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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 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.
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The term working capital refers to the Gross working capital and represents the amount of funds invested in current assets . Thus, the gross working capital is the capital invested in total current assets of the enterprises. Current assets are those assets which are converted into cash within short periods of normally one accounting year. Example of current assets is:
Cash in hand and Bank balance Bills Receivable Sundry Debtors Short term Loans and Advances Inventories of Stock as: Raw Materials Work in Process Stores and Spaces Finished Goods
The term working capital refers to the net working capital. Net working capital is the excess of current assets over current liabilities or say:
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Bills Payable Sundry Creditors or Account Payable Accrued or Outstanding Expenses Short term Loans, Advances and Deposits Dividends Payable Bank Overdraft Provision for Taxation, If does not amount to appropriation of profits
The gross working capital concept is financial or going concern concept whereas net working capital is an accounting concept of working capital.
And ends with the realization of cash from the sale of finished goods. It involves purchase of raw material and stores, its conversion into stocks of finished goods through work in progress with progressive increment of labor and service cost, conversion of finished stocks into sales, debtors and receivables and ultimately realization of cash and this cycle continuous again from cash to purchase of raw materials and so on. The speed/ time of duration required to complete one cycle determines the requirements of working capital longer the period of cycle, larger is the requirement of working capital.
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The gross operating cycle of a firm is equal to the length of the inventories and receivables conversion periods. Thus,
Net Operating Cycle Period = Gross Operating Cycle Period Payable Deferral period
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Further, following formula can be used to determine the conversion periods. Raw Material Conversion Period = Average Stock of Raw Material. Raw Material Consumption per day Work in process Conversion Period = Average Stock of Work-in-Progress Total Cost of Production per day Finished Goods Conversion Period = Average Stock of Finished Goods Total Cost of Goods sold per day Receivables Conversion Period = Average Accounts Receivables Net Credit Sales per day Payable Deferral Period = Average Payable Net Credit Purchase per day
The classification is important from the point of view of the financial manager. On the basis of time, working capital may be classified as:
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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.
Solvency of the Business Goodwill Easy Loans Cash discounts Regular supply of Raw Materials Regular payments of salaries, wages & other day to day commitments. Exploitation of favorable market conditions Ability of crisis Quick and regular return on investments [8]
requirement of enterprises are interlinked. While a manufacturing industry has a long cycle of operation of the working capital, the same would be short in an enterprises involve in providing services. The amount required also varies as per the nature, an enterprises involved in production would required more working capital then a service sector enterprise.
MANAFACTURE PRODUCTION POLICY: Each enterprises in the manufacturing sector has its own production policy, some follow the policy of uniform production even if the demand varies from time to time and other may follow the principles of demand based production in which production is based on the demand during the particular phase of time. Accordingly the working capital requirements vary for both of them.
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OPERATIONS: The requirement of working capital fluctuates for seasonal business. The working capital needs of such business may increase considerably during the busy season and decrease during the dull season.
MARKET CONDITION: If there is a high competition in the chosen project category then one shall need to offer sops like credit, immediate delivery of goods etc for which the working capital requirement will be high. Otherwise if there is no competition or less competition in the market then the working capital requirements will be low.
AVABILITY OF RAW MATERIAL: If raw material is readily available then one need not maintain a large stock of the same thereby reducing the working capital investment in the raw material stock . On other hand if raw material is not readily available then a large inventory stocks need to be maintained, there by calling for substantial investment in the same.
GROWTH AND EXAPNSION: Growth and Expansions in the volume of business result in enhancement of the working capital requirements. As business growth and expands it needs a larger amount of the working capital. Normally the needs for increased working capital funds processed growth in business activities.
PRICE LEVEL CHANGES : Generally raising price level require a higher investment in the working capital. With increasing prices, the same levels of current assets needs enhanced investments.
MANAFACTURING CYCLE: The manufacturing cycle starts with the purchase of raw material and is completed with the production of finished goods. If the manufacturing cycle involves a longer period the need for working capital would be more. At time business needs to estimate the requirement of working capital in advance for proper control and management. The factors discussed above influence the quantum of working capital in the business. The assessment of the working capital requirement is made keeping this factor in view. Each constituents of the working capital retains it form for a certain period and that holding period is determined by the factors discussed above. So for correct assessment of the working capital requirement the duration at various stages of the working capital cycle is estimated. Thereafter proper value is assigned to the respective current assets, depending on its level of completion. The basis for assigning value to each component is given below:
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COMPONENTS OF WORKING CAPITAL Stock of Raw Material Stock of Work -in- Process Stock of finished Goods Debtors Cah
BASIS OF VALUATION Purchase of Raw Material At cost of Market value which is lower Cost of Production Cost of Sales or Sales Value Working Expenses
Each constituent of the working capital is valued on the basis of valuation Enumerated above for the holding period estimated. The total of all such valuation becomes the total estimated working capital requirement. The assessment of the working capital should be accurate even in the case of small and micro enterprises where business operation is not very large. We know that working capital has a very close relationship with day-to-day operations of a business. Negligence in proper assessment of the working capital, therefore, can affect the day-to-day operations severely. It may lead to cash crisis and ultimately to liquidation. An inaccurate assessment of the working capital may cause either underassessment or over-assessment of the working capital and both of them are dangerous.
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profitability. A conservative management prefers to minimize risk by maintaining a higher level of current assets or working capital while a liberal management assumes greater risk by reducing working capital. However, the goal of management should be to establish a suitable trade off between profitability and risk.
3.PRINCIPLE OF EQUITY POSITION: The principle is concerned with planning the total
investments in current assets. According to this principle, the amount of working capital invested in each component should be adequately justified by a firms equity position. Every rupee invested in current assets should contribute to the net worth of the firm. The level of current assets may be measured with the help of two ratios:
1. Current assets as a percentage of total assets and 2. Current assets as a percentage of total sales
While deciding about the composition of current assets, the financial manager may consider the relevant industrial averages.
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Generally shorter the maturity schedule of current liabilities in relation to expected cash inflows, the greater the inability to meet its obligations in time.
Excess of working capital may result in un necessary accumulation of inventories. It may lead to offer too liberal credit terms to buyers and very poor recovery system & cash management. It may make management complacent leading to its inefficiency. Over investment in working capital makes capital less productive and may reduce return on investment. Working Capital is very essential for success of business & therefore needs efficient management and control. Each of the components of working capital needs proper management to optimize profit.
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INVENTORY MANAGEMNT: Inventory includes all type of stocks. For effective working
capital management, inventory needs to be managed effectively. The level of inventory should be such that the total cost of ordering and holding inventory is the least. Simultaneously stock out costs should be minimized. Business therefore should fix the minimum safety stock level reorder level of ordering quantity so that the inventory costs is reduced and outs management become efficient.
RECEIVABLE MANAGEMENT: Given a choice, every business would prefer selling its
produce on cash basis. However, due to factors like trade policies , prevailing market conditions etc. Business are compelled to sells their goods on credit. In certain circumstances a business may deliberately extend credit as a strategy of increasing sales. Extending credit means creating current assets in the form of debtors or account receivables. Investment in the type of current assets needs proper and effective management as, it gives rise to costs such as : Cost of carrying receivables Cost of bad debts losses
Thus the objective of any management policy pertaining to accounts receivables would be to ensure the benefits arising due to the receivables are more then the costs incurred for the receivables and the gap between benefit and costs increased resulting in increase profits. An effective control of receivables Help a great deal in properly managing it. Each business should therefore try to find out coverage credit extends to its clients using the below given formula:
Each business should project expected sales and expected investments in receivable based on various factor, which influence the working capital requirement. From this it would be possible to find out the average credit days using the above given formula. A business should continuously try to monitor the credit days and see that the average. Credit offer to clients is not crossing the budgeted period otherwise the requirement of investment in the working capital would increase and as a result, activities may get squeezed. This may lead to cash crisis.
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CASH BUDGET: Cash budget basically incorporates estimates of future inflow and outflows of
cash cover a projected short period of time which may usually be a year, a half or a quarter year . effective cash management is facilated if the cash budget is further broken down into months, weeks or even a daily basis. There are two components of cash budget are:
The main source for thses flows are given here under:
1. Cash Sales 2. Cash received from debtors 3. Cash received from Loans, deposits etc. 4. Cash receipts other revenue income 5. Cash received from sale of investment or assets.
CASH OUTFLOWS:
1. Cash Purchase
2. Cash payments to Creditors 3. Cash payment for other revenue expenditure 4. Cash payment for assets creation 5. Cash payments for withdrawals, taxes. 6. Repayments of Loan etc.
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Table No. 1
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Chart No.1
PROPORTION OF EACH CURRENT ASSET IN GROSS WORKING CAPITAL
Cash 69%
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Table No. 2
Year
Current Liabilities
(Rs. In Lakhs)
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Chart No.2
Net Working Capital
3000 2500
2000
1500
1000
500
INFERENCE
The working capital indicated the liquidity position of the firm. A negative liquidity may cause harm to the companys reputation.
The net working capital of the company is showing a positive trend over the period from 2007 to 2011. In the year 2010 2011, the company had a net working capital of 2490.57 (in lakhs). The average working capital of the firm from 2007 to 2011 is 1419.14 lakhs.
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Ratio analysis is widely used tool for financial analysis. It is defined as the systematic use of ratio to interpret the financial statements so that the strengths and weakness of a firm as well as its historical performance and current financial condition can be determined. The term ratio refers to the numerical or quantitative relationship between two items. LIQUIDITY RATIOS Liquidity ratio measures the ability of the firm to meet its obligations. WORKING CAPITAL RATIO (CURRENT RATIO) Current ratio is defined as the relationship between current assets and current liabilities. It is a measure of general liquidity & is most widely used to make the analysis of short term financial position of a firm. Current ratio is the ratio of current assets to current liabilities. A relatively higher ratio is an indication that the firm is liquid and has the ability to pay its current obligations on time. On the other hand a low current ratio indicates that the liquidity position of the firm is not good and shall not be able to pay its current liabilities in time. It is also called working capital ratio. The current ratio is a measure of the firms short-term solvency.
It indicates the availability of current assets in rupees for every one rupee of current liability. In a sound business current ratio of 2:1 considered as ideal one.
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Table No.3
Current ratios
Year Current Assets
(Rs. In Lakhs)
Current Liabilities
(Rs. In Lakhs)
Current Ratio
(Times)
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Chart No.3
Current Ratio
1.60 1.40 1.20 1.00 0.80 0.60 0.40 0.20 0.00 2007 2008 2009 2010 2011
Current Ratio
INFERENCE
The above table no.3 deals with current ratio. The standard current ratio for a firm is 2:1. Though this company records a fluctuating trend in its current ratio, the ratios are near to the ideal level. The company has not achieved the standard ratio of 2:1 in any of the years but the firm was able to maintain its current ratio above 1 for the past five years. The company has also shown a positive trend in maintaining the current ratio. The average current ratio is 1.24. The ratio is highest in the year 2010 - 2011 (1.35) and lowest in the year 2006 - 2007 (1.10).
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Table No.4
Quick Ratios
Current Stock Quick Current Quick Assets Asset Liabilities Ratio
(Rs. In Lakhs) (Rs. In Lakhs) (Rs. In Lakhs) (Rs. In Lakhs) (Times)
Year
Average
7151.99
564.44
6587.55
5732.85
1.13
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Chart No.4
Quick Ratio
1.4
1.2
0.4
0.2
INFERENCE
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Table No.5
Cash Ratios
Year
2007 2008 2009 2010 2011 Average
Cash
(Rs. In Lakhs)
Current Liabilities
(Rs. In Lakhs)
Cash Ratio
(Times)
Chart No.5
Cash Ratio
1 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 2007 2008 2009 2010 2011 Cash Ratio
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5.6
the company. The purpose of this ratio is to discuss the credit collection period and policy of the firm. It indicates the number of time debtors turnover each year. Higher the ratio lowers the average debtors to the lower credit sales.
Debtors turnover ratio = Sales/Debtors Average collection period = 360/Debtors turnover ratio
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Table No.6
Debtors turnover Ratios
Sales
(Rs. In Lakhs)
Year
2007 2008 2009 2010 2011 Average
Debtors
(Rs. In Lakhs)
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Chart No.6
Debtors Turnover Ratio
14
12
10
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Chart No.7
Avg collection period
60
50
40
30
20
10
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Table No.7
Fixed Asset Turnover Ratio Sales
(Rs. In Lakhs)
Year
2007 2008 2009 2010 2011 Average
Fixed Assets
(Rs. In Lakhs)
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Chart No.8
Fixed Asset Turnover Ratio
30 25 20 15 10 5 0 2007 2008 2009 2010 2011
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a)
It is also called stock turnover ratio. This ratio indicates the number of times inventory or stock replaced during the year. It measures the relationship between good sold and inventory level. It indicates whether investment in inventory is efficiently used or not. A right inventory turnover indicates of good inventory management.
Inventory turnover ratio = Cost of goods sold / Average inventory Cost of Goods Sold = Opening stock + Purchases + Direct expenses Closing stock
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Table No.8
Average Inventory
Year
2007 2008 2009 2010 2011 Average
Sales
(Rs. In Lakhs)
Opening Stock
(Rs. In Lakhs)
Closing Stock
729.74 504.07 904.41 416.99 266.97 564.44
Average Stock
668.515 616.905 704.24 660.7 341.98 598.47
Table No.9
Cost of goods sold
Year Direct Opening Closing Cost of Purchases Expenses Stock Stock goods sold
(Rs. In Lakhs) 2007 2008 2009 2010 2011 Average 4209.99 5294.23 6631.56 17324.70 12202.15 9132.53 (Rs. In Lakhs) 265.15 335.26 453.43 457.12 570.85 416.36
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Table No.10
Inventory Turnover ratio
Inventor Cost of y goods Average Turnover Inventory holding sold stock Ratio period
(Rs. In Lakhs) (Rs. In Lakhs) (Rs. In Lakhs) (In Days)
Year
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Chart No.9
Inventory Turnover Ratio
40 35 30 25 20 15 10 5 0 2007 2008 2009 2010 2011 Inventory Turnover Ratio
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Chart No.10
Inventory holding period
60
50
40
30
20
10
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Table No.11
Working Capital Turnover Ratio
Working capital
(Rs. In Lakhs)
Year
Sales
(Rs. In Lakhs)
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Chart No.11
Working Capital Turnover Ratio
12
10
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This ratio shows the earnings left for shareholders as a percentage of net sales i.e., profit per rupee of sales. It measures the overall efficiency, production, administration, selling, financing and pricing and tax management.
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Table No.12
Net Profit Ratio
Year Sales Net Profit Net Profit Ratio
(%)
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Chart No.12
Net Profit Ratio
7 6 5 4 3 2 1 0 2007 2008 2009 2010 2011 Net Profit Ratio
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