Working Capital - Vicky
Working Capital - Vicky
Working Capital - Vicky
A PROJECT REPORT
SUBMITTED BY
VICKI
ROLL No.1305003861.
APRIL 2015
Submitted to:
Learning Centre 01716
MEC Computer Education
Sarwari Bazar, Kullu (H.P.)
Examiners Certification
By
VICKI
Title
Working Capital Management
IS APPORVED AND ACCEPTABLE
INTERNAL EXAMINER
EXTERNAL EXAMINER
NAME:
NAME:
Acknowledgement
VICKI
ROLL NO. 1305003861
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BONAFIDE CERTIFICATE
It is hereby certified that this project titled Working Capital Management is the
bonafide work of VICKI who carried out the project work under my supervision.
Signature of Guide
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VICKI
MBA (FINANCE)
Sikkim Manipal University
Learning Code 01716
EXECUTIVE SUMMARY
Project Report: Working Capital Management
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a. Every business concern needs funds to carry out business operations such
as purchase of raw materials, payment of wages and other day-to-day
expenses, working capital becomes an important and integral part of
business. Working capital is the life blood and nerve centre of a business
because no business can run successfully without an adequate amount of it.
Therefore, to manage working capital in any sector is a challenging job.
b. A good way to judge a companys cash flow prospects is to look at its Working
capital management. Working Capital is also known as operating capital. It
represents the day by day operating liquidity available to a business. The goal
of Working capital management is to ensure that a firm is able to continue its
operations and that it has sufficient ability to satisfy both maturing short-term
debt and upcoming operational expenses.
II.
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INDEX
SR.NO.
TOPIC
PAGE NO.
1.
2.
10
3.
13
4.
20
5.
21
24
REQUIREMENT
7.
25
8.
28
9.
RATIO ANALYSIS
29
10.
CASH MANAGEMENT
44
11.
RECEIVABLES MANAGEMENT
54
12.
PAYABLES MANAGEMENT
63
13.
INVENTORY MANAGEMENT
65
67
ECONOMIC ORDER QUANTITY
15.
CONCLUSION
73
16.
BIBLIOGRAPHY
76
INTRODUCTION:
WORKING CAPITAL
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Working Capital is the amount of capital that a business has available to meet
the day to day cash requirements of its operations. It is concerned with the problem
arise in attempting to manage the current assets, the current liabilities and the inter
relationship that exist between them. Working Capital is the difference between
resources in cash or readily convertible into cash and organizational commitments
for which cash will soon be required or within one year without undergoing a
diminution in value and without disrupting the operation of the firm. It also refers to
the amount of current Assets that exceeds current Liabilities. Working Capital refers
to that part of the firm capital, which is required for financing short-term or current
Assets such as cash, Marketable Securities, Debtors and Inventories. Working
capital is also known as Revolving or Circulating Capital or Short Term Capital. The
goal of working capital management is to manage the firms current assets and
current liabilities in such way that the satisfactory level of working capital is
mentioned. The current should be large enough to cover its current liabilities in
order to ensure a reasonable margin of the safety. Capital required for a business
can be classifies under two main categories:
Fixed Capital
Working Capital
Every business needs funds for two purposes for its establishments and to carry out
day to day operations. Long term funds are required to create production facilities
through purchase of fixed assets such as plant and machinery, land and building,
furniture etc. Investments in these assets are representing that part of firms capital
which is blocked on a permanent or fixed basis and is called fixed capital. Funds are
also needed for short term purposes for the purchasing of raw materials, payments
of wages and other day to day expenses etc. These funds are known as working
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capital. In simple words, Working capital refers to that part of the firms capital which
is required for financing short term or current assets such as cash, marketable
securities, debtors and inventories.
Capital required for a business can be classified under two main categories via,
Fixed Capital
Working Capital
Every business needs funds for two purposes for its establishment and to carry out
its day-to-day operations. Long terms funds are required to create production
facilities through purchase of fixed assets such as P&M, land, building, furniture, etc.
Investments in these assets represent that part of firms capital which is blocked on
permanent or fixed basis and is called fixed capital. Funds are also needed for shortterm purposes for the purchase of raw material, payment of wages and other day
to- day expenses etc.
These funds are known as working capital. In simple words, working capital refers to
that part of the firms capital which is required for financing short- term or current
assets such as cash, marketable securities, debtors & inventories. Funds, thus,
invested in current assts keep revolving fast and are being constantly converted in to
cash and this cash flows out again in exchange for other current assets. Hence, it is
also known as revolving or circulating capital or short term capital.
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In a narrow sense, the term working capital refers to the net working. Net working capital is
the excess of current assets over current liability, or, say:
NET WORKING CAPITAL = CURRENT ASSETS CURRENT LIABILITIES
Net working capital can be positive or negative. When the current assets exceeds the
current liabilities are more than the current assets. Current liabilities are those liabilities,
which are intended to be paid in the ordinary course of business within a short period of
normally one accounting year out of the current assts or the income business.
CONSTITUENTS OF CURRENT LIABILITIES
1) Accrued or outstanding expenses.
2) Short term loans, advances and deposits.
3) Dividends payable.
4) Bank overdraft.
5) Provision for taxation, if it does not amt. to app. Of profit.
6) Bills payable.
7) Sundry creditors.
The gross working capital concept is financial or going concern concept whereas net
working capital is an accounting concept of working capital. Both the concepts have their
own merits.
The gross concept is sometimes preferred to the concept of working capital for the following
reasons:
1) It enables the enterprise to provide correct amount of working capital at correct time.
2) Every management is more interested in total current assets with which it has to operate
then the source from where it is made available.
3) It take into consideration of the fact every increase in the funds of the enterprise would
increase its working capital.
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4) This concept is also useful in determining the rate of return on investments in working
capital. The net working capital concept, however, is also important for following
reasons:
It is qualitative concept, which indicates the firms ability to meet to its operating
expenses and short-term liabilities.
IT indicates the margin of protection available to the short term creditors.
It is an indicator of the financial soundness of enterprises.
It suggests the need of financing a part of working capital requirement out of the
permanent sources of funds.
CLASSIFICATION OF WORKING CAPITAL
Working capital may be classified in two ways:
On the basis of concept.
On the basis of time.
On the basis of concept working capital can be classified as gross working capital
and net working capital. On the basis of time, working capital may be classified as:
Permanent or fixed working capital.
Temporary or variable working capital
PERMANENT OR FIXED WORKING CAPITAL
Permanent or fixed working capital is minimum amount which is required to ensure
effective utilization of fixed facilities and for maintaining the circulation of current
assets. Every firm has to maintain a minimum level of raw material, work- inprocess, finished goods and cash balance. This minimum level of current assets is
called permanent or fixed working capital as this part of working is permanently
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blocked in current assets. As the business grow the requirements of working capital
also increases due to increase in current assets.
TEMPORARY OR VARIABLE WORKING CAPITAL
Temporary or variable working capital is the amount of working capital which is
required to meet the seasonal demands and some special exigencies. Variable
working capital can further be classified as seasonal working capital and special
working capital. The capital required to meet the seasonal need of the enterprise is
called seasonal working capital. Special working capital is that part of working
capital which is required to meet special exigencies such as launching of extensive
marketing for conducting research, etc.
Temporary working capital differs from permanent working capital in the sense that
is required for short periods and cannot be permanently employed gainfully in the
business.
IMPORTANCE OR ADVANTAGE OF ADEQUATE WORKING CAPITAL
SOLVENCY OF THE BUSINESS: Adequate working capital helps in maintaining
the solvency of the business by providing uninterrupted of production.
Goodwill: Sufficient amount of working capital enables a firm to make prompt
payments and makes and maintain the goodwill.
Easy loans: Adequate working capital leads to high solvency and credit standing
can arrange loans from banks and other on easy and favorable terms.
Cash Discounts: Adequate working capital also enables a concern to avail cash
discounts on the purchases and hence reduces cost.
Regular Supply of Raw Material: Sufficient working capital ensures regular supply
of raw material and continuous production.
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3. Excessive working capital implies excessive debtors and defective credit policy
which causes higher incidence of bad debts.
4. It may reduce the overall efficiency of the business.
5. If a firm is having excessive working capital then the relations with banks and
other financial institution may not be maintained.
6. Due to lower rate of return n investments, the values of shares may also fall.
7. The redundant working capital gives rise to speculative transactions
DISADVANTAGES OF INADEQUATE WORKING CAPITAL
Every business needs some amounts of working capital. The need for working
capital arises due to the time gap between production and realization of cash
from sales. There is an operating cycle involved in sales and realization of cash.
There are time gaps in purchase of raw material and production, production and
sales, and realization of cash. Thus working capital is needed for the following
purposes:
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expenses are called preliminary expenses and are capitalized. The amount
needed for working capital depends upon the size of the company and ambitions
of its promoters. Greater the size of the business unit, generally larger will be the
requirements of the working capital.
The requirement of the working capital goes on increasing with the growth and
expensing of the business till it gains maturity. At maturity the amount of working
capital required is called normal working capital. There are others factors also
influence the need of working capital in a business.
FACTORS DETERMINING THE WORKING CAPITAL REQUIREMENTS
1. NATURE OF BUSINESS: The requirements of working is very limited in public
utility undertakings such as electricity, water supply and railways because they
offer cash sale only and supply services not products, and no funds are tied up in
inventories and receivables. On the other hand the trading and financial firms
requires less investment in fixed assets but have to invest large amt. of working
capital along with fixed investments.
2. SIZE OF THE BUSINESS: Greater the size of the business, greater is the
requirement of working capital.
3. PRODUCTION POLICY: If the policy is to keep production steady by
accumulating inventories it will require higher working capital.
4. LENTH OF PRDUCTION CYCLE: The longer the manufacturing time the raw
material and other supplies have to be carried for a longer in the process with
progressive increment of labour and service costs before the final product is
obtained. So working capital is directly proportional to the length of the
manufacturing process.
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9.
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The upper portion of the diagram above shows in a simplified form the chain
of events in a manufacturing firm. Each of the boxes in the upper part of the diagram
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can be seen as a tank through which funds flow. These tanks, which are concerned
with day-to-day activities, have funds constantly flowing into and out of them.
The chain starts with the firm buying raw materials on credit.
In due course this stock will be used in production, work will be carried out on the
stock, and it will become part of the firms work-in-progress.
Work will continue on the WIP until it eventually emerges as the finished product.
As production progresses, labor costs and overheads need have to be met.
Of course at some stage trade creditors will need to be paid.
When the finished goods are sold on credit, debtors are increased.
They will eventually pay, so that cash will be injected into the firm.
Each of the areas- Stock (raw materials, WIP, and finished goods), trade debtors,
cash (positive or negative) and trade creditors can be viewed as tanks into and
from which funds flow.
Working capital is clearly not the only aspect of a business that affects the amount of
cash.
The business will have to make payments to government for taxation.
Fixed assets will be purchased and sold
Lessons of fixed assets will be paid their rent
Shareholders (existing or new) may provide new funds in the form of cash
Then......
Collect receivables
(debtors) faster
You release
cash from
the cycle
Collect receivables
(debtors) slower
Your
receivables
soak up
cash
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You increase
your cash
resources
You free up
cash
You
consume
more cash
Unlike, movements in the working capital items, most of these non-working capital
cash transactions are not every day events. Some of them are annual events (e.g.
tax payments, lease payments, dividends, interest and, possibly, fixed asset
purchases and sales). Others (e.g. new equity and loan finance and redemption of
old equity and loan finance) would typically be rarer events.
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Nature of business
Seasonality of operations
Production policy
Market conditions
Conditions of supply
NATURE OF BUSINESS:
The working capital requirement of a firm is closely related to the nature of its business. A
service firm, like electricity undertakes or a transport corporation, which has a short
operating cycle and which sells predominantly on cash basis, has a modest working capital
requirement. On the other hand, a manufacturing concern like a machine tools unit, which
has a long operating cycle and sells largely on credit, has a very substantial working capital
requirement.
SEASONALITY OF OPERATIONS:
Firms which have marked seasonality in their operations usually have highly fluctuating
working capital requirement. To illustrate, consider a firm manufacturing ceiling fans. The
sale of ceiling fans reaches a peak during the summer months and drops sharply during the
winter period. The working capital requirement of such a firm is likely to increase
considerably in summer months decrease significantly during the winter period. On the
other hand, a firm manufacturing a product like lamps which have fairly even sales round
the year tends to have stable working capital requirements.
WORKING CAPITAL POLICY
Two important issues in formulating the working capital policy are:
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An aggressive current asset policy, seeking to minimize the investment in current asset,
exposes the firm to greater risk. The firm may be unable to cope with unanticipated
changes in the market place and operating conditions. Further, the risk of technical
insolvency becomes greater. The compensation of higher risk, of course, is higher expected
profitability.
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A conservative current asset financing policy reduces the risk that the firm will be
unable to repay or replace its short-term debt periodically. It, however, enhances the cost of
financing because the long-term sources of finance, debt and equity, have higher cost
associated with them.
An aggressive current asset financing policy, relying on short-term bank financing, tends to
have opposite effects. It exposes the firm with higher degree of risk, but reduces the
average cost of financing.
Choosing the Working Capital Policy:
The overall working capital policy adopted by the may broadly is conservative,
moderate, or aggressive. A conservative overall working capital policy means that the firm
chooses a conservative current asset policy along with a conservative current asset
financing policy. A moderate overall working capital policy reflects a combination of a
conservative current asset policy and aggressive current asset financing policy or
combination of an aggressive current asset policy and a conservative current asset
financing policy. An aggressive overall working capital policy consists of an aggressive
current asset policy and an aggressive current financing policy.
An overall conservative working capital policy reduces the risk and offer low returns.
An overall moderate working capital policy reduces the risk and low returns. An overall
aggressive working capital policy provides a package of high risk and high return. The
choice of an overall working capital policy would depend on the risk disposition of
management.
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It refers to the systematic use of ratios to interpret the financial statements in terms of the
operating performance and financial position of a firm. It involves comparison for a
meaningful interpretation of the financial statements.
In view of the needs of various uses of ratios the ratios, which can be calculated from the
accounting data are classified into the following broad categories
1.
2.
3.
4.
Liquidity Ratio
Turnover Ratio
Solvency or Leverage ratios
Profitability ratios
1. LIQUIDITY RATIO:
It measures the ability of the firm to meet its short-term obligations, that is capacity of the
firm to pay its current liabilities as and when they fall due. Thus these ratios reflect the
short-term financial solvency of a firm. A firm should ensure that it does not suffer from lack
of liquidity. The failure to meet obligations on due time may result in bad credit image, loss
of creditors confidence, and even in legal proceedings against the firm on the other hand
very high degree of liquidity is also not desirable since it would imply that funds are idle and
earn nothing. So therefore it is necessary to strike a proper balance between liquidity and
lack of liquidity.
The various ratios that explains about the liquidity of the firm are
1. Current Ratio
2. Acid Test Ratio / quick ratio
3. Absolute liquid ration / cash ratio
1. CURRENT RATIO:
The current ratio measures the short-term solvency of the firm. It establishes the
relationship between current assets and current liabilities. It is calculated by dividing
current assets by current liabilities.
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Current assets include cash and bank balances, marketable securities, inventory, and
debtors, excluding provisions for bad debts and doubtful debtors, bills receivables and
prepaid expenses. Current liabilities includes sundry creditors, bills payable, short- term
loans, income-tax liability, accrued expenses and dividends payable.
Quick assets are those current assets, which can be converted into cash immediately or
within reasonable short time without a loss of value. These include cash and bank
balances, sundry debtors, bills receivables and short-term marketable securities.
2. TURNOVER RATIO:
Turnover ratios are also known as activity ratios or efficiency ratios with which a firm
manages its current assets. The following turnover ratios can be calculated to judge the
effectiveness of asset use.
1.
2.
3.
4.
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The average inventory is simple average of the opening and closing balances of
inventory. (Opening + Closing balances / 2). In certain circumstances opening
balance of the inventory may not be known then closing balance of inventory
may be considered as average inventory
Net credit sales consist of gross credit sales minus sales return. Trade debtor
includes sundry debtors and bills receivables. Average trade debtors (Opening +
Closing balances / 2)
When the information about credit sales, opening and closing balances of trade
debtors is not available then the ratio can be calculated by dividing total sales by
closing balances of trade debtor
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When the information about credit purchases, opening and closing balances of
trade creditors is not available then the ratio is calculated by dividing total
purchases by the closing balance of trade creditors.
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a)
b)
c)
d)
e)
Net assets represent total assets minus current liabilities. Intangible and fictitious
assets like goodwill, patents, accumulated losses, deferred expenditure may be
excluded for calculating the net asset turnover.
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Net fixed assets represent the cost of fixed assets minus depreciation.
Working capital is represented by the difference between current assets and current
liabilities.
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The ratio is based on the relationship between borrowed funds and owners capital it
is computed from the balance sheet, the second type are calculated from the profit
and loss a/c. The various solvency ratios are
1.
2.
3.
4.
5.
6.
The outsider fund includes long-term debts as well as current liabilities. The
shareholder funds include equity share capital, preference share capital, reserves
and surplus including accumulated profits. However fictitious assets like
accumulated deferred expenses etc should be deducted from the total of these items
to shareholder funds. The shareholder funds so calculated are known as net worth
of the business.
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The shareholder funds include equity share capital, preference share capital,
reserves and surplus including accumulated profits. However fictitious assets like
accumulated deferred expenses etc should be deducted from the total of these items
to shareholder funds. The shareholder funds so calculated are known as net worth
of the business.
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4. Profitability Ratio:
The profitability ratio of the firm can be measured by calculating various
profitability ratios. General two groups of profitability ratios are calculated.
a. Profitability in relation to sales.
b. Profitability in relation to investments.
Profitability in relation to sales
1. Gross profit margin or ratio
2. Net profit margin or ratio
3. Operating profit margin or ratio
4. Operating Ratio
5. Expenses Ratio
1. GROSS PROFIT MARGIN OR RATIO:
It measures the relationship between gross profit and sales. It is calculated by
dividing gross profit by sales.
Gross profit is the difference between sales and cost of goods sold.
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4. EXPENSES RATIO:
While some of the expenses may be increasing and other may be declining to
know the behaviour of specific items of expenses the ratio of each individual
operating expense to net sales should be calculated. The various variants of
expenses are
Selling and distribution exp. ratio= Selling and distribution expenses X 100
Net sales
5. OPERATING PROFIT MARGIN OR RATIO:
Operating profit margin or ratio establishes the relationship between operating
profit and net sales. It is calculated by dividing operating profit by sales.
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Dividend pay out ratio (Pay out ratio) = Total dividend paid to equity
shareholders
Total earnings available to equity share
holders
Or
Dividend per share /Earnings per share
DIVIDEND AND EARNINGS YIELD:
While the earnings per share and dividend per share are based on the book
value per share, the yield is expressed in terms of market value per share. The
dividend yield may be defined as the relation of dividend per share to the market
value per ordinary share and the earning ratio as the ratio of earnings per share
to the market value of ordinary share.
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Dividend Yield =
Earnings yield =
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What is cash?
Cash include cash items in the process of collection, currency and coin, and
balances due from depository institutes. Cash provides flexibility and carries
minimum risk in the short term. The amount of cash held will vary from to firm, to
firm, depending on anticipated needs.
Because cash is considered a non-earning or lo-earning asset, excessive
cash balance can have an adverse effect on earnings. As such, an opportunity
cost associate with maintaining cash balances exits because these founds could
be invested or applied elsewhere to provide a better overall returns. Excessive
balances may also reflect ineffective administration of organization resources of
management. Conversely, account balances that are too low could leave the
organization in a vulnerable position from an available funds standpoint. The
risks and costs of holding these assets must be adequately managed to ensure
the safety and soundness of the organization.
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3. Excess cash balance costs: If large are idle, the implication is that the firm has
missed opportunities to invest those funds and has thereby lost interest which
it would otherwise earned. This loss of interest is primarily the excess cost.
4. Procurement: These costs are generally fixed and are mainly accounted for
salary, storage, handling of securities, etc.
5. Uncertainty and Cash Management:
Finally, the impact of uncertainty on cash management strategy
relevant as cash flows cannot be predicted with complete
accuracy. The first requirement is a precautionary cushion to
cope with irregularities in cash flows, unexpected delays in
collections and disbursement and defaults and unexpected cash
needs.
Understanding Cash Flow:
In its simplest forms, cash flow is the movement of money in and out of our
business. It could be described as the process in which your business uses cash to
generate goods or services for the sale to your customers collects the cash from the
sales, and then completes this cycle all over again.
Inflows:
Inflows are the movement of money into your cash flows. Inflows are most likely
from the sale of your goods or services to your customers. If you extend credit to
your customers and allow them to charge the sale of the goods or services to their
account, then an inflow occurs as you collect on customers accounts. The proceeds
from a bank loan are also a cash inflow.
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Outflows:
Outflows are the movement of money out of your business. Outflows are
generally the result of paying expenses. If your business involves reselling goods,
then your largest outflow is most likely to be for the purchase of retail inventory. A
manufacturing businesss largest outflows will most likely be for the purchases of raw
materials and other components needed for the manufacturing of the final product.
Purchasing fixed assets, paying back loans, and paying accounts payable are also
cash outflows.
1) CASH BUDGET :
The cash budget is probably the most important tool in cash
management. It is an advice to help a firm to plan and control the uses of
cash. It is a statement showing the estimated income (cash inflow) and the
expenditure (cash outflow) over the firms planning horizon.
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security which has just come by only to discover a week later that high cash
is needed to purchase materials urgently required by the factory. As the
enterprise cannot afford to stop production which is the broad objective of the
business, the finance manager may have to sell out the security, probably at
loss, to buy materials. To prevent situations like this, detail cash forecasting
based on the strategic plan of the business is required to be drawn up.
Different time horizons are used for forecasting with different objectives in
mind.
Long-term Forecasts:
All forecasts beyond one year come under this head. These are needed
for long-range investing and financing of a business in term of the strategic
goals of an enterprise. Purpose of the long-range forecasting is to evaluate the
ability of enterprise to meet specific cash requirement for say, requirement for
say, expansion, modernization, acquisition, etc. if there is a cash gap, how the
enterprise is going to fill it up, whether by capital issues or by contracting
external debt. These are some of the issues that are needed to be resolved in
long-term cash flow forecasts.
It is likely that in the long run, economical and technological
environment will undergo changes. Long-term cash flows forecasts are,
therefore made for possible economic and technological scenario becomes an
input in the long-range plans.
Medium-term Forecasts:
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Short-term forecasts:
This may take the form of weekly or daily forecasts of inflows and
outflows. Finance may know quite accurately average cash flows during a month
or a week but it is difficult for him to determine specific cash flows during a
month or week. It may be difficult but its importance cannot be titled because, on
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the basis of daily cash flow forecasts only a finance manager take a decisions
about cash transfer from one region to other, reduction increase infield balances
and short term investment of surplus cash etc.
Ready Forwards:
Under this arrangement, the bank sells and repurchases the same securities
(this mean that company, in turn, buys and sells securities) at prices determined
beforehand. Ready forwards are commonly done under units, public sector bond and
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government securities. The Company earns a return in the form of price difference,
not in the form of interest income.
While ready forward is a fairly same avenue in short run, the recent scams in the
securities market call for caution and circumspection in these transactions. Ideally
the company should have constructive possession of the securities.
Inter-Corporate Deposits:
A deposit made by one company with another, normally for a period up to six
months is referred to as an inter-corporate deposit. Such deposits are of three types:
a) Call Deposits.
b) Three-month Deposits.
c) Six-month Deposits.
As inter corporate deposits represent unsecured borrowing the lending
company must satisfy itself about the credit-worthiness of the borrowing firm.
Bill Discounting:
A bill arises out of a trade transaction. The seller of goods draws the bill on
the purchaser. The bill is payable on demand or after usage period which
ordinarily does not exceed 90 days. On acceptance of the bill by the purchaser
the seller offers it to the bank for discount/purchase. When bank discounts or
purchases the bill it releases the funds to the seller. As bills are a selfliquidating instrument, bill discounting may be considered superior to lending in
the inter-corporate deposit market.
4. CONTINGENCY PLANNING:
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Accounts receivable also represent an investment. That is, the money tied up in
accounts receivables is not available for paying bills, paying back loans, or
expanding your business. The payoff from an investment in accounts receivable
doesnt occur until your customers pay their bills.
Accounts Receivable and Credit Management:
The profitability of a business is dependent upon its ability to successfully sell
its products for more than its costs to produce them. Selling on credit generally
attracts customers and increases sales volume. There are, however, direct and
indirect costs to extending credit which must be weighed against any potential
benefits. A successful credit policy is one in which the costs of granting credit are
offset by the benefits of higher sales.
When the firm ships the good or performs the services without receiving cash, an
account receivable (AR) is generated. The dollar amount of receivables is
determined by the volume of sales and the average length of time between a sale
and receipt of full cash payment, and may be calculated based on the following
simple formula:
For example, if a business has credit sales of Rs.1000 per day and allows 20 days
for payment, it has a total of Rs.1000 x 20 or Rs.20000 invested in receivables at
any given time (assuming the firms operations are stable). Any changes in the
volume of sales or the length of the collection period will change the receivable
position.
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Credit Policy:
A credit policy refers to the action taken by a business to grant, monitor and collect
cash for outstanding accounts receivables. Four specific factors must be considered
in established an effective credit policy.
a)
b)
c)
d)
First the credit worthiness of the buyer must be evaluated. Most companies measure
credit quality and evaluate a customers probability of default by examining the five
Cs of credit:
a)
b)
c)
d)
e)
Character
Capacity to repay
Capital
Collateral, and
Conditions
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conditions. Credit period is the length of time allowed before the credit buyer must
pay for credit purchases. Collection policy refers to the action that the business is
willing to take to collect slow-paying accounts. The length of time a firm is willing to
take to extend credit to its customers and the toughness of the firm in collecting its
receivables may influence sales and ultimately, its profit, while a relaxed collection
policy may increase the percentage of bad debt.
Moreover, an aging schedule must be constructed to show how long accounts
receivable are outstanding by dividing the receivables position in age categories and
showing the percentage of receivables in age group. Then the small business owner
must decide what actions are appropriate for collecting the past due accounts.
Usually, a letter is sent to remind the credit buyer that the account is past due,
followed by a telephone call if payment is further delayed. Finally, the services of a
collection agency may be necessary.
The collection process may be expensive both in terms of out-of-pocket
expense and the loss of business relations. Therefore, making the decision to grant
credit is an important and delicate business function requiring careful handling.
Advice from other business owners and professionals is often helpful.
The last element of the credit policy is cash discount may be considered as an
incentive for credit customers to pay early and it may reduce the average collection
period. It may also attract new customers who look at cash discounts as a form of
price reduction. These benefits however, must be weighed against the dollar cost of
the discount before any decisions are made.
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The average daily sales volume is computed by:Average Daily Sales = Annual Sales
360
Using the annual sales amount and account receivable balance from the prior year is
usually accurate enough for analyzing and managing cash flow. However, if more
recent information is available, such as the previous quarters sales information, then
it should be used instead.
Using the average collection period:- The average collection period is the
average number of days between 1) the date that a credit sale is made, and 2)
the date that the money is received from the customer. The average collection
period is also referred to as the days' sales
in accounts receivable.
The average collection period can be calculated as follows: 365 days in a year
divided by the accounts receivable turnover ratio. Assuming that a company has
an accounts receivable turnover ratio of 10 times per year, the average collection
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An alternate way to calculate the average collection period is: the average
accounts receivable balance divided by average credit sales per day.
If a company offers credit terms of net 30 days, the company may find that its
average collection period is actually 45 days or more. Monitoring the average
collection period is important for a company's cash flow and its ability to meet its
obligations when they come due.
Accounts Receivable to Sales Ratio:
The account receivables to sales ratio helps to identify recent increases in
accounts receivable. Using monthly sales information, the account receivables to
sales ratio can serve as information of the accounts receivables to sales ratio will
quickly point out cash flow problems related to businesss accounts receivable.
The accounts receivable to sales ratio is calculated by:Accounts receivable to sales ratio = Account Receivable
Sales for the Month
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problems in cash flow. For e.g. an increase in accounts receivable to sales ratio from
one month to the next indicates that investment in accounts receivable is growing
rapidly than sales. This is often one of the first signs of a cash flow problem.
Specific Techniques for Speedy Collection of Receivables
1. Prompt Payment by Customers:
One way to ensure prompt payment by the customers is prompt billing. What
the customer has to pay, the period of payment etc should be notified
accurately and in advance. The uses of mechanical devices for billing along
with the enclosure of a self-addressed return envelope will speed-up payment
by customers. Another and more important technique to encourage prompt
payment by customers is the practice of offering trade discount.
2. Early Conversion of Payment in to Cash:
Once the customer make the payment by writing a cheque in favour of the firm,
the collection can be expedited by prompt encashment of the cheque. There is a
time lag between the cheque is prepared and mailed by the customer and the
time in which funds are included in the cash reservoir of the firm. This period of
time is known as deposit float. The collection of accounts receivables can be
considerably accelerated, by reducing transit, processing and collection time.
This is possible if a firm adopts a policy of decentralized collection.
The principal methods of establishing a centralized collection network are:
(a) Concentration Banking and
(b) Lock-Box System
(a) Concentration Banking:
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1. Managing payables
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Creditors are a vital part of effective cash management and should be managed
carefully enhance the cash position.
Purchasing initiates cash outflows and an over-zealous purchasing function can
create liquidity problems. There is an old adage in business that if you can buy well
than you can sell well. Management of your creditors and suppliers is just as
important as the management of you debtors. It is important to look after your
creditors-slow payment by you may create ill feeling and can signal that your
company is inefficient.
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3. Float :
A very important technique of slowing down the payment is float. The term float
refers to the amount of money tied up in cheques that have been written, but have
yet to be collected and en cashed. A firm can send remittances although it does have
cash in its bank at the time of issuance of the cheques. Meanwhile, funds can be
arranged to make payment when cheques is presented for collection after a few
days. Float used in this sense is called as cheques kitting. There are two ways of
doing it:
a) Paying from a bank away from the creditors bank
b) Scientific cheques analysis on the basis of past experience, the time lag
between issue and encashment of cheques.
For instance, cheques issued to pay wages and salary may not been cashed
immediately; it may be spread over a few days, say, 25% on one day, 59% on
second day and balance on the third day. This strategy would enable the firm to save
the operating cash.
Accruals :
Finally, a potential tool for stretching accounts payables is accruals which are
defined as current liabilities that represent a service or goods received by a firm but
not yet paid for instance, payroll i.e. remuneration to employees, who renders
services in advance and receive payment later. In a way, they extend credit to the
firm for a period at the end of which they are paid, say, a week or a month. Thus,
less frequent payrolls, i.e. weekly as compared to monthly, are an important source
of accrual. They can be manipulated to slow down the disbursements. Other
examples of accruals are rent and tax.
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INVENTORY MANAGEMENT
MEANING OF INVENTORY
Inventory generally refers to the materials in stock. It is also called the idle resource
of a company. Inventories represent those items which are either stocked for sale or
they are in the process of manufacturing or they are in the form of materials which
are yet to be utilized. It also refers to the stockpile of the products a firm would sell in
future in the normal course of business operations and the components that make up
the product. Inventory is a detailed list of those movable items which are necessary
to manufacture a product and to maintain the equipment and machinery in good
working order. Inventories constitute the most important part of the current assets of
large majority of companies. On an average the inventories are approximately 60%
of the current assets in public limited companies in India. Because of the large size
of inventories maintained by the firms, a considerable amount of funds is committed
to them. It is therefore, imperative to manage the inventories efficiently and
effectively in order to avoid unnecessary investment.
Inventory cost:
Costs associated with inventories are as follows:
1. Stock out cost:
It is an implicit cost of lost sales due to shortage of supplies. It includes such
cost as back order costs, lost profit due to loss of present sales, and also cost of
losing goodwill of the firm which affects future sales and profit. Internal shortage cost
occurs when the requirement of production department is not fulfilled or it is delayed,
resulting in delayed completion, lost production idle time, etc.
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2. Holding cost:
This cost has two part:
a) Cost of physical carrying of inventories like storage cost, insurance, rate and
taxes, handling, shrinking, deterioration and obsolescence;
b) Financial cost of funds engaged in inventories which is generally the
opportunity cost of alternative investment.
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made up solely of two parts i.e., ordering cost and carrying cost. The cost
relationships are shown in below figure.
FORMULA FOR CALCULATING ECONOMIC ORDER QUANTITY
Inventory Management Techniques
In managing inventories, the firms objective should be to be in consonance
with the shareholder wealth maximization principle. To achieve this, the firm should
determine the optimum level of inventory. Efficiently controlled inventories make the
firm flexible. Inefficient inventory control results in unbalanced inventory and
inflexibility-the firm may sometimes run out of stock and sometimes pile up
unnecessary stocks.
I.
QUALITY DISCOUNTS:
It is a common practice amongst suppliers to offer quantity discounts as
incentives to buy in larger quantity. The advantages that accrue to the sellers are
lower order processing costs or set-up costs and lesser carrying cost of inventories.
Quantity discounts effectively reduce the unit cost of materials. As the lot sizes are
large, the number of orders will be few and hence, the total ordering costs will be
reduced.
II. MATERIAL REQUIREMENTS PLANNING
Manufacturing can be a highly detailed, highly complex process that requires
specific planning. Material Requirement Planning (or MRP) is an inventory
system that is computer based and used to manage the manufacturing
process. It is designed to assist in the scheduling and filling of orders for raw
materials that are manufactured into finished products.
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a) MPS
Master production scheduling (MPS) is a form of MRP that concentrates
planning on the parts or products that have the great influence on company
profits or which dominate the entire production process by taking critical
resources. These items are marked as A parts (MPS items) and are planned
with extra attention. These items are selected for a separate MPS run that
takes place before the MRP run.
b) BOM
A Bill of Material (B.O.M.) is a hierarchical list of materials (components, sub
assembles, ingredients..) required to produce an item, showing the quantity of
each required item. Other information such as scrap factors may also be
included in the BOM for use in materials planning and costing. An engineering
BOM represents the assembly structure implied by the parts lists on drawings
and drawing tree structure. A manufacturing BOM represents the assembly
build-up the way a product is manufactured.
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III.
KANBAN
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packages consist of modules, each handling a different business process that are all
linked and have a common look and feel.
The different modules of ERP package are: Manufacturing and Operations Modules
Engineering Modules, Documentation Modules
Finance Modules and Customer Relationship Module, etc.
An ERP system manages the information needs of all company functions, including
financial system, human resources and payroll, logistics and distribution, purchasing,
sales, and manufacturing. It consists of a single database and application that allow
employees in different department to access and act on that data.
Using the same information management software company-wide eliminates a data
integration problem that arises when a company operates a purchasing system
from one vendor, an inventory management system from another, and a
manufacturing control system from a third. Dealing with a single software vendor
also facilities software upgrades and maintenance.
To make things easier from mid-sized and small business, some ERP systems offer
packages that are preconfigured according to standard business modules or
provide more limit functionality. This works for large manufacturing companies that
make products using well define, industry-standard planning and control systems
that dont change much over a long period of time.
But for many coating producers, todays rapidly changing business environment is
one where only the fittest survive and they are most flexible.
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Thus, an ERP package can be used for effective working capital management
by linking the financial modules to manufacturing and logistics and to the
people who deal with analytical results for policy formulation.
CONCLUDING ANAYSIS
The working capital position of the company is sound and the various sources
through which it is funded are optimal.
The company has used its dividend policy, purchasing, financing and
investment decisions to good effect can be seen from the inferences made
earlier in the project.
The debts doubtful have been doubled over the years but their percentage on
the debts has almost become half. This implies a sales and collection policy
that get along with the receivables management of the firm.
The various ratios calculated are an indicator as to the fact that the profitability
of the firm and sales are on a rise and also the deletion of the inefficiencies in
the working capital management.
CONCLUSION
I had the opportunity to study the intricacies of a financial world, which runs in each
and every business, the topic Working Capital Management
Even though your business may be fortune 500 conglomerates or a neighborhood
trading organization, this is one aspect where the slightest in difference may decide
the health of an organization.
DEFINATION
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Working Capital is defined as the excess of current assets over current liability and
provision.
Mission
The prime mission of Working Capital Management is to maintain a proper balance
within the firms funds invested in existing resources so to ensure the firms long-term
survival, growth and profitability.
PURPOSE
The purpose why financial experts, organization and students of management
accounting consider Working Capital as a lifeline of the organization because it is
important for the smooth day to day functioning of the organization. Also working
capital is of major importance to internal and external analysis because of its close
relationship with the current day-to day operations of a business. Its effective
provision can do much to ensure the success of business, while its inefficient
management can lead not only to loss of profit but also to the ultimate downfall of
what otherwise might be considered a promising concern.
KALEIDOSCOPE
Working Capital is a broad umbrella under whose grant many aspects of financial
and management, Receivables Management, Inventory Management and Financing
of Working Capital. Various cash management tools include Cash budget, cash flow
forecasting, planning the investment and the contingency planning for liquidity crisis.
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A sound credit policy ensures effective collections from the debtors. Now a days
concentration banking and lock-box system are the most widely used by the
company for smooth collection.
As per payables are concerned the company that I visited never had problems in this
regard. Managing inventory is a juggling act. This is an area where a huge amount of
working capital has been blocked by the firms. Almost all manufacturing firms face
this problem. However, with the introduction of MRP, JIT, EOQ, KANBAN this
problems seems to be resolved to some extent. But according to industry experts it
cannot be absolutely perfect in any scenario.
Mostly firms depend upon trade credit and cash credit loans from banks, which are
obtained after basic procedure of assessing the working capital requirement of the
firm.
BALANCING ACT
A current shift in the trend of replacing manual by technology has taken place. Using
computers, data is stored to determine the inventory at any given level or stage
.Transmission of data as well as money takes place in seconds, Electronic
Transmission of data along with interface with each and every organization allows a
company to determine whether it has a realistic figure of Working Capital or not.
Enterprise Resources Planning Along with SAP has emerged as a major player in
the technology market, tailor made software products like these and in-house
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BIBLIOGRAPHY
Following sources have been sought for the preparation of this report:
Financial Statements (Annual Reports)
Company Magazines and Journals.
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