WORKING CAPITAL

1. Concept And Definition Of Working Capital

There are two concept of Working Capital : gross and net .
a) The term gross working capital , also referred to as working capital , means the total
current assets .
b) The net working capital can be defined in two ways :
1. The most common definition of net working capital ( WC ) is the difference
between current assets and current liabilities ! and
". #lternate definition of WC is that portion of current assets which is financed with
long term funds .
The task of financing manager in managing working capital efficiently is to ensure
sufficient li$uidity in the operations of the enterprise . et working capital , as a measure
of li$uidity is not %ery useful for comparing the performance of different firms , but it is
$uite useful for internal control . The WC helps in comparing the li$uidity of the same
firm o%er time . &or the purpose of working capital management , therefore , WC can
be said to measure the li$uidity of the firm . 'n the other words , the goal of working
capital management is to manage the current assets and liabilities in such a way that an
acceptable le%el of WC is maintained .
2. Coponent! Of Working Capital
The basic components of working capital are ,
Current #ssets :
a) 'n%entories
i) (aw )aterials and Components
ii) Work in *rogress
iii) &inished +oods
i%) ,thers
b) Trade -ebtors
c) .oans #nd #d%ances
d) 'n%estments
e) Cash #nd /ank /alance
Current .iabilities:
a) 0undry Creditors
b) Trade #d%ances
c) /orrowings
d) Commercial /anks
e) *ro%isions
". Need #or Working Capital
+i%en the ob1ecti%e of financial decision making to ma2imise the shareholders3 wealth , it
is necessary to generate sufficient profits . The e2tent to which profits can be earned will
naturally depend , among other things , upon the magnitude of sales . # successful sales
program is , in other words , necessary for earning profits by any business enterprise .
4owe%er , sales do not con%ert into cash instantly ! there is in%ariably a time lag between
sale of goods and the receipt of cash . There is therefore , a need for working capital in
the form of current assets to deal with the problem arising out of the lack of immediate
realisation of cash against goods sold . Therefore sufficient working capital is necessary
to sustain sales acti%ity . Technically this is referred to s operating cycle . The operating
cycle can be said to be at the heart of the need for the working capital . 'n other words
the operating cycle refers to the length of time necessary to complete the following cycle
of e%ents :
a) Con%ersion of cash into raw materials!
b) Con%ersion of raw materials to in%entory !
c) Con%ersion of in%entory into recei%ables !
d) Con%ersion of recei%ables into cash .
'f it were possible to complete the se$uences instantaneously , there would be no need
for current assets (working capital) . /ut since it is not possible , the firm is forced to
ha%e current assets . 0ince the cash inflows and outflows do not match , firms ha%e to
necessarily keep cash or in%est in short term li$uid securities so that they will be in
position to meet obligations when they become due . 0imilarly , firms must ha%e
ade$uate in%entory to guard against the possibility of not being able to meet demand for
their products . #de$uate in%entory , therefore, pro%ides a cushion against being out of
stock . 'f firms ha%e to be competiti%e , they must sell goods to their customer on credit
which necessitates the holding of accounts recei%ables . 't is in these ways that an
ade$uate le%el of working capital is absolutely necessary for smooth sales acti%ity
which , in turn , enhances the owner3s wealth .
$. C%aracteri!tic! Of C&rrent A!!et!
'n management of working capital two characteristics of current assets must be borne in
mind : a) short life span and b) swift transformation into other assets forms .
Current assets may ha%e a short life. Cash balance may be held idle for a week or two,
account recei%ables may ha%e a life span of 56 to 76 days , and in%entories may be held
for 56 days to 166 days . The life span of current assets depend on the time re$uired in
the acti%ities of procurement , production , sales and collection and the degree of
synchronisation among them .
8ach current asset is swiftly transformed into other assets forms : cash is used for
ac$uiring raw materials , raw materials are transformed into finished goods ( this
transform may in%ol%e se%eral stages of work in progress ) ! finished goods , generally
sold on credit , are con%erted into accounts recei%able , and finally account recei%ables
on reliasation , generate cash .
These two characteristics has certain implications ,
i) -ecisions relating to working capital management are repetiti%e and fre$uent
ii) The difference between profit and present %alue is insignificant
iii) The close interaction among working capital components implies that efficient
management of one component cannot be undertaken without simultaneous
consideration of other components .
'. #actor! Affecting Working Capital
The working capital needs of a firm are influenced by numerous factors . The important
ones are
i) Nat&re of (&!ine!! ) The working capital re$uirement of a firm is closely
related to the nature of business . # ser%ice firm , like electricity undertaking
or a transport corporation which has a short operating cycle and which sells
predominantly on cash basis , has a modest working capital re$uirement . ,n
the other hand , manufacturing concern like a machine tools unit , which has
a long operating cycle and which sells largely on credit has a %ery substantial
working capital re$uirement .
ii) *ea!onalit+ of Operation ) &irms which ha%e marked seasonality in there
operations usually ha%e highly fluctuating working capital re$uirement . &or
e2ample , consider a firm manufacturing air conditioners . The sale of air
conditioners reaches the peak during summer months and drops sharply
during winter season . The working capital need of such a firm is likely to
increase considerably in summer months and decrease significantly during
winter period . ,n the other hand , a firm manufacturing consumer goods like
soaps , oil , tooth pastes etc. which ha%e fairly e%en sale round the year ,
tends to ha%e a stable working capital need .
iii) Prod&ction Polic+ ) # firm marked by pronounced seasonal fluctuation in its
sale may pursue a production policy which may reduce the sharp %ariations in
working capital re$uirements . &or e2ample a manufacturer of air conditioners
may maintain steady production through out the year rather than intensify the
production acti%ity during the peak business season . 0uch decision may
dampen the fluctuations in working capital re$uirements .
i%) ,arket Condition! ) When competition is keen , larger in%entory of finished
goods is re$uired to promptly ser%e the customers who may not be inclined to
wait because other manufacturers are ready to meet their needs . &urther
generous credit terms may ha%e to be offered to attract customers in highly
competiti%e market . Thus , working capital needs tend to be high because of
greater in%estment in finished goods in%entory and accounts recei%able .
'f the market is strong and competition is weak , a firm can manage with
smaller in%entory of finished goods because customers can be ser%ed with
delay . &urther in such situation the firm can insist on cash payment and
a%oid lock up of funds in accounts recei%ables 9 it can e%en ask for ad%ance
payment , partial or total .
%) Condition! of *&ppl+ ) The in%entory of raw material , spares and stores
depends on the conditions of supply . 'f supply is prompt and ade$uate , the
firm can manage with small in%entories . 4owe%er if the supply is
unpredictable and scant then the firm , to ensure continuity of production ,
would ha%e to ac$uire stocks as and when they are a%ailable and carry large
in%entories on an a%erage . # similar policy may ha%e to be followed when the
raw material is a%ailable only seasonally and production operations are
carried out round the year .

-. Operating C+cle Anal+!i!
The ,perating cycle of the firm begins with the ac$uisition of raw materials and ends
with the collection of recei%ables . 't may be di%ided into four stages a) raw material and
stores storage stage , b) work:in:progress stage , c) finished goods in%entory stage and
d) debtors collection stage .
-uration of operating cycle : The duration of operating cycle is e$ual to the sum of the
duration of each of these stages less the credit period allowed by the suppliers to the
firms . 't can be gi%en as
, ; ( < W < & < - 9 C
Where , ; -uration of operating cycle
( ; (aw material and stores storage period
W ; Work:in:progress period
& ; &inished goods storage period
- ; debtors collection period
C ; Creditors payment period
The components of ,perating cycle may be calculated as follows !
( ; #%erage stock of raw materials and stores
#%erage raw material and stores consumption per day
W ; #%erage Work:in:progress in%entory
#%erage cost of production per day
& ; #%erage &inished +oods 'n%entory
#%erage cost of goods sold per day
- ; #%erage books debts
#%erage credit sales pert day
C ; #%erage trade creditors
#%erage credit purchase per day
.. Cop&tation of Working capital
The two components of working capital (WC) are current assets (C#) and current
liabilities (C.) . They ha%e a bearing on the cash operating cycle . 'n order to calculate
working capital needs, what is re$uired is the holding period of %arious types of
in%entories , the credit collection period and the credit payment period . Working capital
also depends on the budgeted le%el of acti%ity in terms of producti%ity = sales . The
calculation of WC is based on the assumption that the producti%ity is carried on e%enly
throughout the year and all costs accrue similarly . #s the working capital re$uirements
are related to the cost e2cluding depreciation and not to the sale price , WC is computed
with reference to cash cost . The cash cost approach is comprehensi%e and superior to
the operating cycle approach based on holding period of debtors and in%entories and
payment period of creditors .
8stimation of Current #ssets 9
(aw )aterial 'n%entory : The in%estment in raw materials in%entory is estimated on the
basis of ,
(aw material in%entory ; /udgeted Cost of raw #%erage in%entory
*roduction > material(s) > holding period
( in units ) per unit ( months=days )
1" months = 57? days
Work/in/Progre!! 0WIP1 In2entor+ ) The rele%ant costs to determine W'* in%entory
are the proportionate share of cost of raw materials and con%ersion costs ( labour and
manufacturing o%erhead costs e2cluding depreciation ). 'n case of full unit of raw
material is re$uired in the beginning the unit cost of W'* would be higher , i.e. , cost of
full unit < ?6@ of con%ersion cost , compared to the raw material re$uirement throughout
the production cycle ! W'* is normally e$ui%alent to ?6@ of total cost of production.
0ymbolically ,
/udgeted 8stimated #%erage time span
*roduction > W'* cost > of W'* in%entory
( in units ) per unit ( months = days )
1" months = 57? days
#ini!%ed Good! In2entor+ : Working capital re$uired to finance the finished goods
in%entory is gi%en by factor as below
/udgeted Cost of goods produced &inished goods
*roduction > per unit ( e2cluding > holding period
( in units ) depreciation ) ( months = days )
1" months = 57? days
De(tor! ) The WC tied up in debtors should be estimated in relation to total cost price
(e2cluding depreciation) , symbolically
/udgeted Cost of sales per #%erage debt
Credit sale > unit e2cluding > collection period
( in units ) depreciation ( months = days )
1" months = 57? days
Ca!% and 3ank 3alance! ) #part from WC needs for financing in%entories and debtors
, firms also find it useful to ha%e some minimum cash balances with them . 't is difficult to
lay down the e2act procedure of determining such an amount . This would primarily
based on the moti%es for holding cash balances of the business firm , attitude of
management toward risk , the access to the borrowing sources in times of need and past
e2perience , and so on .
4!tiation of C&rrent Lia(ilitie! 5
The working capital needs of business firms are lower to that e2tent such needs are met
through the current liabilities ( other than bank credits ) arising in the ordinary course of
business . The important current liabilities ( C. ) , in this conte2t are , trade creditors ,
wages and o%erheads :
Trade Creditor! )
/udgeted yearly (aw material Credit period
*roduction > re$uirement > allowed by creditors
( in units ) per unit ( months = days )
1" months = 57? days
ote : proportional ad1ustment should be made to cash purchase of raw materials.
Direct Wage! )
/udgeted yearly -irect .abour #%erage time:lag in
*roduction > cost per unit > payment of wages
( in units ) ( months = days )
1" months = 57? days
The a%erage credit period for the payment of wages appro2imates to a half:a:month in
the case of monthly wage payment: The first days3 wages are , again , paid on the 56
th
day of the month , e2tending credit for "A days and so in . #%erage credit period
appro2imates to half:a:month .
O2er%ead! 0 Ot%er T%an Depreciation and Aorti!ation 1
/udgeted yearly ,%erhead #%erage time lag in
*roduction > cost per unit > payment of o%erheads
( in units ) ( months = days )
1" months = 57? days
The amount of o%erheads may be separately calculated for different types of o%erheads .
'n case of selling o%erheads , the rele%ant item would be sales %olume instead of
production %olume .
6. Trade/Off 3et7een Profita(ilit+ and Ri!k
'n e%aluating firm3s net working capital position an important consideration is the trade:
off between profitability and risk . 'n other words , the le%el of WC has a bearing on
profitability as well as risk . The term profitability used in this conte2t is measured by
profit after e2penses . The term risk is defined as the profitability that a firm will become
technically insol%ent so that it will not be able to meet its obligations when they become
due for payment .
The risk of becoming technically insol%ent is measured using WC . 't is assumed that
the greater the amount of WC , the less risk prone the firm is . ,r , the greater the
WC , the more li$uid is the firm and , therefore , the less likely it is to become
technically insol%ent . Con%ersely , lower le%el of WC and li$uidity are associated with
increasing le%el of risk . The relationship between li$uidity , WC and risk is such that if
either WC or li$uidity increases , the firms risk decreases .
Nat&re of Trade/Off )
'f a firm wants to increase its profitability, it must also increase its risk. 'f it is to decrease
risk, it must decrease profitability. The trade:off between these %ariables is that
regardless of how the firm increases profitability through the manipulation of WC, the
conse$uence is a corresponding increase in risk as measured by the le%el of WC.
'n e%aluating the profitability:risk trade:off related to the le%el of WC, three basic
assumptions which are generally true , are
a) that we are dealing with a manufacturing firm ,
b) that current assets are less profitable than fi2ed assets and c) the short term funds
are less e2pensi%e than long term funds .
4ffect of t%e Le2el of C&rrent A!!et! on t%e Profita(ilit+/Ri!k Trade/Off )
The effect of the le%el of current assets on profitability:risk and trade:off can be shown
using the ratio of current assets to total assets . This ratio indicates the percentage of
total assets that are in the form of current assets . # change in the ratio will reflect a
change in the current assets . 't may either increase or decrease .
4ffect of Increa!e 8 9ig%er Ratio
#n increase in the ratio of current assets to total assets will lead to a decline in
profitability because current assets are assumed to be less profitable than fi2ed assets .
# second effect of the increase in the ratio will be that the risk to technical insol%ency
would also decrease because the increase in current assets , assuming no change in
current liabilities, will increase WC .
4ffect of Decrea!e 8 Lo7er Ratio
# decrease in the ratio of current assets to total assets will result in an increase in
profitability as well as risk . The increase in profitability will primarily be due to the
corresponding increase in fi2ed assets which are likely to generate higher returns. 0ince
the current assets decrease without a corresponding reduction in current liabilities, the
amount of WC will decrease, thereby increasing risk.
4ffect of C%ange in C&rrent Lia(ilitie! on Profita(ilit+/Ri!k Trade/off )
#s in the case of current assets, the effect of change in current liabilities can also be
demonstrated by using the ratio of current liabilities to total assets. This ratio will indicate
the percentage of total assets financed by current liabilities.
The effect of change in le%el of current liabilities would be that the current liabilities:total
assets ratio will either a) increase or b) decrease .
4ffect of an Increa!e in t%e Ratio
,ne effect of the increase in the ratio of current liabilities to total assets would be that
profitability will increase. The reason for the increased profitability lies in the fact that
current liabilities, which are a short term sources of finance will be reduced. #s short
term sources of finance are less e2pensi%e than long:run sources, increase in ratio will,
in effect, means substituting less e2pensi%e sources for more e2pensi%e sources of
financing. There will, therefore, be a decline in cost and a corresponding rise in
profitability.
The increased ratio will also increase the risk. #ny increase in the current liabilities,
assuming no change in current assets, would ad%ersely affect the WC. # decrease in
WC leads to an increase in risk. Thus, as the current liabilities:total assets ratio
increases, profitability increases, but so does risk.
4ffect of a Decrea!e in t%e Ratio
The conse$uences of a decrease in the ratio are e2actly opposite to the results of an
increase. That is, it will lead to a decrease in profitability as well as risk. The use of more
long term funds which, by definition, are more e2pensi%e will increase the cost! by
implication profits will also decline. 0imilarly, risk will decrease because of the lower le%el
of current liabilities on the assumption that current assets remains unchanged.
Co(ined 4ffect of C%ange! in C&rrent A!!et! and C&rrent Lia(ilitie! on
Profita(ilit+/Ri!k Trade/off)
The combined effects of changes in current assets and current liabilities can be
measured by considering them simultaneously. We ha%e seen the effect of decrease in
the current assets:total assets ratio and effect of an increase in the current liabilities:total
assets ratio. These changes, when considered independently, lead to an increased
profitability coupled with a corresponding increase in risk. The combined effect of these
changes should, logically, be to increase o%er all profitability as also risk and at the same
time decrease WC.
#INANCING WORKING CAPITAL
#fter determining the le%el of Working Capital, the firm has to decide how it is to be
financed. The need for finance arises mainly because the in%estment in
working capital=current assets, that is, raw material, work:in:progress, finished
goods and recei%ables typically fluctuates during the year. #lthough long:term
funds partly finance current assets and pro%ide the margin money for working
capital, such working capitals are %irtually e2clusi%ely supported by short term
sources. The main sources of working capital financing are namely, Trade
credits, /ank credits and commercial bankers.
1. Trade Credit
Trade credit refers to the credit e2tended by the supplier of goods and ser%ices in the
normal course of business of the firm. #ccording to trade practices, cash is not
paid immediately for purchases but after an agreed period of time. Thus, trade
credit represents a source of finance for credit purchases.
There is no formal=specific negotiation for trade credit. 't is an informal agreement
between the buyer and the seller. 0uch credit appears in the books of buyer as sundry
creditors=accounts payable. The most of the trade credit is on open account as accounts
payable, the supplier of goods does not e2tend credits indiscriminately. Their decision as
well as the $uantum is based on a consideration of factors such as earnings record o%er
a period of time, li$uidity position of the firm and past record of payment.
Ad2antage!
i) 't is easily, almost automatically a%ailable.
ii) 't is fle2ible and spontaneous source of finance.
iii) The a%ailability and the magnitude of trade credit is related to the siBe of
operation of the firm in terms of sales=purchases.
i%) 't is also an informal, spontaneous source of finance.
%) Trade credit is free from restrictions associated with formal=negotiated source of
finance=credit.
2. 3ank Credit
/ank credit is primarily institutional source of working capital finance in 'ndia. 'n fact, it
represents the most important source for financing of current assets. Working Capital
finance is pro%ided by banks in fi%e ways :
(a) Ca!% Credit 8 O2erdraft! ) Cnder cash credit= o%erdraft agreement of
bank finance, the bank specifies a predetermine borrowing=credit limit. The
burrower can burrow upto the stipulated credit. Within the specified limit,
any number of drawings are possible to the e2tent of his re$uirements
periodically. 0imilarly, repayment can be made whene%er desired during
the period. The interest is determined on the basis of the running
balance=amount actually utiliBed by the burrower and not on the
sanctioned limit. 4owe%er, a minimum charge may be payable on the
unutiliBed balance irrespecti%e of the le%el of borrowing for a%ailing of the
facility. This type of financing is highly attracti%e to the burrowers because,
firstly, it is fle2ible in that although borrowed funds are repayable on
demand, and, secondly, the burrower has the freedom to draw the amount
in ad%ance as an when re$uired while the interest liability is only on the
amount actually outstanding. 4owe%er, cash credit=o%erdraft is
incon%enient to the banks and hampers credit planning. 't was the most
popular method of bank financing of working capital in 'ndia till the early
nineties. With the emergence of the new banking since mid:nineties, cash
credit cannot at present e2ceed "6@ of the ma2imum permissible bank
finance ()*/&)=credit limit to any borrower.
(b) Loan! ) under this arrangement, the entire amount of borrowing is credited
to the current account of the borrower or released in cash. The borrower
has to pay interest on the total amount. The loans are repayable on
demand or in periodic installments. They can also be renewed from time to
time. #s a form of financing, loans imply a financial discipline on the part of
the borrowers. &rom a modest beginning in the early nineties, at least A6@
of )*/& must be in form of loans in 'ndia.
(c) 3ill! P&rc%a!ed8Di!co&nted ) This arrangement is of relati%ely recent
origin in 'ndia. With introduction of the ew /ill )arket 0cheme in 1DE6 by
(/', bank credit is being made a%ailable through discounting of usance bills
by banks. The (/' en%isaged the progressi%e use of bills as an instrument
of credit as against the pre%ailing practice of using the widely:pre%alent
cash credit arrangement for financing working capital. The cash credit
arrangement ga%e rise to unhealthy practices. #s the a%ailability of bank
credit was unrelated to production needs, borrower en1oyed facilities in
e2cess of their legitimate needs. )oreo%er, it led to double financing. This
was possible because credit was taken form different agencies for financing
the same acti%ity. This was done, for e2ample, by buying goods on credit
from suppliers and raising cash credit b hypothecating the same goods.
The bill financing is intended to link credit with sale and purchase of goods
and, thus eliminate the scope for misuse or di%ersion of credit to other
purposes./efore discounting he bill, the bank satisfies itself about the credit
worthiness of the drawer and the genuineness of the bill. To populariBe the
scheme, the discount rates are fi2ed at lower rates than those of cash
credit. The discounting banker asks the drawer of the bill to ha%e his bill
accepted by the drawee bank before discounting it. The later grants
acceptance against the cash credit limit, earlier fi2ed by it, on the basis of
the borrowing %alue of stocks. Therefore, the buyer who buys goods on
credit cannot use the same goods as a source of obtaining additional bank
credit.
The modus operandi of bill finance as a source of working capital financing
is that a bill that arises out of a trade sale:purchase transaction on credit.
The seller of goods draws the bill on the purchaser of goods, payable on
demand or after a usance period not e2ceeding D6 days. ,n acceptance of
the bill by the purchaser, the seller offers it to the bank for
discount=purchase. ,n discounting the bill, the bank releases the funds to
the seller. The bill is presented by the bank to the purchaser=acceptor of the
bill on due date for payment. The bills can be rediscounted with the other
banks=(/'. 4owe%er, this form of financing is not popular in the country.
d) Ter Loan! for Working Capital ) Cnder this arrangement, banks ad%ance
loans for 5:E years payable in yearly or half:yearly installments.
e) Letter of Credit : While the other forms of bank credit are direct forms of
financing in which banks pro%ide funds as well as bear risk, letter of credit is
an indirect form of working capital financing and banks assume only the
risk, the credit being pro%ided by the suppliers himself.
The purchaser of goods on credit obtains a letter of credit from a bank. The
bank undertakes the responsibility to make payment to the supplier in case
the buyer fails to meet his obligations. Thus , the modus operandi of letter
of credit is that the supplier sells goods on credit=e2tends credit to the
purchaser, the bank gi%es a guarantee and bears risk only in case of default
by the purchaser.
". ,ode of *ec&rit+
a) 9+pot%ecation : Cnder this mode of security, the banks pro%ide credit to
borrowers against the security of mo%able property, usually in%entory of goods.
The goods hypothecated, howe%er, continue to be in the possession of the owner
of these goods (i.e. the borrower ). The rights of the lending bank (hypothecate)
depend upon the terms of the contract between the borrower and the lender.
#lthough the bank does not ha%e physical possession of the goods, it has the
legal right to sell the goods to realiBe the outstanding loan. 4ypothecation facility
is normally is not a%ailable to new borrowers.
b) Pledge : *ledge, as a mode of security, is different from hypothecation in that in
the former, unlike in the later, the goods which are offered as security are
transferred to the physical possession of the lender. #n, essential per$uisite of
pledge, therefore, is that the goods are in the custody of the bank. The borrower
who offer the security is, called a Fpawnor3 (pledgor), while the bank is called the
Fpawnee3 (pledgee). The lodging of goods by the pledgor to the pledgee is a kind
of bailment. Therefore, pledge creates some liabilities for the bank. 't must take
reasonable care of goods pledged with it. 'n case of non:payment of the loans,
the bank en1oys the right to sell the goods.
c) Lien : The term lien refers to the right of a part to retain goods belonging to
another party until a debt due to him is paid. .ien can be of two types: (i)
particular lien, and (ii) general lien. *articular lien is a right to retain goods until a
claim pertaining to theses goods is fully paid. ,n the other hand, general lien can
be applied till all dues of the claimant are paid. /anks usually en1oy general lien.
d) ,ortgage : 't is the transfer of a legal=e$uitable interest in specific immo%able
property for securing the payment of debt. The person who parts with the interest
in the property is called mortgagor and the bank in whose fa%our the transfer
takes place is the mortagagee. The instrument of transfer is called the mortgage
deed. )ortgage is, thus, con%eyance of interest in the mortgaged property. The
mortgage interest in the property is terminated as soon as the debt is paid.
)ortgage are taken as an additional security for working capital credit b banks.
e) C%arge : Where immo%able property of one person is, by the act of parties or by
the operation of law, made security for the payment of money to another and the
transaction does not amount to mortgage, the latter person is said to ha%e a
charge on the property and all the pro%isions of simple mortgage will apply to
such a charge. The pro%ision are as follows:
# charge is not the transfer of interest in the property though it is
security for payment. /ut mortgage is a transfer of interest in the
property.
# charge may be created by the act of parties or by the operation of
law. /ut a mortgage can be created only by the act of parties.
# charge need not be made in writing but a mortgage deed must be
attested.
+enerally, a charge cannot be enforced against the transferee for
consideration without notice. 'n a mortgage, the transferee of the
mortgage property can ac$uire the remaining interest in the property, if
any is left.
$. Re!er2e 3ank of India #rae7ork for Reg&lation of 3ank Credit
#fter mid:nineties, the framework for regulation of bank credits has been rela2ed
permitting banks greater fle2ibility in tune with the emergence of new banking in
the country, focusing on %iability and profitability in contrast to the earlier thrust
on social=de%elopment banking. The notable features of the framework=regulation
related to fi2ation of norms for bank lending to industry. The norms are:
a) In2entor+ and Recei2a(le Nor! : The norms refer to the ma2imum le%el for
holding in%entories and recei%ables in each industry. (aw materials were
e2pressed as so many months consumptions! W'* as so many month3s cost of
production! finished goods and recei%ables as so many months of cost of sales
and sales respecti%ely. These norms represent the ma2imum le%els of holding
in%entory and recei%ables in each industry. /orrowers were not e2pected to hold
more than that le%el. The fi2ation of these norms was, thus, intended to reduce
the dependency of industry on bank credit.
b) Lending Nor!8Approac% to Lending8,P3# : #ccording to the lending norms,
a part of the current assets should be financed by the trade credit and other
current liabilities. The remaining part of the current assets, termed as working
capital gap, should be partly financed by the owners funds and long term
borrowings and partly by short term bank credit. The approach to lending is %itally
significant. 't takes into account all the current assets re$uirements of borrowers
total operational needs and not merely in%entories or recei%ables! it also takes
into account all the other sources of finance at his command. #nother merit of the
approach is that it in%ariably ensures a positi%e current ratio and, thus, keeps
under check any tendency to o%ertrade with borrowed funds.
c) #or! of #inancing8*t+le of Credit : 'n 1DD?, a mandatory limit on cash credit
and a loan system of deli%ery of bank credit was introduced. The cash:credit limit
was initially limited to 76@ of the )*/&. The balance G6@ could be a%ailed of as
short term loans. The cash credit limit sanctions are currently "6@ and loan
component A6@.
d) Inforation and Reporting *+!te : The main components of the information
and reporting system are four, namely,
:&arterl+ Inforation *+!te ) #or I. 'ts contents are (i) production
and sales estimates for the current and the ne2t $uarter, and (ii) current
assets and current liabilities estimates for the ne2t $uarter.
:&arterl+ Inforation *+!te ) #or II. 't contains (i) actual production
and sales during the current year and for the latest completed year, and
(ii) actual current assets and current liabilities for the latest completed
$uarter.
9alf/+earl+ Operating *tateent ) #or III. The actual operating
performance for the half:year ended against the estimates are gi%en in
this.
9alf/+earl+ Operating *tateent ) #or III3. The estimates as well as
the actual sources and uses of funds for the half:year ended are gi%en.
'. Coercial Paper!
Commercial *aper (C*) is a short term unsecured negotiable instrument, consisting of
usance promissory notes with a fi2ed maturity. 't is issued on a discount on a face %alue
basis but it can also be issued in interest bearing form. # C* when issued by a company
directly to the in%estor is called a direct paper. The companies announce current rates of
C*s of %arious maturities, and in%estors can select those maturities which closely
appro2imate their holding period. When C*s are issued by security dealer on behalf of
their corporate customers, they are called dealer paper. They buy at a price less than the
commission and sell at the highest possible le%el. The maturities of C*s can be tailored
within the range to specific in%estments.
a) Ad2antage!
- C* is a simple instrument and hardly in%ol%es any documentation.
- 't is fle2ible in terms of maturities which can be tailored to match the cash
flow of the issuer.
- # well rated company can di%ersify its sort:term sources of finance from
banks to money market at cheaper cost.
- The in%estors can get higher returns than what they can get from the
banking system.
- Companies which are able to raise funds through C*s ha%e better
financial standing.
- The C*s are unsecured and there are no limitations on the end:use of
funds raised through them.
- #s negotiable=transferable instruments, they are highly li$uid.
b) #rae7ork of Indian CP ,arket
The C*s emerged as sources of short:term financing in the early nineties. They are
regulated by (/'. The main element of present framework are gi%en below.
C*3s can be issued for periods ranging between 1? days and one year. (enewal
of C*3s is treated as fresh issue.
The minimum siBe of an issue is (s."? lakh and the minimum unit of subscription
is (s.? lakh.
The ma2imum amount that a company can raise by way of C*s is 166@ of the
working capital limit.
# company can issue C*s only if it has a minimum tangible net worth of (s.G
crore, a fund:based working limit of (s.G crore or more, at least a credit rating of
*" (Crisil ), #" ( 'cra ), *(:" ( Care ) and -:" ( -uff H *helps ) and its borrowal
account is classified as standard asset.
The C*s should be issued in the form of usance promissory notes, negotiable by
endorsement and deli%er at a discount rate freely determined by the issuer. The
rate of discount also includes the cost of stamp duty ( 6."? to 6.?@ ), rating
charges (6.1 to 6."@), dealing bank fee ( 6."?@ ) and stand by facility ( 6."?@ ).
The participants=in%estors in C*s can be corporate bodies, banks, mutual funds,
CT', .'C, +'C, ('3s on non:repatriation basis. The -iscount and &inance 4ouse
of 'ndia ( -&4' ) also participates by $uoting its bid and offer prices.
The holder of C*s would present them for payment to the issuer on maturity.
c) 4ffecti2e Co!t8Intere!t ;ield
#s the C*s are issued at discount and redeemed at it face %alue, their effecti%e pre:ta2
cost=interest yield
; I (&ace Jalue 9 et amount realised) = (et amount realised) K2I(576) = ()aturity
period) K
where net amount realised ; &ace %alue 9 discount 9 issuing and paying agent ('*#)
charges that is, stamp duty, rating charges, dealing bank fee and fee for stand by facility.
-. #actoring
&actoring pro%ides resources to finance recei%ables as well as facilitates the collection of
recei%ables. #lthough such ser%ices constitute a critical segment of the financial ser%ices
scenario in the de%eloped countries, they appeared in the 'ndian financial scene only in
the early nineties as a result of (/' initiati%es. There are two bank sponsored
organisations which pro%ide such ser%ices: (i) 0/' &actors and Commercial 0er%ices
.td., and (ii) Canbank &actors .td. The first pri%ate sector factoring company, &oremost
&actors .td. 0tarted operations since the beginning of 1DDE.
a) Definition : &actoring can broadly be defined as an agreement in which
recei%ables arising out of sales or goods=ser%ices are sold by a firm ( client ) to
the Ffactor3 ( a financial intermediary ) as a result of which the title of the
goods=ser%ices represented by the said recei%ables passes on to the factor.
4enceforth, the factor becomes responsible for all credit control, sales
accounting and debt collection from the buyer. 'n a full ser%ice factoring concept (
without resource facility ), if any of the debtor fails to pay the dues as a result of
his financial inability=insol%ency=bankruptcy, the factor has to absorb the losses.
b) ,ec%ani! : Credit sales generate the factoring business in the ordinary course
of business dealings. (ealisation of credit sales is the main function of factoring
ser%ices. ,nce a sale transaction is completed, the factor steps in to realise the
sales. Thus the factor works between the seller and the buyer and sometimes
with the seller3s bank together.
c) #&nction! of a #actor : -epending on the type=form of factoring, the main
functions of a factor, in general terms, can be classified into fi%e categories:
i) #inancing facilit+8trade de(t! )
The uni$ue feature of factoring is that a factor purchases the book debts
of his client at a price and the debts are assigned in fa%our of the factor
who is usually willing to grant ad%ances to e2tent of, say, A6@ of the
assigned debts. Where the debts are factored with recourse, the finance
pro%ided would become refundable by the client in case of non:payment
of the buyer. 4owe%er, where the debts are factored without recourse, the
factor3s obligation to the seller becomes absolute on the due date of the
in%oice whether or not the buyer makes the payment.
ii1 ,aintenance8adini!tration of !ale! ledger )
The factor maintains the clients3 sales ledger. 'n addition, the factor also
maintains a customer:wise record of payments spread o%er a period of
time so that any change in the payment pattern can be easily identified.
iii1 Collection facilit+ of acco&nt! recei2a(le )
The factor undertakes to collect the recei%ables on the behalf of the client
relie%ing him of the problems in%ol%ed in collection, and enables him to
concentrate on other important functional areas of the business. This also
enables the client to reduce the cost of collection by way of sa%ings in
manpower, time and efforts.
i21 Credit Control and Credit Re!triction )
The factor in consultation with the client fi2es credit limits for appro%ed
customers. Within these limits, the factor undertakes to purchase all trade
debts of the customer without resource. 'n other words, the factor
assumes the risk of default in payment by the customer. ,perationally, the
line of credit=credit limit up to which the client can sell to the customer
depends on his financial position, his past payment record and %alue of
goods sold by the client to the customer.
21 Ad2i!or+ *er2ice! )
These ser%ices are a spin:off of the close relationship between a factor
and a client. /y %irtue of their specialised knowledge and e2perience in
finance and credit dealings and access to e2tensi%e credit information,
factors can pro%ide a %ariety of incidental ad%isory ser%ices to their
clients.
2i1 Co!t of *er2ice! )
The factors pro%ide %arious ser%ices at a charge. The charge for
collection and sales ledger administration is in the form of a commission
e2pressed as a %alue of debt purchased. 't is collected in ad%ance. The
commission for short term financing as ad%ance part:payment is in the
form of interest charge for the period between the date of ad%ance
payment and the date of collection date. 't is also known as discount
charge.
,ANAGING WORKING CAPITAL
1. Ca!% ,anageent
A1 O(<ecti2e!)

The basic ob1ecti%e of cash management are two fold: a) to meet the cash disbursement
needs and b) to minimise funds committed to cash balances. These are conflicting and
mutually contradictory and the task of the cash management is to reconcile them.
,eeting Pa+ent *c%ed&le
'n normal course of business, firms ha%e to make payments of cash on a continuous and
regular basis to suppliers of goods, employees and so on. #t the same time, there is a
constant inflow of cash through collections from debtors. # basic ob1ecti%e of cash
management is to meet the payment schedule, that is, to ha%e sufficient cash to meet
the cash disbursement needs of a firm.
The ad%antages of ade$uate cash are : (i) it pre%ents or bankruptcy , (ii) the relationship
with banks is not strained, (iii) it helps in fostering good relations with trade creditors and
suppliers of raw materials, as prompt payment may help their own cash management,
(i%) a cash discount can be a%ailed of if payment is made within the due date, (%) it leads
to a strong credit rating , (%i) to take ad%antage of fa%orable business opportunities that
may be a%ailable periodically, and finally (%ii) the firm can meet unanticipated cash
e2penditure with a minimum of strain during emergencies, such as strikes, fires, or a
new marketing campaign by competitors. Leeping large cash balances, howe%er, implies
a high cost.
,inii!ing #&nd! Coitted to Ca!% 3alance!
The second ob1ecti%e of Cash )anagement is to minimise cash balances. 'n minimiBing
the cash balances, two conflicting aspects ha%e to be reconciled. # high le%el of cash
balances will, as mentioned abo%e, ensure prompt payment together with all the
ad%antages. /ut it also implies that large funds will remain idle, as cash is a non earning
asset and the firm will ha%e to forgo profits. # low le%el cash balances, on the other
hand, may mean failure to meet the payment schedule. The aim of cash management,
therefore, should be to ha%e optimal amount of cash balances.
#actor! Deterining Ca!% Need!
i) *+nc%oni!ation of ca!% flo7! ) The proper synchroniBation between the
outflows and inflows should be followed . This is possible by adopting cash
budget techni$ue. The properly prepared budget will pinpoint the
months=periods when the firm will ha%e an e2cess or a shortage of cash.
ii) *%ort Co!t! ) The cash budgets re%eals the periods of shortage of cash, but,
in addition, there may be some une2pected shortfalls. The e2penses incurred
as a result of shortfalls is called as 0hort Costs.
iii) 4=ce!! Ca!% 3alance Co!t!) The cost of ha%ing e2cessi%ely large cash
balances is known as the e2cess cash balance cost. 'f large funds are idle,
the implication is that the firm has missed opportunities to in%est those funds
and has thereby lost interest which it would otherwise ha%e earned. This loss
of interest is primarily the e2cess cost.
i%) Proc&reent and ,anageent : These are the costs associated with
establishing and operating cash management staff and acti%ities. They are
generally fi2ed and are mainly accounted for by salary, storage, handling of
securities and so on.
%) >ncertaint+ and Ca!% anageent ) &inally, the impact on cash
management strategy is also rele%ant as cash flows cannot be predicted with
complete accuracy.
31 Ca!% 3&dget ) ,anageent Tool
Cash /udget is the most important tool in cash management. 't is the statement showing
the estimated cash inflows and cash outflows o%er the planning horiBon.
The %arious purposes of cash budgets are : (i) to co:ordinate the timings of cash needs,
(ii) it pinpoints the period when there is likely to be e2cess cash, (iii) it assists
management in taking cash discounts on its account payables, (i%) it helps to arrange
needed funds on the most fa%orable terms and pre%ents accumulation of e2cess funds.
Preparation of Ca!% 3&dget
The principle aim of the cash budget, as a tool is to predict cash flows o%er a gi%en
period of time, and to ascertain whether at any point of time there is likely to be e2cess
or shortage of cash.
The first element of cash budget is the selection of the period of time to be co%ered by
the budget. 't s referred to as the planning horiBon o%er which the cash flows are to be
pro1ected. There is no fi2ed rule , it %aries from firm to firm. The period selected should
be neither too long nor too short. 'f it is too long, it is likely that the estimates will be
inaccurate. 'f, on the other hand, the time span is too small many important e%ents which
lie 1ust beyond the period cannot be accounted for and the work associated with the
preparation of the budget becomes e2cessi%e. 'f the flows are e2pected to be stable and
dependable, such a firm may prepare a cash budget co%ering a long period, say, a year
and di%ide it into $uarterly inter%als. 'n the case of firms whose flows are uncertain, a
$uarterly budget, di%ided into monthly inter%als, may be appropriate. 'f the flows are
sub1ected to e2treme fluctuations, e%en a daily budget may be called for. The idea
behind subdi%iding the budget period into smaller inter%als is to highlight the mo%ement
of cash from one subperiod to another.
The second element of the cash budget is the selection of the factors that ha%e a
bearing on cash flow. 'tems included in cash budget are only cash items! non:cash items
like depreciation and amortisation are e2cluded. The cash budgets are broadly di%ided
into two broad categories: (a)operating and (b) financial. The former includes cash
generated by the operations of the firms and are known as operating cash flows, the
later consists of financial cash flows.
Operating Ca!% #lo7
Operating Ca!% #lo7 Ite!
'nflows = Cash (eceipts ,utflows = -isbursements
1. Cash 0ales 1. #ccounts payable = *ayable payments
". Collection of #ccounts (ecei%ables ". *urchase of raw materials
5. -isposals of &i2ed #ssets 5. Wages and 0alaries
G. &actory 82penses
?. #dministrati%e and selling e2penses
7. )aintenance 82penses
E. *urchase of &i2ed #ssets
#mong the operating factors affecting cash flows, are the collection of accounts ( inflows
) and accounts payable ( outflows ). The terms of credit and the speed with which the
customer pay would determine the lag between the creation of accounts recei%able and
their collection. #lso, discounts and allowances for early payments, returns from
customers and bad debts affect cash inflows. 0imilarly in case of accounts payable
relating to credit purchase, cash outflows are affected by the purchase terms.
#inancial Ca!% #lo7!
#inancial Ca!% #lo7 Ite!
Cash 'nflows = (eceipts Cash ,utflows = *ayments
1. .oans = /orrowings 1. 'ncome:ta2 = Ta2 payment
". 0ales of 0ecurities ". (edemption of loan
5. 'nterest recei%ed 5. (epurchase of shares
G. -i%idend recei%ed G. 'nterest paid
?. (ent recei%ed
7. (efund of ta2
?. -i%idend paid
E. 'ssue of new shares and securities
Preparation of Ca!% 3&dget
#fter the time span of the cash budget decided and the pertinent operating and financial
factors ha%e been identified, the final step is the construction of the cash budget. Thus
the total cash inflows, cash outflows and the net receipt or payment is worked out.
C1 Ca!% ,anageent ) 3a!ic *trategie!
The cash budget, as a management tool, would throw light on the net cash position of
the firm. #fter knowing the cash position, the management should workout the basic
strategies to be employed to manage its cash.
The broad cash management strategies are essentially related to the cash turno%er
process, that is, the cash cycle together with the cash turno%er. The cash cycle refers to
the process by which the cash is used to purchase materials from which are produced
goods, which are then sold to customers, who later pay the bills. The firm recei%es cash
from customers and the cycle repeats itself. The cash turno%er means the number of
times the cash is used during each year. The cash cycle in%ol%es se%eral steps along the
way as fund flows from the firms accounts.
,ini& Operating Ca!%
The higher the cash turno%er, the less is the cash a firm re$uires. # firm should,
therefore, try to ma2imiBe the cash turno%er. /ut it must maintain a minimum amount of
operating cash balance so that it does not run out of cash. The basic strategies that can
be employed to do the needful are as follows:
i) *tretc%ing acco&nt! pa+a(le ) 'n other words, a firm should pay its
accounts payable as late as possible without damaging its credit standing. 't
should, howe%er take ad%antage of the cash discount a%ailable on prompt
payment.
ii) 4fficient In2entor+/Prod&ction ,anageent ) 'ncrease in%entory turno%er,
a%oiding stock:outs, that is, shortage of stocks. This can be done in following
ways:
a) 'ncreasing the raw materials turno%er by using more efficient in%entory
control techni$ues.
b) -ecreasing the production cycle through better production planning,
scheduling and control techni$ues, it will lead to an increase in W'*
in%entory turno%er.
c) 'ncreasing the finished goods turno%er through better forecasting of
demand and a better planning of production.
iii) *peeding Collection of Acco&nt! Recei2a(le ) #nother strategy for
efficient cash management is to collect account recei%able as $uickly as
possible without losing future sales because of high:pressure collection
techni$ues. The a%erage collection period of the recei%ables can be reduced
by changes in (a) credit terms, (b) credit standards, and (c) collection policies.
i%) Co(ined Ca!% ,anageent *trategie! ) We ha%e seen strategies related
to (i) accounts recei%ables, (ii) in%entory, and (iii) accounts recei%ables but
there are certain problems for management . &irst, if the accounts payable
are postponed too long, the credit standing of the firm may be ad%ersely
affected. 0econdly, a low le%el of in%entory may lead to a stoppage of
production as sufficient raw materials may not be a%ailable for uninterrupted
production, or the firm may be short of enough stock to meet the demand for
its product, that is, Fstock:out3. &inally, restricti%e credit standards, credit terms
and collection policies may 1eopardiBe sales. These implications should be
constantly kept in %iew while working out cash management strategies.
2. Recei2a(le! ,anageent
A1 O(<ecti2e!
The term recei%ables is defined as debt owed to the firm by the customers arising from
sale of goods or ser%ices in the ordinary course of business. When a firm makes an
ordinary sale of goods or ser%ices and does not recei%e payment, the firm grants trade
credit and creates accounts recei%ables which could be collected in the future.
(ecei%ables management is also called trade credit management. Thus accounts
recei%able represent an e2tension of credit to customers, allowing them a reasonable
period of time in which to pay for the goods recei%ed.
The sale of goods on credit is an essential part of the modern competiti%e economic
systems. 'n fact, the credit sale and, therefore, the recei%ables, are treated as a
marketing tool to aid the sale of goods. #s a marketing tool, they are intended to
promote sales and obligations through a financial instrument. )anagement should weigh
the benefits as well as cost to determine the goal of recei%ables management. The
ob1ecti%e of recei%able management is to promote sales and profits until that point is
reached where the return on in%estment in further funding recei%ables is less than the
cost of funds raised to finance that additional credit. The specific costs and benefits
which are rele%ant to the determination of the ob1ecti%es of recei%ables management are
e2amined below.
a) Co!t! ) The ma1or categories of costs associated with the e2tension of credit and
accounts recei%able are
(i) Collection Co!t ) Collection costs are administrati%e costs
incurred in collecting the recei%ables from the customers to
whom credit sales ha%e been made.
(ii) Capital Co!t ) The increased le%el of accounts recei%able is
an in%estment in assets. They ha%e to be financed thereby
in%ol%ing a cost. 't includes the additional funds re$uired to
meet its own obligation while waiting for payment from its
customer and also the cost on the use of additional capital to
support credit sales, which alternati%ely could be profitably
employed elsewhere.
(iii) Delin?&enc+ Co!t ) This cost arises out of the failure of the
customers to meet their obligations where payment on credit
sales become due after the e2piry of the credit period. 0uch
costs are called delin$uency costs.
(i%) Defa&lt Co!t! ) &inally, the firm may not be able to reco%er
the o%erdues because of the inability of the customers. 0uch
debts are treated as bad debts and ha%e to be written off as
they cannot be realiBed. 0uch costs are treated as default
costs associated with credit sales and accounts recei%ables.
b) 3enefit! ) #part from the costs, another factor that has a bearing on accounts
recei%able management is the benefit emanating from credit sales. The benefits
are the increased sales and anticipated profits because of the more liberal policy.
The impact of the liberal trade credit policy is likely to take two forms. &irstly, it is
oriented to sales e2pansion. 0econdly, the firm may e2tend credit to protect its
current sales against emerging competition. 4ere, the moti%e is sales:retention.
&rom the abo%e discussion, it is clear that in%estments in recei%ables in%ol%e
both benefits and costs. The e2tension of trade credit has a ma1or impact on
sales, cost and profitability. Therefore account recei%able management should
aim at a trade off between profit (benefits) and risk (cost).
While it is true that general economic conditions and industry practices ha%e a
strong impact on the le%el of recei%ables, a firms in%estment in this type of
current assets is also greatly affected by its internal policy. # firm has little or no
control o%er en%ironmental factors, such as economic conditions and industry
practices. /ut it can impro%es its profitability through a properly concei%ed trade
credit policy or recei%ables management.
/) Credit Policie!
'n the preceding discussion it has been clearly shown that the firms ob1ecti%e with
respect to recei%ables management is not merely to collect recei%ables $uickly but
attention should also be gi%en to the benefit:cost trade:off in%ol%ed in the %arious areas
of accounts recei%able management. The first decision area is Credit *olicies.
The credit policy of the firm pro%ides the framework to determine (a) whether or not to
e2tend credit to a customer and (b) how much credit to e2tend. The credit policy decision
of firm has two broad dimensions:
(i) Credit *tandard! ) The term credit standards represents the basic criteria for
the e2tension of credit to customers. The $uantitati%e basis of establishing
credit standards are factors such as credit ratings, credit references, a%erage
payment period and certain financial ratios. 0ince we are interested in
illustrating the trade:off between benefit and cost to the firm as a whole, we
do not consider here these indi%idual components of credit standards. To
illustrate the effect, we ha%e di%ided the o%erall standards into (a) tight or
restricti%e, and (b) liberal or non:restricti%e. The trade:off with reference to
credit standards co%ers
(a) Collection Co!t! ) The implications of the rela2ed credit standards are (i)
more credit, (b) a large credit department to ser%ice accounts recei%able
and related matters, (iii) increase in collection costs. The effect of
tightening of credit standards will be e2actly the opposite. These costs are
likely to be semi:%ariable.
(b) In2e!tent! in Recei2a(le! or t%e A2erage Collection Period ) The
in%estment in accounts recei%able in%ol%es a capital cost as funds ha%e to
be arranged by the firm to finance them till customer makes payment.
)oreo%er higher the a%erage accounts recei%ables, the higher is the
capital or carrying cost. # change in credit standards:rela2ation or
tightening:leads to a change in the le%el of accounts recei%able either (i)
through a change in sales, or (ii) through a change in collections.
# rela2ation in credit standards, as already stated, implies an increase in
sales which, in turn, would lead to higher a%erage accounts recei%able.
&urther rela2ed standards would mean that credit is e2tended liberally so
that it is a%ailable to e%en less credit:worthy customers who will take a
longer period to pay o%erdues. 'n contrast, a tightening of credit standards
would signify (i) a decrease in sales and lower a%erage accounts
recei%ables, and (ii) an e2tension of credit limited to more credit:worthy
customers who can promptly pay their bills and, thus, a lower a%erage
le%el of accounts recei%able.
(c) 3ad De(t 4=pen!e! ) #nother factor which is e2pected to be affected by
changes in credit standards is bad debt e2penses. They can be e2pected
to increase with rela2ation in credit standards and decrease if credit
standards become more restricti%e.
(d) *ale! @ol&e ) Changing credit standards can also be e2pected to
change the %olume of sales. #s standards are rela2ed, sales are
e2pected to increase! con%ersely, a tightening is e2pected to cause a
decline in sales.
C1 Credit Anal+!i!
/esides establishing credit standards, a firm should de%elop procedures for e%aluating
credit applicants. The second aspect of credit policies of a firm is credit analysis and
in%estigation. Two basic steps are in%ol%ed in the credit in%estigation process :
(a) O(taining Credit inforation ) The first step in credit analysis is obtaining
credit information on which to base the e%aluation of a customer. The sources of
information, broadly speaking, are
(i) Internal ) Csually, firms re$uire their customers to fill %arious forms and
documents gi%ing details about financial operations. They are also
re$uired to furnish trade references with whom the firms can ha%e
contacts to 1udge the suitability of the customer for credit. This type of
information is obtained from internal sources of credit information.
#nother internal source of credit information is deri%ed from the records of
the firms contemplating an e2tension of credit.
(ii) 4=ternal ) The a%ailability of information from e2ternal sources to assess
the credit:worthiness of customers depends upon the de%elopment of
institutional facilities and industry practices. 'n 'ndia, the e2ternal sources
of credit information are not as de%eloped as in the industrially ad%anced
countries of the world. -epending upon the a%ailability, the following
e2ternal sources may be employed o collect information.
- #inancial *tateent! ) ,ne e2ternal source of credit information is
the published financial statements, that is, the balance sheet and the
profit and loss account. They contain %ery useful information such as
applicants financial %iability, li$uidity, profitability, and debt capacity.
They are %ery helpful in assessing the o%erall financial position of a
firm, which significantly determines its credit standing.
- 3ank Reference! ) #nother useful source of credit information is the
bank of the firm which is contemplating the e2tension of credit. The
modus operandi here is that the firm3s banker collects the necessary
information from the applicants bank. #lternati%ely, the applicant may
be re$uired to ask his banker to pro%ide the necessary information
either directly to the firm or to its bank.
- Trade Reference! ) These refer to the collection of information from
firms with whom the applicant has dealings and who on the basis of
their e2perience would %ouch for the applicant.
- Credit 3&rea& Report ) &inally, specialist credit bureau reports from
organiBations specialiBing in supplying credit information can also be
utiliBed.
(b) Anal+!i! of Credit Inforation ) ,nce the credit information has been
collected from different sources, it should be analysed to determine the credit:
worthiness of the applicant. The analysis should co%er two aspects:
(i) :&antitati2e ) The assessment of the $uantitati%e aspects is based on
the factual information a%ailable from the financial statements, the past
records of the firm, and so on. The first step in%ol%ed in this type of
assessment is to prepare an #ging 0chedule of the accounts payable of
the applicant as well as calculate the a%erage age of accounts payable.
This e2ercise will gi%e an insight into the past payment pattern of the
customer. #nother step in analyBing the credit information is through a
ratio analysis of the li$uidity, profitability and debt capacity of the
applicant. These ratios should be compared with the industry a%erage.
)ore%er, trend analysis o%er a period of time would re%eal the financial
strength of the customer.
(ii) :&alitati2e ) The $uantitati%e assessment should be supplemented by a
$ualitati%e=sub1ecti%e interpretation of the applicants credit:worthiness.
The sub1ecti%e 1udgement would co%er aspects relating to the $uality of
management. 4ere, the reference from other suppliers, bank references
and specialist bureau reports would form the basis for the conclusion to
be drawn. 'n the ultimate analysis, therefore, the decision whether to
e2tend credit to the applicant and what amount to e2tend will depend
upon the sub1ecti%e interpretation of his credit standing.
D1 Credit Ter!
The second decision area in accounts recei%ables management is the credit terms. #fter
the credit standards ha%e been established and the credit:worthiness of the customer
has been assessed, the management of a firm must determine the terms and conditions
on which the trade credit will be made a%ailable. The stipulations under which goods are
sold on credit are referred to as credit terms. The credit terms specifies the repayment
terms of recei%ables.
The credit terms ha%e three components : (i) credit period, in terms of duration of time
for which trade credit is e2tended:during this period the o%erdue amount must be paid by
the customer! (ii) cash discount, if any, which the customer can take ad%antage of,
that is, the o%erdue amount will be reduced by this amount! and (iii) cash discount
period, which refers to the duration during which the discount can be a%ailed of.
The credit terms, like the credit standards, affect the profitability as well as the cost of a
firm. # firm should determine the credit terms on the basis of cost:benefit trade:off. The
components of credit are here below:
(a) Ca!% Di!co&nt ) The cash discount has implications for the sales %olume, a%erage
collection period=a%erage in%estment recei%ables, bad debt e2penses and profit per unit.
'n taking a decision regarding the grant of cash discount the management has to se
what happens to these factors if it initiates increase, or decrease in the discount rate.
The changes in the discount rate would ha%e both positi%e and negati%e effects. The
implications of increasing or initiating cash discount are as follows:
i. The sales %olume will increase. The grant of discount implies reduced prices.
'f the demand for the products is elastic, reduction in prices will result in higher
sales %olume.
ii. 0ince the customers, to take ad%antage of the discount, would like to pay
within the discount period, the a%erage collection period would be reduced.
The reduction in the collection period would lead to a reduction in the
in%estment in recei%ables as also the cost. The decrease in the a%erage
collection period would also cause a fall in bad debt e2penses. #s a result,
profits would increase.
iii. The discount would ha%e a negati%e effect on the profits. This is because the
decrease in prices would affect the profit margins per unit of sale.
41 Collection Policie!
The third area in%ol%ed in accounts recei%able management is collection policies. Thy
refer to the procedures followed to collect the accounts recei%able when, after the e2piry
o the credit period, they become due. These policies co%er two aspects:
(i) Degree of Collection 4ffort ) To illustrate the effect of the collection effort, the credit
policies of a firm may be categorised into (i) strict = light, and (ii) lenient. The collection
policy would be tight if %ery rigorous procedures are followed. # tight collection policy has
implications which in%ol%e benefits as well as costs. The management has to consider a
trade:off between them. .ikewise, a lenient collection effort also affects the cost:benifit
trade:off. The effect of tightening the collection is discussed below :
- /ad debt e2penses would decline.
- The a%erage collection period will be reduced.
- #s a result profit will increase.
- 'ncreased collection costs.
- -ecline in sales %olume.
The effect of lenient policy will 1ust be the opposite.
(ii) T+pe of Collection 4ffort! ) The second aspect of collection policies relates to the
steps that should be taken to collect o%erdues from the customers. # well established
collection policy should ha%e clear:cut guidelines as to the se$uence of collection efforts.
#fter the credit period is o%er and payment remains due, the firm should initiate
measures to collect them. The effort should in the beginning be polite, but, with the
passage of time, it should gradually become strict. The steps usually taken are (i) letters,
including reminders, to e2pedite payment! (ii) telephone calls for personal contact! (iii)
personal %isits! (i%) help of collection agencies! and finally,(%) legal action. The firm
should take recourse to %ery stringent measures, like legal actions, only after all other
a%enues ha%e been fully e2hausted. They not only in%ol%e cost but also affect the
relationship with the customers. The aim should be to collect as early as possible!
genuine difficulties of the customers should be gi%en due consideration.
". ,arketa(le *ec&ritie!
A1 ,eaning And C%aracteri!tic!
,nce the optimal le%el of cash balance of a firm has been determined, the residual of its
li$uid assets is in%ested in marketable securities. 0uch securities are short term
in%estment instruments to obtain a return on temporarily idle funds. 'n other words, they
are securities which can be con%erted into cash in a short period of time, typically a few
days. To be li$uid, a security must ha%e two basic characteristics: a ready market and
safety of principal. (eady marketability minimiBes the amount of time re$uired to con%ert
a security into cash. # second determinant of li$uidity is that there should be little or no
loss in the %alue of a marketable security o%er time. ,nly those securities that can be
easily con%erted into cash without any reduction in the principal amount $ualify for short
term in%estments. # firm would be better off lea%ing the balances in cash if the
alternati%e were to risk a significant reduction in principle.
31 *election Criterion
# ma1or decision confronting the financial managers in%ol%es the determination of the
mi2 of cash and marketable securities. 'n general, the choice of the mi2 is based on a
trade:off between the opportunity to earn a return on idle funds during the holding
period, and the brokerage costs associated with the purchase and sale of marketable
securities.
There are three moti%es for maintaining li$uidity and therefore for holding marketable
securities: transaction moti%e, safety moti%e and speculati%e moti%e. 8ach moti%e is
based on the premise that a firm should attempt to earn a return on temporarily idle
funds. #n assessment of certain criteria can pro%ide the financial manager with a useful
framework for selecting a proper marketable securities mi2. These considerations
include e%aluation of :
(i) #inancial Ri!k ) 't refers to the uncertainty of e2pected returns from a
security attributable to possible changes in the financial capacity of the
security issuer to make future payments to the security owner. 'f the
chances of default on the terms of the in%estment is high, then the
financial risk is said to be high and %ise %ersa .
(%) Intere!t Rate Ri!k! : The uncertainty associated with the e2pected
returns from a financial instrument attributable to changes in interest
rates is known as interest rate risk. 'f pre%ailing interest rates rise
compared with the date of purchase, the market price of the securities
will fall to bring their yield to maturity in line with what financial
managers could obtain by buying a new issue of a gi%en instrument, for
instance, treasury bills. The longer the maturity of the instrument, the
larger will be the fall in prices. To hedge against the price %olatility
caused by interest rate risk, the market securities portfolio will tend to
be composed of instruments that mature o%er short period.
(%i) Ta2ability : #nother factor affecting obser%ed difference in market yields
is the differential impact of ta2es. # differential impact on yields arises
because interest income is ta2ed at the ordinary ta2 rate while capital
gains are ta2ed at a lower rate.
(%ii) .i$uidity : With reference to marketable securities portfolio, li$uidity
refers to the ability to transform a security into cash. The financial
manager will want the cash $uickly and will not want to accept a large
price reduction in order to con%ert the securities.
(%iii) Mield : The final selection criterion is the yields that are a%ailable on the
different financial assets suitable for inclusion in the marketable
portfolio. #ll the four factors listed abo%e, influence the a%ailable yields
on financial instruments. The finance manager must focus on the risk:
return trade:offs associated with the four factors on yield through his
analysis.
C) ,arketa(le *ec&rit+ Alternati2e!
i) Trea!&r+ 3ill! ) There are obligations of the go%ernment. They are sold on a
discount basis. The in%estor does not recei%e an actual interest
payment. The return is the difference between the purchase price and
the face %alue of the bill. The treasury bills are issued only in bearer
form. They are purchased, therefore, without the in%estors name on
them. #s the bills ha%e the full financial backing of the go%ernment, they
are, for all practical purposes, risk:free.
ii) Negotia(le Certificate! of Depo!it! ) These are marketable receipts for
funds that ha%e been deposited in a bank for a fi2ed period of time. The
deposit funds earn a fi2ed rate of interest. The C-3s are offered by
banks on a basis different from treasury bills, that is, they are not sold at
discount. When the certificate mature, the owner recei%es the full
amount deposited plus the earned interest.
iii) Coercial Paper ) 't refers to short:term unsecured promissory note sold
by large business firms to raise cash. #s they are unsecured, the
issuing side of the market is dominated by large companies which
typically maintain sound credit rating. Commercial paper can be sold
either directly or through dealers. Companies with high credit ratings
can sell directly to the in%estors. They can e%en be purchased with
%arying maturities. &or all practical purposes, there is no acti%e trading
in secondary market for commercial papers although direct sellers of
C*s often repurchase it on re$uest.
i%) 3anker!A Acceptance! ) These are draft (order to pay) drawn on a specific
bank by an e2porter in order to obtain payment for goods he has
shipped to a customer who maintains an account with that specific
bank. They can also be used in financing domestic trade. The draft
guarantees payment by the accepting bank at a specific point of time.
The seller who holds such acceptance may sell it at a discount to get
immediate funds. They ser%e the wide range of maturities and are sold
on a discount basis, payable to the bearer.
%) Rep&rc%a!e Agreeent!) These are legal contracts that in%ol%e the actual
sale of securities by a borrower to the lender with a commitment on the
part of the former to repurchase the securities at the current price plus a
stated interest charge. The securities in%ol%ed are go%ernment
securities and other money market instruments. The borrower is either a
financial institution or a security dealer.
%i) >nit! ) The units of Cnit Trust of 'ndia (CT') offers a reasonably con%enient
alternati%e a%enue for in%esting surplus li$uidity as (i) there is a %ery
acti%e secondary market for them, (ii) the income for units is ta2:e2empt
up to a specified amount and, (iii) the units appreciate in a fairly
predictable manner.
%ii) Intercorporate Depo!it! ) 'ntercorporate deposits, that is, short:term
deposits with other companies is a fairly attracti%e form of in%estment of
short:term funds in terms of rate of return which currently ranges
between 1" and 1? per cent. 4owe%er, apart from the fact that one
month3s time is re$uired to con%ert them into cash, intercorporate
deposits suffers from high degree of risk.
%iii) 3ill Di!co&nting ) 0urplus funds may be de%eloped to purchase=discount
bills. /ills of e2change are drawn by seller on the buyer for the %alue of
goods deli%ered to him. 'f the seller is in need of funds, he may get the
bills discounted. /ill discounting is superior to intercorporate deposits
for in%esting surplus funds.
i2) Call arket ) 't deals with funds borrowed=lent o%ernight=one:day (call)
money and notice money for periods up to 1G days. 't enables
corporates to utiliBe their float money gainfully. 4owe%er the returns are
highly %olatile. The stipulations pertaining to the maintenance of cash
reser%e ratio (C(() by banks is the ma1or determinant of the demand of
funds and is responsible for %olatility in call rates. .arge borrowings by
them to fulfill their C(( re$uirements pushes up the rates and a sharp
decline takes place once these funds are met.
$. In2entor+ ,anageent
A1 O(<ecti2e!
The basic responsibility of the financial manager is to make sure the firms cash flows are
managed efficiently. 8fficient management of in%entory should ultimately result in the
ma2imiBation of the owner3s wealth. #s we know that in order to minimise cash
re$uirements, in%entory should be turned o%er as $uickly as possible, a%oiding stock:
outs that might result in closing down the production line or lead to a loss of sales. 't
implies that while the management should try to pursue the financial ob1ecti%e of turning
in%entory as $uickly as possible, it should at the same time ensure sufficient in%entories
to satisfy production and sales demands. The ob1ecti%e of in%entory management
consists of two counterbalancing parts: (i) to minimise in%estment in in%entory, and (ii)
meet a demand for the product by efficiently organiBing the production and sales
operations. These two conflicting ob1ecti%es of in%entory management can also be
e2pressed in terms of cost and benefit associated with in%entory. That the firm should
minimise in%estment in in%entory implies that maintaining in%entory in%ol%es costs, such
that the smaller the in%entory, the lower is the cost to the firm. /ut in%entories also
pro%ide benefits to the e2tent that they facilitate the smooth functioning of the firm: the
larger the in%entory, the better it is from the %iewpoint. ,b%iously, the financial managers
should aim at a le%el of in%entory which will reconcile these conflicting elements. That is
to say, an optimum le%el of in%entory should be determined on the basis of the trade:off
between costs and benefits associated with the le%els of in%entory.
31 Co!t! of 9olding In2entor+
,ne operating ob1ecti%e of in%entory management is to minimise cost. 82cluding the cost
of merchandise, the cost associated with in%entory fall into two basic categories:
(i) Ordering or Ac?&i!ition or *et/&p co!t! ) This category of cost is associated
with the ac$uisition or ordering of in%entory. &irms ha%e to place orders with
suppliers to replenish in%entory of raw materials. The e2pense in%ol%ed are
referred to as ordering costs. The ordering costs consist of (a) preparing the
purchase order or re$uisition form and (b) recei%ing, inspection, and recording
the goods recei%ed to ensure both $uantity and $uality. The cost of ac$uiring
materials consists of clerical costs and costs of stationery. 't is therefore, called,
a set:up cost. They are generally fi2ed per order placed, irrespecti%e of the
amount of the order. The ac$uisition costs are in%ersely related to the siBe of
in%entory: they decline with the in%entory. Thus, such costs can be minimised by
placing fewer orders for a large amount. /ut ac$uisition of a large $uantity would
increase the cost associated with the maintenance of in%entory, that is, carrying
cost.
(ii) Carr+ing co!t! ) The second broad category of costs associated with in%entory
are the carrying costs. They are in%ol%ed in maintaining or carrying in%entory.
The cost of holding in%entory may be di%ided into two categories:
(a) Those that arise due to the storing of in%entory : The main
components of this category of carrying costs are (1). 0torage
costs, that is, ta2, depreciation, insurance, maintenance of the
building, utilities and 1anitorial ser%ices! ("). insurance of
in%entory against fire and theft! (5). -eterioration in in%entory
because of pilferage, fire, technical obsolescence, style
obsolescence and price decline! (G). 0er%ing costs, such as,
labour for handling in%entory, clerical and accounting costs.
(b) The opportunity cost of funds : This consists of e2penses in
raising funds (interest on capital) to finance the ac$uisition of
in%entory. 'f funds are not locked in in%entory, they would ha%e
earned a return. This is the opportunity cost of funds or financial
cost component of the cost.
The carrying costs and the in%entory siBe are positi%ely related
and mo%e in the same direction. 'f the le%el of in%entory
increases, the carrying costs also increase and %ice %ersa.
The sum of the order and carrying costs represents the total
cost of in%entory. This is compared with the benefits arising out
of in%entory to determine the optimum le%el of in%entory.
C1 3enefit! of 9olding In2entor+
The second element in the optimum in%entory decision deals with the benefits
associated with holding in%entory. The three types of in%entory, raw materials, work:in:
progress and finished goods, perform certain useful functions. The rigid tying (coupling)
of purchase and production to sales schedules is undesirable in the short run as it will
depri%e the firms certain benefits. The effect of uncoupling (maintaining in%entory) are as
follows
(i) 3enefit! in P&rc%a!ing ) 'f the purchasing of raw materials and other goods
is not tied to production=sales, that is, a firm can purchase independently to
ensure the most efficient purchase, se%eral ad%antages would become
a%ailable. 'n the first place, a firm can purchase larger $uantities than is
warranted by usage in production or the sales le%el. This will enable it to a%ail
of discounts that are a%ailable on bulk purchases. )oreo%er, it will lower the
ordering cost as fewer ac$uisitions would be made. There will, thus, be a
significant sa%ing in the costs. 0econdly, firms can purchase goods before
anticipated or announced price increases. This will lead to a decline in the
cost of production. 'n%entory, thus, ser%es as a hedge against price increases
as well as shortages of raw materials. This is highly desirable in%entory
strategy.
(ii) 3enefit! in Prod&ction : &inished goods in%entory ser%es to uncouple
production and sale. This enables production at rate different from that of
sales. That is, production can be carried on at a rate higher or lower than the
sales rate. This would be a special ad%antage to firms with seasonal sales
pattern. 'n their case, the sales rate will be higher than the production rate
during the part of the year (peak season) and lower during the off season.
The choice before the firm is either to produce at a le%el to meet the actual
demand, that is, higher production during peak season and lower (or nil)
production during off:season, or, produce continuously throughout the year
and build up in%entory which will be sold during the period of seasonal
demand. The former in%ol%es discontinuity in the production schedule while
the later ensures le%el production. The le%el production is more economical
as it allows the firm to reduce the cost of discontinuities in the production
process. This is possible because e2cess production is kept as in%entory to
meet future demands. Thus, in%entory helps a firm to coordinate its
production scheduling so as to a%oid disruption and the accompanying
e2penses. 'n brief, since in%entory permits least cost production scheduling,
production can be carried on more efficiently.
(iii) 3enefit! in Work/in/Progre!! ) The in%entory in Work:in:*rogress performs
two functions. 'n the first place, it is necessary because production processes
are not instantaneous. The amount of such in%entory depends upon
technology and efficiency of production. The larger the steps in%ol%ed in the
production process, the larger the W'* and %ice %ersa. /y shortening the
production time, efficiency of the production process can be impro%ed and the
siBe of this type of in%entory reduced. 'n a multi:stage production process, the
W'* ser%es a second purpose also. 't uncouples the %arious stages of
production so that all of them do not ha%e to be performed at the same time
rate. The stages in%ol%ing higher set:up costs may be most efficiently
performed in batches with W'* in%entory accumulated during a production
run.
(i%) 3enefit! in *ale! ) The maintenance in in%entory also helps a firm to
enhance its sales efforts. &or on thing, if there are no in%entories of finished
goods, the le%el of sales will depend upon the le%el of current production. #
firm will not be able to meet demand instantaneously. The in%entory ser%es to
bridge the gap between current production and actual sales. # basic
re$uirement in a firms competiti%e position is its ability %is:N:%is its competitor
to supply goods rapidly. 'f it is not able to do so, the customer are likely to
switch to suppliers who can supply goods at short notice. )oreo%er, in the
case of firm ha%ing a seasonal pattern of sales, there should be a substantial
finished goods in%entory prior to the peak sales season. &ailure to do so may
mean loss of sales during the peak season.
To summarise the preceding discussion relating to ob1ecti%e of in%entory management,
the two main aspects pertain to the minimisation of in%estment in in%entory, on the one
hand, and the need to ensure that there is enough in%entory to meet demand such that
production and sales operations are smooth. /y holding less in%entory, the cost can be
minimiBed, but there is a risk that the operations will be disturbed as the emerging
demands cannot be met. ,n the other hand, by holding a large in%entory, the chances of
disruption of operations are reduced, but, the cost will increase. The appropriate le%el of
in%entory should be determined in terms of a trade:off between the benefits and cost
associated with maintaining in%entory.
D1 Tec%ni?&e!
There are many sophisticated mathematical techni$ues a%ailable to handle in%entory
management problems. We will discuss some of the simple production:oriented methods
of in%entory control to indicate a broad framework for managing in%entories efficiently in
conformity with the goal of wealth ma2imiBation. The ma1or problem 9 areas that
comprise the heart of in%entory control are

0i1 Cla!!ification Pro(le ) A 3 C *+!te
The # / C 0ystem is a widely used classification techni$ue to classify different types
of in%entories and to determine the type and degree of control re$uired for each.
This techni$ue is based on the assumption that a firm should not e2ercise the same
degree of control on all items of in%entory. 't should rather keep a more rigorous
control on items that are (a) the most costly, and=or (b) the slowest:turning, while
items that are less e2pensi%e should be gi%en less control effort.
,n the basis of the cost in%ol%ed, the %arious in%entory items are classified into three
classes #, / and C. The items included in group # in%ol%es largest in%estment.
'n%entory control for such items must be most rigorous and intensi%e and most
sophisticated in%entory control techni$ues should be applied to these items. The C
group item consists of items of in%entory which in%ol%e relati%ely small in%estments
although the number of items is fairly large. These items deser%e minimum attention.
The / group stands midway. 't deser%es less attention than # but more than C. 't can
be controlled by less sophisticated techni$ue.
0ii1 Order :&antit+ Pro(le ) 4conoic Order :&antit+ 0 4O: 1 ,odel
#fter determining the type of controls for each categories of items ( # / and C ),
$uestion arises regarding the appropriate $uantity to be purchased in each lot to
replenish the stock. /uying a large $uantity implies a higher a%erage in%entory le%el
which will assure (a) smooth production=sales operations, and (b) lower ordering or
setup costs. /ut it will in%ol%e higher carrying costs. ,n the other hand, if the order
$uantity is small then the carrying cost is reduced but it will increase the ordering
costs. ,n the basis of the trade:off between the both the optimum le%el of order to
be placed should be determined. The optimum le%el of in%entory is called as
economic order $uantity (8,O). The economic order $uantity can be defined as that
le%el of in%entory order that minimises the total cost associated with in%entory
management.
#ssumptions : 8,O model is based on following assumptions:
- the firm knows with certainty the annual consumption of a particular
item of in%entory.
- The rate at which the firm uses in%entory is steady o%er time.
- The order placed to replenish in%entory stocks are recei%ed at e2actly
that point in time when in%entories reach Bero.
- There are two distinguishable costs associated with in%entories: cost
of ordering and cost o carrying.
- Cost of order is constant regardless of the siBe of the order.
- The cost of carrying is fi2ed percentage of the a%erage %alue of
in%entory.
8,O &ormula :
4O: B I 2#>
CCCCCCCC CCC PC
where
C ; annual sales
& ; fi2ed cost per order
* ; purchase price per unit
C ; Carrying cost
.imitations :
- The assumption of constant consumption and the instantaneous
replenishment of in%entories are of doubtful %alidity. 't is possible that
deli%eries from suppliers may be slower than e2pected for reasons
beyond control. 't is also possible that there may be an unusual and
une2pected demand for stocks. To meet such contingencies additional
stock called as safety stock is kept.
- #nother weakness of 8,O model is that the assumption of a known
annual demand for in%entories is open to $uestion. There is likelihood
of discrepancy between the actual and the e2pected demand, leading
to a wrong estimate of the economic ordering $uantity.
- 'n addition, there are some computation problems in%ol%ed. # more
difficult situation may occur when the number of orders to be placed
may turn out to be a fraction.
A Ca!e *t&d+ On *I4,4N* LTD )
The present study seeks to analyse the working capital management with a case study
of a noted company in the capital goods industry, %iB. 0iemens .td. The case study
aims at e2amining in the conte2t of the published figures of the accounting
statements how far the management of WC has been successful in case of
0iemens during period 1DDE to "661.

0iemens .td. is a leading electrical and electronics engineering company in 'ndia.
8stablished in 1D"", it was incorporated as a company in 1D?E and in 1D7" was
con%erted into a public limited company with ?1@ of its e$uity held by 0iemens #+
and the remaining GD@ held by 'ndian shareholders. 't operates in the energy,
industry, health care, transportation, information, communications and components
business segments 't also operates 1oint %entures in the fields of
telecommunications and information technology.
'n addition, 0iemens +roup in 'ndia has presence in the field of *ower -esign,
(eno%ation H )odernisation of e2isting power plant, .ighting, and 4ousehold
goods. The 0iemens +roup in 'ndia has a widespread marketing and distribution
network in addition to multiple manufacturing facilities in 'ndia. 't also has a well
organised up:market %alue addition in 8ngineering, 0oftware, 0ystem 'ntegration,
8rection, Commissioning and Customer 0er%ices
General Perforance Re2ie7
The first recession of the new millennium has set in. )ost indicators suggest that the
'ndian economy is running out of steam. The uncertainty of its re%i%al has cast a shadow
on the prospects of a 7.?@ +-* growth rate for the current fiscal. Conse$uently, the
Central 0tatistical ,rganiBation has scaled down +-* growth for "666:61 to ?."@ This
makes it the third worst growth rate since 1DD1:D".
'n the 'nfrastructure area, the *ower +eneration sector continued to e2perience a
sluggish growth for the 7th consecuti%e year, with a meager G,666 )W being added to
the installed capacity last year. The issue of payment security as offered by the 0tate
8lectricity /oards has put in%estors on high caution. #s part of power sector reforms, the
+o%ernment3s focus on the *ower Transmission and -istribution (TH-) sector,
generated a higher demand in the 4igh Joltage and )etering businesses. (educed
budgetary support to (ailways put new pro1ects on hold, with emphasis shifting to areas
such as safety. 0iemens too e2perienced similar trends, with *ower +eneration3s order
inflow contracting, although the *ower *lant #utomation and 4igh Joltage business
witnessed higher growth than other segments. Transportation 0ystems business %olume
too remained steady. -espite the difficult en%ironment, these businesses ha%e posted
satisfactory results.
The 'ndustrial segment continued to remain stagnant due to the lack of fresh
in%estments. 'n the first four months of "661:6" (#pril 9 Puly "661), industrial production
grew by only ".5@ as compared to ?.D@ during the same period of the pre%ious year.
,%erall, the market characteristics changed to smaller siBed orders, while the industry
continued to e2perience price cut:backs due to competiti%e forces. 'n order to combat
the pressures, se%eral key players in this segment were engaged in restructuring their
businesses in order to optimiBe capacities and reduce costs. /esides, as a conse$uence
of lower demand, new pro1ects suffered. Met, in this lackluster market, 0iemens
succeeded in gaining market shares in most areas, while impro%ing its o%erall
profitability position through the launch of inno%ati%e products, systems, solutions and
ser%ices, as well as an impro%ed cost structure. ,ne area that remains of high concern
is the .ow Joltage -istribution 0ystems, which is saddled with e2cess capacity.
0iemens3 o%erall market and customer focus approach saw it launch numerous
inno%ati%e products, systems, solutions and ser%ice. This enabled it to attain an
increased market share. #t the same time, impro%ed producti%ity and effecti%e asset
management, ga%e the Company a better cost structure, which boosted its bottom:line.
While the top:line has remained steady, the Company substantially impro%ed the $uality
of its results, bringing it further to a healthier and more stable position.
4nerg+
Po7er Generation
'n the last year, *ower +eneration in 'ndia continued to e2perience sluggish growth,
which saw a meager G,666 )W being added to the installed capacity. 'n the wake of the
continued slow pace of reforms, no ma1or pro1ects took off the ground, considerably
affecting the new order inflow position. 'ssues surrounding the payment security as
offered by the 0tate 8lectricity /oards (08/s) ha%e additionally acted as deterrents
putting in%estors on high caution.
The *ower +eneration -i%ision3s business was therefore impacted due to the declining
market conditions. While ew ,rder intake and turno%er o%erall declined by "5@ and
"A@ respecti%ely as compared to the pre%ious year, the -i%ision3s e2port business
%olume witnessed a two:fold increase. The -i%ision posted a healthy margin, with the
#utomation group being a ma1or contributor to the profitability, which also gained
substantial market share.
'n the last year, the -i%ision signed an agreement with 'nstrumentation .td., Lota, a
public sector enterprise, to address the power plant automation needs of 08/s and
Central *ower 0ector Ctilities. 'n keeping with its policy to continually pro%ide enhanced
%alue, the -i%ision launched new automation solutions that ha%e met with considerable
success. The introduction of new technologies and inno%ati%e customer:centric
strategies supported its increased market penetration. 'n the area of ser%ice, the -i%ision
has launched new initiati%es, which included a Call Center concept to ensure round:the:
clock connecti%ity with customers. 't also recei%ed its first comprehensi%e CH'
maintenance contract worth (s. A million from -JC )e1ia.
0ome of the other important orders recei%ed last year include those bagged by the
-i%ision3s #utomation +roup for the (eno%ation H )odernisation of W/08/ 0antaldih
%alued at (s G? million and capti%e power plant units of 4indalco, (enusagar ("2AG )W)
%alued at (s. E1 million. 'n addition the 0er%ice +roups too, recei%ed significant orders
from *aguthan (7?? )W CC**) and (eliance for a "? )W (eplacement Turbine at
*atalganga.
O&tlook) 'n the backdrop of the continued slow pace of reforms and the long gestation
period for the benefits to be realiBed, this sector is e2pected to remain QstagnantR for the
current year. The scaling down of the power capacity addition from G6,666 )W to "6,666
)W in the inth &i%e:Mear *lan period (1DDE:"661) is a further dampener to the much:
needed progress. While the Cnion /udget "661 has not pro%ided any ma1or relief to the
'**s, it is e2pected that capti%e power generation and co:generation will see some
growth.
The *ower +eneration -i%ision3s focus will continue to be the same as in the last year
with added thrust on pro%iding newer technologies to %arious areas, like steam
generation for thermal power plants. 't intends to step up pro%iding comprehensi%e
ser%ices by enhancing its all:'ndia network and pro%iding ma2imum benefits to its
customers
4nerg+
Po7er Tran!i!!ion and Di!tri(&tion Di2i!ion
The Transmission and -istribution (TH-) sector emanated mi2ed signals last year.
'dentification of TH- as a priority sector, with the +o%ernment3s plans to in%est (s G66
million o%er three years, is a positi%e sign. ,n the other hand, the poor financial state of
the 0tate 8lectricity /oards (08/s), continues to hinder growth. ,%erall, the TH- market
has a C#+( of ?@, with below a%erage growth in the medium %oltage and transformer
segments, and abo%e a%erage growth in the high %oltage and automation segments.
-uring the last fiscal, the -i%ision introduced new products such as the 57kJ #ir
'nsulated metal:clad 0witchgear as well as the low:cost numerical relays targeted at the
'ndustry and Ctilities segment. 't also %entured into a new business area, that of
protection systems for high:capacity generators. 'n a significant de%elopment, the
-i%ision was awarded market de%elopment responsibilities in eight more #sian and
#frican countries by 0iemens #+. 't also signed a Technical Collaboration agreement
with a 0witchboard manufacturer abroad to promote e2ports..
0ome ma1or orders bagged by the -i%ision in the last year include those from Larnataka
*ower Transmission Corporation .td (L*TC.) and 4aryana Jidyut *rasarak igam .td
(4J*.) for 4J 0witchgear worth (s 5D" million and (s "AE million respecti%ely. 't also
procured an order worth (s A6 million from )08/ for 8nergy )anagement systems.
The -i%ision has successfully e2ecuted orders from L*TC. and +ridco notched in the
pre%ious fiscal.
O&tlook) With TH- emerging as a priority sector, increase in demand for substations,
transmission lines and metering e$uipment is e2pected to pro%ide greater business
opportunities in which the -i%ision looks forward to being a key participant. While
enhancing its dominance as a ma1or TH- player in 'ndia, it has in the offing new
initiati%es in the area of 8nergy )anagement 0ystems. The -i%ision will increase its
presence in the o%erseas market through a higher thrust in e2port business. 'n order to
stem losses and return back to profitability, the -i%ision will undertake restructuring
measures entailing resource ad1ustments across all processes, particularly in the
manufacturing area.
Ind&!tr+
A&toation D Dri2e!
The 'ndustry segment, as a whole, witnessed a downward trend during the last fiscal,
mainly due to the substantial drop in new in%estments. # ma1or portion of the 0tandard
*roducts -i%ision3s (#H-) business is triggered as a result of such in%estments, as well
as from the maintenance sector, both of which ha%e remained sluggish during the last
fiscal. To remain afloat in the difficult competiti%e en%ironment, se%eral leading
companies in this segment to which #H- caters, focused attention on restructuring,
rather than enhancing business.
O&tlook) The market in which #H- operates is e2pected to remain stagnant in the year
ahead. 'n order to strengthen it3s position in this situation, the -i%ision is working on
strategies for increasing sales through an increased presence in unser%ed market and
will introduce new offerings in )otors, +enerators and -ri%es. 't is in%esting in impro%ing
ser%ice le%els and will re%iew processes so as to reduce cycle time, and costs.
Ind&!trial *ol&tion! D *er2ice! Di2i!ion
(ecessionary trends in the 'ndian economy dampened business sentiment in the
in%estment dependent industrial sector. -uring the last fiscal, the capital goods sector of
the industry continued its downward slide due to paucity of new in%estments and in the
first four months of "661:6" (#pr 9 Puly "661), it shrunk by 7.1@, compared to a growth
of G.?@ during the corresponding period of the pre%ious year.
O&tlook) With the decline in new in%estments in the industrial sector and sections of
industry shifting focus on restructuring operations, the market sentiments are e2pected
to remain dampened. Cnder the circumstances, the -i%ision foresees a challenging year
ahead, specially since realiBations from industrial pro1ects usually ha%e long gestation
periods.
Lo7 @oltage Di!tri(&tion *+!te!
#t present, the low %oltage distribution industry in 'ndia suffers from e2cessi%e
manufacturing capacity due to the presence of a large number of players and dwindling
demand as a result of the depressed market conditions.
'n its endea%or to make operations %iable, the -i%ision has proposed to introduce
se%eral measures. This includes an offer of alternati%e 1obs to its workers at 0iemens
)etering, a plant in the neighborhood. This process of implementation has seen some
delays resulting in the unit making e%en more production losses, thus affecting the
o%erall result.
O&tlook) The market conditions are e2pected to remain depressed, with the prices
witnessing a further drop due to competiti%e forces. Cnder the present circumstances,
the -i%ision3s business outlook is not %ery encouraging and it will ha%e to undertake
some ma1or actions to make the operations %iable. Therefore, the -i%isionFs ma1or
ob1ecti%e during the new fiscal is to bring the business back into the black with a new
approach.
9ealt%care
,edical *ol&tion! Di2i!ion
The 'ndian healthcare market grew at about 1?@ with cardiology, oncology and high:end
diagnostics being the key growth areas in the metro centers and routine imaging and
critical care e$uipment in the non:metros. The entry of pri%ate healthcare ser%ice
pro%iders had a catalytic influence in offering world:class medical diagnostic and
treatment facilities. These positi%e trends fueled business opportunities for the )edical
0olutions -i%ision.
O&tlook) The outlook for the 4ealthcare sector in 'ndia looks highly positi%e. 0iBable
in%estments are e2pected to be made by pri%ate players for setting up corporate
hospitals and diagnostic centers
Tran!portation
Tran!portation *ol&tion! Di2i!ion
'n the face of the se%ere resource crunch o%er the last two years, the 'ndian (ailways
ha%e put new in%estment programs on hold. /arring wagons, procurement of all rolling
stock items such as 8)Cs, )etro Coaches, -iesel H 8lectric .ocomoti%es ha%e been
curtailed and there are no fresh pro1ects in the pipeline.
O&tlook) 'ndian (ailwaysS emphasis on safety impro%ements will see higher in%estments
in this segment in the future with a pro1ected 11@ growth in 0ignalling and 1A@ growth
in miscellaneous electricals. To retain it3s leadership position, the -i%ision will seek out
opportunities that may so arise and will also %enture into newer segments such as rolling
stock upgradation, multiple units etc.
Inforation D Co&nication
4nterpri!e Net7ork!
The 'nformation H Communication 9 8nterprise etworks ('C 8) -i%ision, after a slow
start during the first $uarter, had a successful fiscal year registering a 1?@ growth in line
units %ersus the pre%ious fiscal year. 't made a substantial reco%ery from the second half
onwards with a strong sales momentum that resulted in a modest increase in re%enues
by 7@ o%er the pre%ious year.
. O&tlook) The 'ndian enterprise telecommunication market is poised to grow at 1A :
"6@ in the current year. The migration to Joice o%er '* (J,'*) technology, drop in tariffs
for long distance calls, a%ailability of leased lines at competiti%e rates, growth in the
ser%ice industry with attendant boost in the call center market, are some key factors that
are e2pected to dri%e growth in the data, %oice and %ideo usage.
Inforation D Co&nication
,o(ile P%one!
The 'nformation and Communication 9 )obile *hones -i%ision ('C) )*), has achie%ed
a commendable 1GE@ growth in sales units during the last fiscal. Correspondingly,
re%enues surged by AD@ as a result of the -i%ision3s aggressi%e sales and marketing
efforts.
-emand for mobile phones in 'ndia is being increasingly fueled by preference for
lifestyle:oriented brands, rather than technology and features. 'n keeping with this trend,
in the last year, 'C) launched two new models, the #5? at the lower end and the 0. G?
at the higher end. 0.G?, a technological re%olution with a built:in )*5 player and a 5":bit
multimedia card, enables the user to listen to high:$uality music. 't is positioned as a
lifestyle accessory for the status:conscious. The #5?, being one of the smallest and
lightest phones, is particularly attracti%e for the youth segment.
O&tlook) 'n the current fiscal, the mobile phones market is e2pected to grow by nearly
E6@. To meet the increased demand, 'C) will increase retail %isibility, strengthen
distribution network and further intensify its dealer de%elopment program to increase
sales at point:of:sale in ma1or cities in 'ndia. 't would also concentrate on continued
brand building efforts through the Q0iemens 'nspired -ealersR program and 0iemens
Q0hop:in:0hopR program.
Inforation D Co&nication
*ieen! Inforation *+!te! Liited
The 'ndian software sector, which saw a phase of rapid growth in the last decade, has
begun to e2perience the effects of the global economic slowdown. +lobally and in 'ndia,
the industry has witnessed a downward trend that began in the last $uarter of &M "666,
and in "661, e2perienced its full impact.
O&tlook) The current fiscal would continue to be tough for the software de%elopment
sector. 'n partnership with 0iemens /usiness 0ystems, 0'0. e2pects to grow in the
8urope H #sia9*acific regions. The company also plans to impro%e its 8J# through
better payment collection.
O&tlook for *ieen! Ltd.
'n the backdrop of continued economic slowdown, the infrastructure and industry sectors
in 'ndia are e2pected to remain QstagnantR. 8%en if there is a pick:up, it3s effects will be
e%ident anywhere between si2 months to one year in time lag. While the scaling down of
the power capacity addition from G6,666 )W to "6,666 )W in the Dth fi%e year plan
period (1DDE:"661) has retarded growth in this sector, it is e2pected that capti%e power
generation and co:generation will pickup, pro%iding opportunities for 0iemens.
*ower Transmission H -istribution is emerging as a priority sector in 'ndia and if the
issues surrounding payments and financing are resol%ed, this segment is e2pected to
see an increased demand for substations, transmission lines and metering e$uipment. 'f
this happens, 0iemens e2pects to garner business opportunities as a key participant in
the de%elopment of this sector.
The low %oltage distribution industry in 'ndia is suffering from o%er capacity and so is the
0iemens manufacturing unit at Poka, Lolkata. 'n order to make the operations of this unit
%iable, the Company plans to initiate further actions to streamline and optimiBe
resources
The telecommunications sector, in particular for 8nterprise etworks, is on the upswing.
ew business opportunities continue to emerge in this sector, with the hospitality and
corporate sector showing stronger growth. 0iemens plans to strengthen sales channels
to take ad%antage of this growth potential. 'n the fast growing mobile phones business,
0iemens plans to focus on increased retail %isibility through special programs,
strengthen the distribution network and further intensify its channel sales to boost point:
of:sale %olumes in ma1or 'ndian cities.
The entry of corporate healthcare ser%ice pro%iders and opening up of the healthcare
insurance sector to pri%ate players will make access to healthcare ser%ices easier and
pro%ide the much:needed fillip to this sector. 4ere, 0iemens is strongly poised to
le%erage these emerging opportunities and plans to launch top:of:line products and
ser%ices, as called for by the market.
A&dited 3alance *%eet Of *ieen! LTD
Ta(le 1
S.R. No. Particulars
;ear
ended
"E.F.E1
012 t!1
;ear
ended
"E.EF.EE
0 12 t! 1
;ear
ended
"E.EF.FF
0 12 t! 1
;ear
ended
"E.EF.F6
0 12 t! 1
;ear
ended
"E.EF.F.
0 16 t! 1
1
et 0ales H 0er%ices (e2cluding
82cise -uty)
11572.8 16A5".E? 16?6?.AA DD?D.5 1E?1G.1
2 .ease and ,ther 'ncome 778.74 AD7.5D E1?.67 ?"?." G71.D
3 Total 82penditure 10962 16?E5.DG 16"5?."1 D7A6.7E 17A6E.E
4
,perating *rofit before 'nterest H
-epreciation
1389.3 11??." DA?.E5 A65.A5 117A.5
5 'nterest 17.12 GA.A? "EA." G77.6" 1"G5.1
6
+ross *rofit=.oss(:) after 'nterest but
before -epreciation
1372.18 1167.5? E6E.?5 55E.A1 :EG.A
7 -epreciation 294.58 51?.61 5?A.6A GE".E7 E"G.G
8
*rofit = .oss(:) before 82ceptional
items and Ta2 #d1ustment
1077.6 ED1.5G 5GD.G? :15G.D? :EDD."
9 82ceptional items -113.37 1?G.A7 51.?? :551.AE -924.6
10 Ta2 #d1ustment -236.43 167.17 "D.A :D5.G1 -37.5
11 NetProfit8Lo!!0/1 687.21 6$E.E$ "'1.2 /'-E.2" -1556.3
12 *aid up 8$uity 0hare Capital 336.27 5?G.DG "A5.DE "A5.DE 284
13
(eser%es e2cluding re%aluation
reser%es
2873.69 "GA6.A" ?D1.15 11E5.EE 1188.9
2. O(<ecti2e! of t%e *t&d+
The ob1ecti%e of the study is to make a comprehensi%e analysis of Working Capital )anagement of
the company . 0pecifically the ob1ecti%es are :
i) To find out the siBe of Working Capital ( WC ) and to measure its li$uidity and the operational
efficiency by using ratio analysis .
ii) To ascertain the estimated WC needs by fitting linear regression line , to find out the degree
of association between the estimated and the actual WC by competing simple correlation
coefficient and to test the significance of such coefficient .
iii) To make element:wise analysis of WC and to identify the elements = components responsible
for %ariation in WC .
". ,et%odolog+ of *t&d+

The methods or the techni$ues which ha%e been used for collection and analysis of data in this
study are as follows :
(i) Collection of Data ) The data of 0. for the period 1DDE to "661 used in this study has
been collected from the #nnul (eports for the years 1DDE to "661.
(ii) Anal+!i! of Data ) &or analysing the data the techni$ue of ratio analysis , simple
mathematical tools like percentages and a%erages etc. and simple statistical techni$ue
like 0imple Correlation Techni$ue ha%e been used .
&indings of the study with detailed discussion
The obser%ations on the findings of the study are as follows :
#. The siBe of WC and some li$uidity and efficiency ratios of 0iemens for the period of study ha%e
been depicted in Table" and 5. &or this purpose , Q +ross Working Capital ( +WC ) Concept Q is
followed . The amount of +WC decreased from E"D.7 crores in 1DDA to GE".A7 crores in "666
showing a decrease of 5?." @t . This $uantitati%e comparison is not sufficient to 1udge the
efficiency of the WC) . &or this reason , li$uidity analysis and analysis of operational efficiency
ha%e been done to assess the $uantitati%e efficiency of the WC) of the company by computing
the following ratios .
I. Li?&idit+ Anal+!i! )
Li?&idit+ ratio
Ta(le 2
*.R.No Partic&lar! 1FF6 1FFF 2EEE 2EE1
1 Ouick (atio 6.G6 6.5? 6.G" 6.75
" Current ratio 6.A? 6.D5 6.D6 1.61
5 -ebt e$uity (atio 1.DD 1."? 6.?1 6.1?
G */-'T = 'nterest 6.GE 6.5E 1.?" A.1A
? 'nterest 'ncidence 51.AG 1E.A? 1E.5A 1".?G
(i) C&rrent Ratio 0 CR 1 ) This ratio is a basic measure of 1udging the ability of the company to
pay off its current obligations out of its short:term resources . The higher the C(, the larger is
the amount a%ailable per rupee of short term obligations and accordingly , the greater is the
feeling of security . #lthough sometimes it is said that a C( of " : 1 is ideal , but there is no
rigidity about it . 8ach firm has to de%elop its own standards or ideal ratio from past
e2perience and this only can be taken as a norm . 't is obser%ed from Table 1 from year 1DDA
the ratio was 6.A? : 1 . 'n the year "661 the C( was 1.61 which is far below the con%entional
standard of " : 1 which implies that li$uidity position of the company was not satisfactory .
(ii) :&ick Ratio 0 :R 1 ) This ratio is a stricter test of li$uidity than the C( as it gi%es no
consideration to in%entory which may be slow mo%ing . O( places more emphasis on
immediate con%ersion of assets into cash than does the C(. (ule of thumb is 1 : 1 for the O(
. Pudged from the traditional norms, li$uidity position of 0. as weak as its O( fluctuated
between 6.G6 in 1DDA to 6.75 in "661. ,n an a%erage , this ratio was 6.? . 4owe%er, there
was a slight impro%ement in the O( during the last 5 years of the study period. #lthough it is
clear that in all the years under study li$uid assets of the company were not ade$uate to
meet %ery short term debt, it is a fact that many well managed pri%ate sector enterprises in
'ndia are successfully operating with a O( of 1ust 6.?.
(iii) De(t 4?&it+ Ratio ) The debt e$uity ratio has shown a downward trend in the recent years
and has also been in good . 'n the year 1DDA the -=8 ratio was 1.DD while in "661 the same
is 6.1?
(i%) Intere!t Co2erage Ratio ) This ratio measures the firms capacity to ser%ice the fi2ed interest
on term loan 't is determined by di%iding the operating profits or earnings before interest and
( 56 )
ta2 by the fi2ed assets interest charges on loans . 't has been obser%ed that 0. has
continuously been increasing the ser%ice co%erage ratio from 1DDA to "661. 'n the year 1DDA
the ratio was 6.GE and the same today in the year "661 is A.1A
II. Operational 4fficienc+ Anal+!i! )
In2entor+ T&rn O2er Ratio
Ta(le "
*.R.No Partic&lar! 1FF6 1FFF 2EEE 2EE1
1. #%erage days of raw material in 0tores 166 1"E ED ?"
". #%erage -ays of *roduction 56 "E "" 1E
5. #%erage days of finished goods "6 "G 1D 1"
G. #%erage days of -ebtors AE 15? 115 165
?. +ross working Capital Cycle "57 515 "55 1A?
7. #%erage days of Creditors 11A "65 1D7 1A1
E. et working capital cycle 11D 111 57 G
(i) In2entor+ T&rno2er Ratio 0 ITR 1 ) This ratio is a %aluable measure of the efficiency of
in%entory management . +enerally speaking, the higher the 'T( the shorter the a%erage
time between in%estment in in%entory and its con%ersion into sales and thus the greater
the efficiency of in%entory management. The 'T( of the company was higher in all the
years under when compared to F'ndian )anufacturing industry3 a%erage of ".1". 't
indicates that the company had cared or been able to manage its in%entory %ery
impressi%ely. 'n 1DDA the cost of goods sold was (s A"G.DG( crores )where as the
in%entory was (s 1?6.E1 ( crores ) the calculated 'n%entory turn o%er ratio is ?.GE. While
in "661 the same was 11.A1.4ence we also see an increase in the 'n%entory turno%er
ratio which shows a positi%e trend during the period under study reflecting the substantial
impro%ement in the efficiency of in%entory management of the company.
(ii) De(tor T&rno2er Ratio 0 DTR 1 ) This ratio shows the efficiency achie%ed in using the
funds in%ested in debtors. This ratio can be gi%en as Total 0ales to debtor ( 0undry
-ebtors and #d%ances reco%erable in Cash ). The higher -T( implies $uicker collection
of debtors and also enables the company to transact a larger %olume of business without
corresponding increase in in%estment in debtors.
( 57 )
/. To estimate the re$uired amount of WC of 0. assuming a linear dependency of WC on 0ales,
the regression e$uation of WC on 0ales y ; a < b2 has been considered where y ; WC , 2 ;
0ales b ; regression coefficient of y on 2 and a ; intercept . (efer Table G . &urther , the
de%iation between WC (y) and the estimated WC (y3) and co:efficient of correlation between
them ha%e been found out .
Ta(le $
Sr.

Y X^2 XY Y^2 Year X
No. Sales GWC
Rs.'00 Rs.'00
Crores Crores
1 1997 1777.3 961.84 3158937.5 1709516.7 925136
2 1998 1042.1 729.06 1085930.7 759738.84 531528
3 1999 1099.4 552.48 1208570.4 607368.89 305234
4 2000 1142.8 472.86 1306014.7 540389.14 223597
Summ 5061.6 2716 6759453 3617014 1985495
,4AN 12-'.$ -.F.1 1-6F6-"." FE$2'".$ $F-".".6
&rom Table G we can say
)ean 2 ; 1"7?."?
)ean y ; 7ED.6?
0y2 ; 0ummation(y2) 9 (0ummation(2).summation(y))=n
( Where n ; number of years )
0y2 ; 1ED556
022 ; 0ummation(2T"):((0ummation(2))T")=n
022 ; 5?G??5
0yy ; 0ummation(yT"):((0ummation(y))T")=n
( 58 )
0yy ; 1G16?A
Co:efficient of Correlation r ; 0y2 = 0$rt.(02220yy)
; 6.A6
b ; 02y=022 ; 6.A6
therefore a ; 55E.16 using the e$uation M;a<b> where M and > are the mean %alues )
The %alue of co:efficient of correlation signifies that there is a direct relation between WC and sales .
Csing these %alues we can arri%e to the e$uation as
M ; 55E.16 < 6.A6>
C. ,perating Cycle
&or the year 1DDD the operating cycle can be calculated as
, ; ( < W < & < - 9 C
( ; (aw )aterial storage period ; #%erage stock of raw materials and stores
#%erage raw material H stores consumption per day
W ; W'* 0torage period ; #%erage W'* 'n%entory
#%erage cost of production per day
& ; &inished +oods 0torage *eriod ; #%erage &inished +oods 'n%entory
#%erage cost of goods sold per day
- ; -ebtors Collection *eriod ; #%erage /ook -ebts
( 59 )
#%erage credit 0ales=day
C ; Creditors *ayment *eriod ; #%erage Trade Credit
#%erage Credit *urchase=day
Partic&lar! ;ear *ep F. ;ear *ep F6 ;ear *ep FF ;ear *ep EE
16 t! 12 t! 12 t! 12 t!

In2entor+ anageent 0 tie! 1
(aw )aterial 5.7 ".DG G.A" 7.AD
0tores Turn o%er E.1A 1.5" 6.A7 6.E"
0emi &inished goods turn o%er 1".1D 15.?? 17.D5 "1.7?
&inished goods turn o%er 1A.7A 1?.1 1D.G5 "D.7?

-ebtors Turn,%er G."1 ".E 5."G 5.?5
Creditors Turno%er 5.1 1.A 1.A7 ".6"

0tock accumulation rate (@) :51.57 :"7."? :15.61 :G7."D
'n%entories = Current assets ( @ ) "G.6G "1.EE 1A.EA 11."1
'n%entories = working Capital( @ ) :157.G? :"7D.71 :1E1.GD A"?.A"

Working Capital C+cle

#%erage -aily ( (s cr )
*urchase of raw material 6.A 6.GE 6.?1 6.?1
Cost of sales G.6E ".55 ".5A ".?7
0ales G.AE ".A? 5.61 5.15

9olding period 0 No! of da+! 1
(aw material and spares 166 1"E ED ?"
*roduction 56 "E "" 1E
&inished goods "6 "G 1D 1"
-ebtors AE 15? 115 165


+ross working capital cycle "57 515 "55 1A?
Credit a%ailed from creditors 11A "65 1D7 1A1
et working capital cycle 11D 111 57 G

+ross working Capital re$d . ( Cr ) D71.AG E"D.67 ??".GA GE".A7
et working capital cycle ( Cr ) GA".7" "?E.?1 A7."E D.DG

Ra7 ,aterial prod&cti2it+ 0 Tie! 1
( 60 )
J,*= (aw material ".GG "."5 5.DA G.D7
+ross Jalue added = raw material cost 1.1A 1.1 1.1" 1.5D

,anageent of *&ndar+ de(tor!
'ncremantal 0ales E6".7G :E5?."D ?E.5 G5.G7
'ncremental Contribution 161.61 :1EA.57 51.5" :"E.GG
'ncremental /ad -ebts G6.5 :?6.?A 6 6
et Contribution 76.E1 :1"E.EA 51.5" :"E.GG

'ncremental -ebtors :1"."1 :?A."E :5?.?? 5."A
'ncremental -ebtors at cost :16." :GE.GD :"A.6G ".7A
,pportunity cost of debtors :5.77 :16.DE :E.D7 6.?E
0urplus 7G.5E :117.A1 5D."A :"A.61

Credit Period 0 No! of da+! 1 6. 1"' 11" 1E"

$. O(!er2ation!
The general performance regarding the Working Capital )anagement in 0. was %ery much
encouraging during the period under study .
The *lus *oints are :
The company is in right direction of reducing the in%entory , it is reduced from E"@ in 1DAA to
G1.A@ in 1DDG and then it is nearly constant there after with G5.?@ in 1DDD of the +WC.
-ebtors ha%e shown an increasing trend say from AE days in 1DDA to 165 days in "661this is
also keeping in mind the recession shown by the market
Through regression analysis we also ha%e realiBed that the estimated working capital and the
actual can be analysed gi%e the standard de%iation between them . The fluctuation between
them is also minimum to operate at a better margins there by increasing o%er all profitability
of the business 4ence the company would not face the risk of ma2imum o%er or under
utiliBation of WC funds which is also an indicator of better efficiency in managing WC on the
part of the company.
,perating Cycle has reduced from 11D days in 1DDA to 1ust G days in the year "661
. *rofit can be increased by controlling (a) bad debts , (b) control o%er -ebtors and (c) also
by controlling in%entory.
( 61 )
3I3LIOGRAP9;
1. #inance India ,agaGine
2. Ann&al Report 0 1FF. 5 2EE1 1
". We( *ite 5 Indiaifoline.co
$. Confideration for ,onitoring Indian 4cono+ 0 *oft7are Pro7e!!1
'. #inancial ,anageent 5 K%an D Hain
.. #inancial ,anageent 5 Pra!annac%andra
6. Ca!% ,anageent and 7orking Capital ,anageent 5 * *rini2a!an
( 62 )