ASPECTS OF WORKING CAPITAL

INVENTORY CONTROL
Discuss about Significance of Inventory Management-

Inventory refers to the stock of a product of a company. In a company mainly three types of
inventories exist, various types of material, semi-finished goods and finished goods. These
three inventories are necessary for any company. The company has to manage this inventory
properly. By the proper inventory management, production takes place at the proper time.
Inventory is very crucial link to produce goods for sales. It is the responsibility of the manager
to maintain various stocks in a company.

Inventory is one part of the current assets in which company invests around 50%-60% amount
of total current assets. Improper mgt of inventory is undesirable for company and consumer
also. The significance of inventory mgt is given below-
1. By the proper inventory mgt, investment can be reduced in inventory because excess
inventory can increase the interest cost.
2. Proper and efficient use of raw material is possible by proper inventory Mgt sales and
production can be improved.
3. Inventory mgt is helpful for optimum use of financing resources and physical resources.
4. By the proper inventory Mgt Company can maintain all types of inventory.
5. Customers demand can be fulfilled at proper time by inventory mgt.
6. Profit can be increased by inventory Mgt.
Objective of inventory management
The objectives of inventory management are mentioned below:
1. To supply the required materials continuously: there should be a continuous available of
materials in the factory or finished goods for trade. The main objective of inventory
management in to maintain required inventory so that production and sales process run
smoothly.
2. To minimize the risk of under and over stocking of material: if a company keeps
inventory without proper analysis, there will be a chance of overstocking, which will increase
the cost of carrying the inventory or under stocking of inventory that create problem in smooth
operation of a business. So one of the main objectives of the inventory management is to
minimize the risk caused due to under and over stocking of inventory.
3. To maintain systematic record of inventory: management needs different information
regarding inventory for planning and decision-making. A systematic recodes of inventory helps
provides such information to the management. It also assists to evaluate the current inventory
management policy.
4. To reduce losses, damages and misappropriation of materials: inventory management
aims to reduce or remove the losses and misappropriate of materials. This is done by
maintaining the proper stocks of materials with utmost care.
5. To minimize the cost associated with inventory: the proper maintenance of the
information regarding inventory helps to make decisions like whether to take discounts or not,
the size of order to be placed, when to order etc. the total cost associated with inventory may be
minimized by analyzing the lot size to be acquired, the offer of discount on variable lot size and
the timing of order. Such analysis helps to reduce the unnecessary inventory in inventories.
6. To make stability in price: an effective inventory management system minimizes the
effects of regular price fluctuation. This is turn helps to gain the stability is selling price.
Reasons or motives of holding inventory
The main reason or motives of holding inventory is to supply the required of inventory to
different department as needed so that production/ sales process does not get hampered. The
motives or reason of holding inventory are:
1. Transaction motive: The manufacturing concerns need inventories of raw material and
work in progress so as to maintain regular production activities. Similarly, the trading
organization need the inventories of finish goods for supplying the goods and services to the
customers regularly, in this way, holding of inventories helps to have regular transactions.
2. Precautionary motive: due to different reasons, like shortage of inventory with the
suppliers, week relation with the supplier, disturbance in transaction, delay in inventory supply
etc. might take place. It is also importance objective of holding the inventory to take precaution
from take the above.
3. Speculative motive: generally the price of inventories rise, so the companies may keep
additional amount of inventory to get benefit by selling the surplus inventory at higher price than
purchase price. It crates risk when the price of inventory falls.

Which are the uses of inventory management?

Safety or Buffer Inventory

Safety inventory provides a buffer against uncertainty. There is often an uncertainty of demand
for one's products. Without safety inventory, there would be lots of missed opportunities when
unexpected demand spikes aren't fulfilled because of insufficient stock. Supply uncertainties
are another reason for maintaining safety inventory. A supplier might fail to deliver on time
because of any number of reasons. For example, the transport of the goods might get delayed
because of weather problems or a traffic accident.

2. Raw Materials Inventory

If you are a manufacturer or practice delayed differentiation to minimize your safety stock of
finished goods, you would have a raw materials inventory. The raw materials could be
subassemblies, sub-components, or possibly elemental things like minerals, metals, and wood.
It's the 'stuff' required to make your finished product. This allows you to assemble or
manufacture your goods without the delay of acquiring your raw materials.

3. Anticipation Inventory

When a business anticipates an event that will require more inventory than usual, it acquires
anticipation inventory. For example, a business may anticipate increased demand because a
competitor will go out of business and will build up inventory for that event. Inventory may be
increased because a supplier is going out of business or because the supplier plans to increase
its prices in the future.

4. Cycle Inventory

Cycle inventory covers normal demand. It's ordered from suppliers in batches, the size of which
is determined by factors such as supplier lead times, bulk pricing, shipping costs, and order
processing costs. When the batch is used up and gets replaced again, it has 'turned over'.
Businesses seek to maximise inventory turnover while minimising the associated costs. Cycle
inventory does not include safety inventory which covers "abnormal" demand or supply
problems.

5. Finished Goods Inventory

Finished goods inventory is the product you keep on hand so that you can immediately respond
to customer orders without the delays of ordering or manufacturing the goods requested in the
order. Its purpose is to maintain good customer satisfaction levels.

6. Decoupling Inventory

Finished goods are often produced by the flow of materials through a chain of operations or
manufacturing centres. Each operation processes the material in some way before the material
proceeds to the next operation centre. Decoupling inventory allows the operation centres to
work independently of each other. In this way, temporary bottlenecks don't affect downstream
operations.

Which are different methods of EOQ

Introduction

Inventory management is an important part for any company. To maximize the profit
company has to maintain inventory properly and should also determine the level of inventory.
More stock of inventory can decrease the profitability and less stock is not beneficial for the
company. In over stock there will be increase in interest cost and in under stock there will be
decrease in the supply of goods. So, it is necessary to decide the proper order quantity. How
much order should be placed can be decided by economic order quantity. If company wants
to run its production properly then it has to decide how much quantity should be ordered.
This problem is solved by deciding economic order quantity. By deciding EOQ company can
know how much various type of raw material should be purchased, which would decrease the
cost. There should be considered two types of cost:

1. Ordering Cost

2. Carrying Cost

 Ordering Cost:

Ordering cost is concerned with raw material procurement cost. Whenever company
gives order for the material at that time some expenses are accrued which is called
‘ordering cost’. In this cost clerical expenses, receiving, quality inspection, tenders
related expenses, etc. are included. It is found that ordering cost decreases with larger
orders and increases with small orders.

 Carrying Cost :

Cost included maintaining a given level of inventory is called ‘carrying cost’. In carrying
cost storage, insurance, clerical expensive, interest cost etc. are included.

Carrying cost includes interest cost also because that much amount is locked for
maintaining a material. if this amount is invested at another place then interest can be
earned.

When inventory carrying cost and ordering cost are in balance then total cost of order
quantity decreases. So, it is called economic quantity.

There are three methods to determine the EOQ:

 Graphical Method:

The economic order quantity can be found out by graphical method. In the figure,
carrying cost, ordering cost and total cost are given on Y-axis and on x-axis EOQ is
presented. Order cost decreases with increase in order size. Total cost declines as
we can see in the figure that carrying cost line and order cost line interact at N point.
 This N point is called economic order quantity. At this point carrying cost and
ordering cost are minimum. So, company should purchase that much quantity
because it can minimize total cost and increase the profits.

 Formula Method :

To find out an EOQ formula method is also popular. To calculate EOQ one formula is
given below:

A= Annual Consumption O= Ordering Cost C= Carrying

Cost

Assumption of EOQ:

 The firm or company knows annual usage of an inventory.

 The rate at which the firm uses inventory is over a time.

 The order placed for fresh inventory is received at extra point of time when inventory
reach at zero level.

 Trial and Error Method :

Trial and error method is also helpful to find out EOQ which can decrease the cost.
The inventory should be purchased in such quantity in which ordering and carrying
cost will be minimum. In this method formula is not used to find out EOQ. In this
method ordering cost and carrying cost are calculated for the different sizes. We
should place an order in which total cost is minimum.

 Average inventory = Order size ÷2

 Total carrying cost =average inventory ×carrying cost per unit

 Total ordering cost = number of order × cost per order

Which are the Various Levels of Inventory?

There are some important levels in inventory. The company should be aware of these
important levels. There are four levels of inventory.

1. Re-ordering point:

We already solve the problem related how much produced but we still not get the
answer when to order when can get this answer by re-ordering point. The re-ordering
point is inventoried level at which an order should be place for the inventory. To
determine the re-ordered point we should know:
Lead time : Lead time is the time normally taken in receiving order. It is also known as delivering time.
  Average usage:

Average usage means average material used for the production.

Re-ordering point = lead time × average consumption

Re-ordering point = maximum consumption × maximum delivering time

2. Minimum level :

It represents the minimum quantity of stock that should be maintained otherwise

company has to face some problems. If company does not maintain this level then
production might get stop. So, the company should maintain a minimum level.

Minimum level = Re-ordering level – (normal consumption × normal time)

3. Maximum level :

It represents the upper limit of level of stock. It means that the company should not
keep a stock above this level. If company keeps more stock than companies more
capital will be locked and company may have to pay interest if capital is borrow.

Minimum level and maximum is also depending upon the company’s financial
condition, delivering time and damage raw materials etc. . . .

Maximum level = re-ordering level – minimum consumption × minimum time period +

re-ordering quantity

4. Safety stock :

The usage of inventory cannot be forecast perfectly. Generally, it fluctuates over period
of time. To protect against fluctuation, The Company maintains some margin of stock is
called safety stock.

Safety stock = Maximum consumption*(maximum time-normal time)

Discuss about ABC Technique- Always Better Control-

Generally a firm has to maintain several types of inventory. It is not desirable to keep same
degree of control on all the items. Therefore the firm should adopt ABC control system. Under
this system, inventory is divided into three categories- A, B and C.
 Category A-

The high valued items are classified under ‘A’. These types of items require more control
because they have high value in terms of money, but their quantity is low. About 70% of
total money is invested in Category A.

 Category B-

Under this category, items are included whose value is relatively lower than that of items
in ‘A’. The requirement for control will be low. In these types of items, around 25% of
investment is made.

 Category C-

Under this category, Items which hold relatively low prices are included. About 5% to 10%
of money is invested. While quantity of such items is high. There is less requirement of
control under ‘C’ category.

The below are some steps to implement ABC analysis-

1. Classify the items of inventories; determine the expected use in units and the price
per unit for each item.

2. Determine the total value of each item by multiplying the expected quantity with its
unit price.

3. Rank the items in accordance with total value. Giving first rank to the item with
highest total value and so on.

4. Compute the percentage of number on units of each item to total units of all items.

5. Combine items on the basis of their relative value to form three category prices- A, B
and

Advantages-

1) It ensures closer control on costly items in which a large amount of capital has been
invested.

2) It helps in developing a scientific method of controlling inventories. Clerical costs are

reduced and stock is maintained at optimum level.

3) Profit is increased because cost decreases by applying this method.

4) Store in-charge can give attention on other matters.

5) This method does not encourage over-stocking. This it helps in limiting the increased
storage space, insurance charges etc.
 6) By applying this method, right item can be acquired at proper time.

just in time production (JIT)

As the name suggests, the JIT inventory management technique says that the item will be
ordered only if it is needed for shipping or manufacturing. The item may be ordered a few
days back depending on the delivery time promised by the supplier. A mandatory requirement
of this approach is the proper identification of each item before the manufacturer or reseller
requires it. Since, there can be many goods required by supplier or manufacturer at any time,
each and every future requirement should be properly identified and timely ordered.

Another crucial requirement for this technique is the timely delivery of the order by the
supplier. Since the item is ordered just before it is needed, any delay in the arrival of the item
may delay the whole production process; this may be treated as a drawback in the approach.
The JIT inventory management technique helps reduce the size of the inventory and leads to
low storage costs.

Advantages of JIT

 Lower stock holding means a reduction in storage space which saves rent and insurance
costs
 There is little room for mistakes as minimal stock is kept for re-working faulty product
 As stock is only obtained when it is needed, less working capital is tied up in stock
 There is less probability OF obsolete or out of date
 Avoids the build-up of unsold finished product that can occur with sudden changes in
demand
 Less time is spent on checking and re-working the product of others as the emphasis is
on getting the work right first time

Disadvantages of JIT

 Production is very reliant on suppliers and if stock is not delivered on time, the whole
production schedule can be delayed
 There is no spare finished product available to meet unexpected orders, because all
product is made to meet actual orders – however, JIT is a very responsive method of
production

VED Analysis

The VED analysis is done to determine the criticality of an item and its effect on
production and other services. It is specially used for classification of spare parts. If a
part is vital it is given ‘V’ classification, if it is essential, then it is given ‘E’
classification and if it is not so essential, the part is given ‘D’ classification. For ‘V’
items, a large stock of inventory is generally maintained, while for ‘D’ items, minimum
stock is enough. 

FSN Analysis
 In F-S-N analysis, items are classified according to their rate of consumption. The items are
classified broadly into three groups: F – means Fast moving, S – means Slow moving, N –
means Non-moving. The FSN analysis is conducted generally on the following basis:

The last date of receipt of the items or the last date of the issue of items, is taken into account.
 The time period is usually calculated in terms of months or number of days and it
pertains to the time elapsed seems the last movement was recorded.
 FSN analysis helps a company in identification of the following

a)      The items to be considered to be “active” may be reviewed regularly on more frequent
basis.

b)      Items whose stocks at hand are higher as compared to their rates of consumption.

c)      Non-moving items whose consumption is “nil” or almost in significant.

Various methods of inventory control

 ABC analysis

 VED analysis

 FSN analysis

 By deciding maximum and minimum limit

 Economic order quantity

 JIT method

 Reordering point.

 Ratio analysis

Ratio analysis is also one method under which such ratio which are concern with
inventory should be maintain properly. Inventory related ratio include stock turnover
ratio, sales ratio, etc. by maintaining this type of ration we can maintain inventory in
predefined inventory.

Management of Account Receivables

What is Account Receivables? Which are the elements of it?
All firms sale its goods and services out of them many firms sale on the basis of cash and also
allow grant credit and creates account receivable. Account receivables are direct result of
credit sale. A firm grants credit to protect its sales form the competitions and to attract the
potential customers. When firms grant credit to its customer becomes a debtor which will be
pay that amount of bill in future. The company should sanction credit after proper checking
the customer. No doubt liberal policy of credit can increase the sales but still company should
decide the criteria properly.

The significances of Account Receivables is given below-

 Determining credit policy-

Credit policy is concern with liberal or strict policy when allow credit. Liberal or strict policy
affect to the sales and bad debts. When financial manager allows credit policy, he should
compare between the benefits of credit and the cost of credit. Liberal or strict policy affect
to the requirement of working capital. the company should decide the credit policy after
considering the basic information about consumer. the company should give credit by
proper inspection of customer. It is possible through trade refrences, financial statement,
bank statement etc.

Determining credit terms-

The credit terms includes the decisions like period, cash amount, discounts. Credit terms
depend upon seasonal demands, estimation of debt, losses, and default risk and
determination of discount period.

The credit terms can be liberalized but it still depends upon profits which arise due to
increase in sales and cost. Credit terms should be decide properly. it is one type of
agreement between two parties.

Evaluating the credit applicants-

A firm cannot follow the same policy for all customers. The firm should give clear
guidelines and procedures for granting credit to individual customers. Each case should be
decided on its own merits-

1) Collection of credit information of the customers.

2) Investigation of the credit capacity of those customers.
3) Credit analysis.
4) Fixing credit limits.
5) Deciding collection procedures.
The credit information about individual customer may be collected from trade references,
financial statements, bank references, etc.

 Determining collection policy method-

Every firm has a good, well-designed collection policy which aims at collecting money on
proper time, so that bad debts are not created. To recover the amounts due from
customers on time, a firm may follow any of the following methods-

1) Direct and strict collection from customers on due date.

2) Bill discounting with commercial banks.

3) Taking the assistance of capital finance companies.

 Control and analysis of receivables-

To analyze the size of investment in the current assets from time to time, some ratios are
helpful like debtors turnover ratio, average collection period, ratio of credit sales etc. The
finance manager should analyze these ratios properly. By this he can know, who pays at
what time. If such parties are pay late or default than credit should be stop or decrease.

WHICH ARE THE MOTIVES OF HOLDING A CASH OR ?

In business inventory or cash maintain in order to meet the contingencies and to run
the business on regular basis. Cash or inventory are part of current assets which should be
maintain till the some level. By the way we can maintain the business properly.

Transaction Motive:

Requirement of cash to meet day to day needs is known as transaction motive. For
example: On day to day basis the company is required to make regular payments like
purchases, salaries/wages, taxes, interest, dividends etc. for which company will hold
the cash. Similarly, company receives cash from its sale operations. However,
sometimes receipts of the cash and the cash payments do not match with each other;
in such situations the company should have enough cash to honor the commitments
whenever they are due.

Precautionary Motive:
 Holding up of cash balance in order to take care of contingencies and unforeseen
circumstances is known as precautionary motive. In addition to requirement of cash
for regular transactions, the company may require the cash for such purposes which
cannot be estimated or foreseen. For example: Sudden decline in the collection from
the customers or sharp increase in the prices of raw materials may put the company in
such a situation where they need additional funds to deal with such situation without
affecting its regular business.

Speculative Motive:

Holding up of some reserve in the form of cash to take the benefit of some specific
nature of favorable market conditions is known speculative motive. For example: If the
company assumes that in near future prices of raw material is going to be low, then it
will reserve that cash for future purchase of raw material. In another case if interest
rates are expected to increase then the company will purchase securities from the
reserved cash.
Which are Benefits of holding cash or objectives of cash management:

The following are the main objectives of cash management.

(i) Useful in making payment as per schedule:

The main object of cash management is to pay its liabilities on the due date. The payment of purchase of
Raw material, wages, salary, interest, dividend, taxes and routine payments.

(ii) No Danger of Insolvency:

Sufficient cash holding will increase the goodwill of the organisation and pay its creditors and taxes on
due date thus, danger of insolvency will not be faced.
(iii) Good relation with Bank:

The reasonable cash balance will be helpful in paying customers on the due date. No need to go for Bank
credit in the form of cash credit, Bank overdraft and bill discounting.

(iv) Facility of Cash Discount:

The reasonable cash balance will benefit in large scale purchases and its payment in cash will be useful
in availing cash discount facility.

(v) Good relations with Suppliers:

 The reasonable cash balance is always desirable to pay suppliers on the due date.
This will increase the creditability of the firms which will give a rich dividend in the
future profitability of the organisation.
(vi) Helpful in odd situations:
When a firm has a reasonable cash balance, it can match out odd business situations.
For example, Deflation is such a situation where shortage of currency in circulation in
such situation commodities will be cheaper, a firm has sufficient cash balance will be
benefited by purchasing commodities and assets.

What is cash budget? Discuss the functions or importance of it.

The cash budget is an estimate of cash receipt and disbursements for a future period of time. A cash
budget is a forecast of future cash receipts and cash disbursements over various intervals of time.
Availability of cash may be a matter of life or death. Sufficiency of cash can keep even an
unsuccessful firm going in the face of prospective earnings.

Functions of Cash Budget in an Organization

Cash budget is used as means of coordinating the activities of the various operating departments of a
concern. It is a device for coordinating and controlling the financial side of the business to ensure
solvency. Its main functions are as follows :

(1) Forecasting the future needs of funds : It is possible to determine in advance, how much funds
will be needed and when ? The raising of funds through most profitable source at reasonable terms can
be planned.
(2) Controlling Cash Expenditure : It acts as a control device too. The expenses of various
departments can be cost controlled so as not to exceed the means of business.
(3) Maintenance of Cash Planning : It helps in maintenance of Cash Planning : It helps in
maintaining an adequate cash balance for expected requirements and provides a reasonable margin for
the unexpected.
(4) Helpful in Cash Planning : Cash budget helps in cash planning also. It shows the cash surplus as
well as deficiency of cash at selected points of time. If suggests the suitable sources of financing,
necessary to fill deficiency and investment of short-term surpluses.
(5) Testing the influence of proposed expansion programmes : Cash budget helps in advance to test
the influence of proposed programme on cash position. It serves as a device for coordinating the
financial aspect of the growth.
(6) Maintenance of Liquidity : It enables a firm to maintain sound liquidity. By planning ahead, the
credit position of the enterprise may be strengthened.
(7) Evaluation of Performance : It acts as a standard for evaluating the performance of operation.
(8) Maintenance of a sound dividend policy : It assists in maintaining a sound dividend policy
consistent with the liquidity position of the firm. Cash dividend is always preferred by share- holders.
They maintain prestige, ensure good relations with share-holders and facilitate any stock financing.
(9) Basis of Long-term planning : Cash budget is an important basis of long-term financial planning.
It is mainly useful for the study of long-term financing with respect to probable amounts, timing, forms
of security and methods of repayment. Thus, it is an important tool for financial planning and Control.
What is capital rationing ? discuss advantages and disadvantages of it.
capital rationing is a common practice in most of the companies as they have more profitable projects
available for investment as compared to the capital available. In theory, there is no place for capital
rationing as companies should invest in all the profitable projects. However, a majority of companies
follow capital rationing as a way to isolate and pick up the best projects under the existing capital
restrictions.
ADVANTAGES OF CAPITAL RATIONING
BUDGET
The first and important advantage is that capital rationing introduces a sense of strict budgeting .
Whenever there is question of investment .than company inject money in those projects which are
more profitable.by selecting proper project cost of capital can be paid on time. 
NO WASTAGE
Capital rationing prevents no wastage of resources by investing in moneyfor projects which is more
profitable.

FEWER PROJECTS
Capital rationing ensures that less number of projects are selected by imposing capital restrictions. This
helps in keeping the number of active projects to a minimum and thus manage them well.
HIGHER RETURNS
Through capital rationing, companies invest only in projects where the expected return is high, thus
eliminating projects with lower returns on capital.
MORE STABILITY
As the company is not investing in every project, the finances are not over-extended. This helps in
having adequate finances for tough times and ensures more stability and an increase in the stock price
of the company.
DISADVANTAGES OF CAPITAL RATIONING
Capital rationing comes with its own set of disadvantages as well. Let us describe the problems that
rationing can lead to:
EFFICIENT CAPITAL MARKETS
Under efficient capital markets theory, all the projects that add to company’s value and
increase shareholders’ wealth should be invested in. However, by following capital rationing and
investing in only certain projects, this theory is violated.
THE COST OF CAPITAL
In addition to limits on budget, capital rationing also places selective criteria on the cost of capital of
shortlisted projects. However, to follow this restriction, a firm has to be very accurate in calculating the
cost of capital. Any miscalculation could result in selecting a less profitable project.
SMALL PROJECTS
Capital rationing may lead to the selection of small projects rather than larger-scale investments.
INTERMEDIATE CASH FLOWS
Capital rationing does not add intermediate cash flows from a project while evaluating the projects. It
bases its decision only on the final returns from the project. Intermediate cash flows should be
considered in keeping the time value of money in mind.