9% decrease’s a result creditors payment period decreased
from 132 days in 2001-2002 to 88 days in 2002-2003.It seemed that the company
has pushed hard its cost cutting drive, and effectively negotiated with its major
suppliers to reduce the price of the supplies and compensated the suppliers to a
certain extend by accepting a lower credit period. Also, the company seems to have
generated enough cash from its operation to pay off the suppliers on a timely basis.
The company has strived hard to reduce its liabilities by paying off the creditors,
which shows that they have efficiently planned their finance.
To summarize one can say that, Gujarat Ambuja Cement has utilized its
working capital efficiently. It has been able to process at lower prices by
compromising on credit period from its creditors up to 88 days and has efficiently
collected from debtors in nine days. But the inventory seem to be slightly on the
65

higher side as compared to the previous year, which may me due to the company
availing the benefits of low price of material in the market.
PROFITABILITY RATIO:
This is the ratio that measures the firm’s activity and the ability to generate profits.
The gross profit margin ratio of Gujarat Ambuja Cement has decreased from 23% in
01-02 to 21% in 02-03.On an average it shows that company has made good profit
as compared to the earlier year.
CHAPTER – 29
ANALYSES 2
SHREE CEMENTS LTD
SHREE cements is one of the major energy efficient and productive cement
manufacturing in the world. SHREE cements is engaged in manufacture of cement
through the dry process route in north India. The company process two plants in
Bewar and Rajastan.Shree cements manufacture cements of two varieties – Gray
cement and Clinker cement. Its competitive advantage lays in its ability to
constituently generate a production in excess of its installed capacity.
In 2002 – 2003,Shree Company recorded a turnover of Rs 399.27 crore as
against Rs 554.60 crore in 2001 - 2002.This was because 2002 - 2003 comprised 9
66

working months as compared to 12 working months the previous year. In 2002 -
2003 SHREE cements posted a 28% increase in its cash profits i.e. 49.84 crore as
compared to the previous year.
The vision of SHREE cement is to register a strong consumer surplus through
a superior cement quality at affordable prices. And their mission is to strengthen
realization through intelligent brand building and to increase he awareness of
superior products through a realistic and convincing communication process with
consumers.
The company is looking forward to make financial accounting module
available online for the authorized users. It also plans to get input from Weigh Bridge
online to exercise better control on inbound and out bound logistics. In coming days
IT is expected to play an even more important role in terms of integrating various
activities of business, maintaining Data and providing information.
PERFORMANCE HIGHLIGHTS OF SHREE CEMENTS LTD FOR THE
YEAR 2001-2002 & 2002-2003
PARTICULARS
2002-2003
(NINE MONTHS)
Rs in crores
2001-2002
(TWELVE MONTHS)
Rs in crores
Sales 397.21 554.60
Other income 0.30 0.28
Increase/Decrease in stock 6.01 (13.31)
(-) Expenditure 326.75 445.80
67

PBDIT 76.77 95.77
(-) Interest and financial charges 26.93 44
Gross profit 49.84 51.77
(-) Depreciation and a moralization 43.12 25.64
PBT 6.72 26.13
(-) Provision for tax 3.10 -
(-) Provision for deferred tax 2.14 -
PAT 1.48 26.13
Statement showing working capital of shree cements ltd
PARTICULARS
2002-2003
All rs in crores
2001-2002
All rs in crores
Current assets:
Inventories 4103 3472
Sundry debtors 3003 4082
Cash and bank balance 553 1891
Loan and advance 6423 6584
Total current assets (A) 14082 16029
Current liabilities
Current liability 5840 5488
Provisions 446 599
Total current liability (B) 6286 6087
Net working capital (A-B) 7796 9942
68

Statement indicating Short term ratios
Liquidity ratio:
RATIO FORMULAE 2002-2003 2001-2002
A) CURRENT RATIO CURRENT ASSETS /
CURRENT LIABILITY
14082/6286
= 2.24
16029/6087 =
2.63
B) QUICK RATIO CURRENT ASSETS –
INVENTORY /CURRENT
LIABILITY
9979/6286 =
1.59
12557/607 =
2.06
C) CASH RATIO CASH + MARKETABLE
SECURITIES/CURRENT
LIABILITY
553/6286 =
0.08
1891/6087 =
0.31
Turnover ratio:
RATIO FORMULAE 2002-2003 2001-2002
A) Inventory turnover
ratio
Goods sold/closing stock 39722/4103
= 9.68
55460/3472 =
16
Inventory holding period 365 days/ITR 274/9.68 =
28 days
365/16 = 23
days
B) Debtor turnover ratio Net credit sales/Closing
debtors
39722/3003
= 13
55460/4082 =
14
Debtor collection period 365 days/DTR 274/13 = 21
days
365/14 = 27
days
C) Creditor turnover Net credit 14829/3754 20823/3405 =
69

period purchases/Closing
creditors
=3.95 6.11
Creditor payment period 365/CTR 274/3.96 =
69 days
365/6.11 = 60
days
EFFECT OF THE TURNOVER RATIO ON WORKING CAPITAL
RATIO 2002-2003 2001-2002
Inventory holding period 28 DAYS 23 DAYS
ADD Debtor collection period 21 DAYS 27 DAYS
LESS Creditor payment period 69 DAYS 60 DAYS
TOTAL (20) (10)
PROFITABILITY RATIO
RATIO FORMULAE 2002-2003 2001-2002
Gross profit margin
ratio
Gross profit/Net
sales
4984/39722 = 0.13
= 13%
5176/55461 = .09 =
9%
ANALYSIS:
WORKING CAPITAL OUTLAY:
In the cement business where the production and marketing cycle can be
long, working capital funds a number of activity: the purchase of raw materials,
making advances, availing cash discount on the total billing, maintaining an inventory
on production spares, sustaining the production cycle without interruption and
sustaining all the usual function within the organization.
Working capital accounted for 12 percent of the companies total capital
employed in 2002 – 2003.The total quantum of working capital was rs 77crore in
2002-2003 compared to 99.42 crore in 2001-2002,a 21.58% decrease.
70

LIQUIDITY RATIOS: It implies the firms ability to pay its debtors I the short run. It
involves the relationship between the current asset and the current liability. In the
case of SHREE cements, the net working capital was rs 99.42 crores in 2001-2002
and reduced to RS 77.96 cr in 2002-2003.It means that the liquidity position of the
company has decreased.
The current ratio implies the firm’s ability to meet its current obligation. In 01-
02 the current ratio was 2.63,which has now come down to 2.24, which means that
the company has current asset, which are 2.24 times the current liability. Thus the
liquidity position of the company has reduced. The quick ratio implies the firms ability
to pay off its liabilities without relaying on the sale of the inventory or its recovery.
The quick ratio is reduced from 2.06 in 01-02 to 1.59 in 02-03.,which means the
inventories are reduced over a period of time and that liquidity position is good
although the current ratio gives a different picture.
SUNDRY DEBTORS: Retail sale increased by ten percent in 2002-2003 and sundry
debtors decreased by Rs 10.79 crore. This indicates that the companies collets its
outstanding faster from the marketplace. Sundry debtors stood at 30.03 crore in
2002-2003 compared with 40.82 crore in 2001-2002, a 26.43% decrease. Debtor’s
day decreased from 27 days in 2001-2002 to 21 days in 2002-2003,reflecting
prudent debtor management. Credit worthiness was appraised on a periodic basis.
Attractive financial incentive scheme were instituted to ensure a quick settlement of
outstanding.
INVENTORY :Inventories increased from 34.05 crore in 2001-2002 to 37.54 crore in
2002-2003 which is a 10.24% increase. Creditor payment period increased from
sixty days in 2001-2002 to sixty nine days in 2002-2003, which shows a prudent
credit management. The company has strived hard to push their creditors, which
shows they have efficiently planed things.
PROFITABILITY RATIO: This is the ratio that measures the firm’s activity and its
ability to generate profit. The gross profit margin of SHREE CEMENTS has
decreased from thirteen percent to nine percent but on average it shows that the
companies has made good profit as compared to the earlier year.
71

CHAPTER –30
CONCLUSIONS – COMPARISONS OF THE TWO CEMENT
INDUSTRIES
In the cement industry, where the production cycle and the marketing cycle
may be long, working capital is required for various reason like purchase of raw
material, making advances, availing cash discounts on the total billings, maintaining
an inventory of production spares, sustaining the production cycle without
interruption, payment of wages and salaries and sustaining all the useful function
within the companies.
Gujarat Ambuja Cement working capital accounted for 7.8% of the total
capital employed for the year 2003,indicating 157.9% increase as compared to the
previous year where as that of SHREE cement accounted for 12% indicating 21.58%
decrease of the capital employed.
In general comparing the two cement industries, the inventory management of
SHREE cements ltd is very good as it holds inventory for only 28 days in comparison
Gujarat Ambuja who hold it for 121 days.
AS far as the debtor management is concerned, It is Gujarat Ambuja cements
that manage its debtors efficiently as it receives from the debtors on an average
period of nine days. SHREE CEMENTS, in 21 days.
Gujarat Ambujas payable period has reduced from 132 days in 2001 - 2002 to
88 days in 2002 – 2003. Thus Ambuja has supplemented its cost cutting effort by
accepting lower credit period from suppliers from lower price. On the other hand
payable period of SHREE cements has increased from 60 days in 2001 - 2002 to 69
days in 2002 - 2003, indicating that they has negotiated a better credit period with its
suppliers at the same price.
On an average one can say that both the cement industries are managing
their working capital in such a way as to increase their profitability in the market.
72

working capital management

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