INTRODUCTION

Financial Management is that managerial activity which is concerned with the planning
and controlling of the firms financial resources.
Financial management focuses on finance manager performing various tasks as
Budgeting, Financial Forecasting, Cash Management, Credit Administration, Investment
Analysis, Funds Management, etc. which help in the process of decision making.
Financial management includes management of assets and liabilities in the long run and
the short run.
The management of fixed and current assets, however, differs in three important ways:
Firstly, in managing fixed assets, time is very important; consequently discounting and
compounding aspects of time element play an important role in capital budgeting and a minor
one in the management of current assets. Secondly, the large holdings of current assets,
especially cash, strengthen firms liquidity position but it also reduces its overall profitability.
Thirdly, the level of fixed as well as current assets depends upon the expected sales, but it is only
the current assets, which can be adjusted with sales fluctuation in the short run.
Here, we will be focusing mainly on management of current assets and current liabilities.
Every business needs funds for two purposes for its establishment and to carry out its
day- to-day operations. Long terms funds are required to create production facilities through
purchase of fixed assets such as plant and machinery, land, building, furniture, etc.
Investments in these assets represent that part of firms capital which is blocked on
permanent or fixed basis and is called fixed capital.
Funds are also needed for short-term purposes for the purchase of raw material, payment
of wages and other day to- day expenses etc. These funds are known as working capital.
In simple words, working capital refers to that part of the firms capital which is required
for financing short- term or current assets such as cash, marketable securities, debtors &
inventories. Funds, thus, invested in current assets keep revolving fast and are being constantly
converted in to cash and this cash flow out again in exchange for other current assets. Hence, it is
also known as revolving or circulating capital or short term capital.

Components of Working Capital:The basic components of working capital are:Current assets:a

Inventories
i

Raw Materials and Components

ii

Work in Progress

iii

Finished Goods

iv

Others

Trade Debtors

Loans And Advances

Investments

Cash And Bank Balance

Current Liabilities:
a

Sundry Creditors

Trade Advances

Borrowings

Commercial Banks

Provisions

LITERATURE REVIEW
Purpose:The purpose of this paper is to review research on working capital management
(WCM) and to identify gaps in the current body of knowledge, which justify future research
directions. WCM has attracted serious research attention in the recent past, especially after the
financial crisis of 2008.

Findings:Detailed content analysis reveals that most of the research work is empirical and
focuses mainly on two aspects, impact of working capital on profitability of firm and working
capital practices. Major research work has concluded that WCM is essential for corporate
profitability. The major issues with prior literature are lack of survey-based approach and lack of
systematic theory development study, which opens all new areas for future research. The future
research directions proposed in this paper may help develop a greater understanding of
determinants and practices of WCM.

Practical implications:Till date, literature on classification of WCM has been almost nonexistent. This paper reviews a large number of articles on WCM and provides a classification
scheme in to various categories. Subsequently, various emerging trends in the field of WCM are
identified to help researchers specifying gaps in the literature and direct research efforts.

Originality/value:This paper contains a comprehensive listing of publications on the WCM and

their classification according to various attributes. The paper will be useful to researchers,
finance professionals and others concerned with WCM to understand the importance of WCM.
To the best of the authors knowledge, no detailed SLR on this topic has previously been
published in academic journals.

TYPES OF WORKING CAPITAL:There are broad two categories under which we will learn the concept of working capital.
1. Balance sheet concept
2. Operating Cycle concept
Balance sheet Concept has recognized working capital as
a. Gross Working Capital
b. Net Working Capital

Gross Working Capital means

-The total of all current assets or all short term assets. Current assets here mean cash, marketable
securities, inventories and receivables. They are meant for a lesser period. They represent liquid
asset.
-Gross working capital represents the liquidity position of the organization. That this much of the
asset they are holding for Getting readily available as the cash in the business.

Net Working Capital

It is a broader concept. It works on the principle on solvency. It is more appropriate concept
while analyzing the financial position of an organization. The corporate experts are using
networking capital as a medium to evaluate the short-term financial position of the organization.
What do we mean by Net working capital?
Net working capital means excess of current assets over Current liabilities. Current assets we all
know are cash, marketable securities, receivables and stock. Assuming them to be Rs.100/-and

our current liabilities that means trade creditors, outstanding expenses they all shall form part of
current liabilities assume them to be Rs. 70/-the working capital will come out to be
Working capital = current Assets current liabilities
= 100 70
= 30
This is the formula by which we can assess the net working capital of the organization.

CONCEPT OF WORKING CAPITAL

Working Capital Management is the process of planning and controlling the level and
mix of current assets of the firm as well as financing these assets. Specifically, Working Capital
Management requires financial managers to decide what quantities of cash, other liquid assets,
accounts receivables and inventories the firm will hold at any point of time.
Working capital is the capital you require for the working i.e. functioning of your business in the
short run.
Gross working capital refers to the firms investment in the current assets and includes cash,
short term securities, debtors, bills receivables and inventories.
It is necessary to concentrate on the fact that the investment in the current assets should be
neither excessive nor inadequate.
WC requirement of a firm keeps changing with the change in the business activity and hence the
firm must be in a position to strike a balance between them. The financial manager should know
where to source the funds from, in case the need arise and where to invest in case of excess
funds.
Net working capital refers to the difference between the current assets and the current liabilities.
Current liabilities are those claims of outsiders, which are expected to mature for payment within
an accounting year and include creditors, bills payable, bank overdraft and outstanding expenses.
When current assets exceed current liabilities it is called Positive WC and when current
liabilities exceed current assets it is called Negative WC.
The Net WC being the difference between the current assets and current liabilities is a qualitative
concept. It indicates:

The liquidity position of the firm

Suggests the extent to which the WC needs may be financed by permanent sources of
funds

It is a normal practice to maintain a current ratio of 2:1. Also, the quality of current assets is to be
considered while determining the current ratio. On the other hand a weak liquidity position poses
a threat to the solvency of the company and implies that it is unsafe and unsound. The Net WC

concept also covers the question of judicious mix of long term and short-term funds for financing
the current assets.

NEED AND IMPORTANCE OF WORKING CAPITAL MANAGEMENT

The importance of working capital management stems from the following reasons:
1. Investment in current assets represents a substantial portion of the total investment.
2. Investments in current asset and the level of current liabilities have to be geared quickly
to change in sales, which helps to expand volume of business.
3. Gives a company the ability to meet its current liabilities
4. Take advantage of financial opportunities as they arise.

FACTORS INFLUENCING THE WORKING CAPITAL REQUIREMENT

All firms do not have the same WC needs .The following are the factors that affect the WC
needs:
1. Nature and size of business : The WC requirement of a firm is closely related to the
nature of the business. We can say that trading and financial firms have very less investment
in fixed assets but require a large sum of money to be invested in WC. On the other hand
Retail stores, for example, have to carry large stock of variety of goods little investment in
the fixed assets.
Also a firm with a large scale of operations will obviously require more WC than the smaller
firm.
2. Manufacturing cycle: It starts with the purchase and use of raw materials and completes
with the production of finished goods. Longer the manufacturing cycle larger will be the WC
requirement; this is seen mostly in the industrial products.
3. Business fluctuation: When there is an upward swing in the economy, sales will increase
also the firms investment in inventories and book debts will also increase, thus it will
increase the WC requirement of the firm and vice-versa.
4. Production policy: To maintain an efficient level of production the firms may resort to
normal production even during the slack season. This will lead to excess production and
7

hence the funds will be blocked in form of inventories for a long time, hence provisions
should be made accordingly. Since the cost and risk of maintaining a constant production is
high during the slack season some firms may resort to producing various products to solve
their capital problems. If they do not, then they require high WC.
5. Firms Credit Policy: If the firm has a liberal credit policy its funds will remain blocked
for a long time in form of debtors and vice-versa. Normally industrial goods manufacturing
will have a liberal credit policy, whereas dealers of consumer goods will a tight credit policy.
6. Availability of Credit: If the firm gets credit on liberal terms it will require less WC
since it can always pay its creditors later and vice-versa.
7. Growth and Expansion Activities: It is difficult precisely to determine the
relationship between volume of sales and need for WC. The need for WC does not follow
the growth but precedes it. Hence, if the firm is planning to increase its business activities, it
needs to plan its WC requirements during the growth period.
8. Conditions of Supply of Raw Material: If the supply of RM is scarce the firm may
need to stock it in advance and hence need more WC and vice-versa.
9. Profit Margin and Profit Appropriation: A high net profit margin contributes
towards the WC pool. Also, tax liability is unavoidable and hence provision for its payment
must be made in the WC plan, otherwise it may impose a strain on the WC.
Also if the firms policy is to retain the profits it will increase their WC, and if they
decide to pay their dividends it will weaken their WC position, as the cash will flow out.
However this can be avoided by declaring bonus shares out of past profits. This will help the
firm to maintain a good image and also not part with the money immediately, thus not affecting
the WC position.
10.

Depreciation policy: of the firm, through its effect on tax liability and retained

earnings, has an influence on the WC. The firm may charge a high rate of depreciation, which
will reduce the tax payable and also retain more cash, as the cash does not flow out. If the
dividend policy is linked with net profits, the firm can pay fewer dividends by providing more
depreciation. Thus depreciation is an indirect way of retaining profits and preserving the firms
WC position.

OPERATING CYCLE

CASH

BILLS
RECEVIABL

RAW
RAW MATERIAL

RAW MATERIAL

WORK IN
PROGRESS

Permanent and variable working capital:

The minimum level of current assets required is referred to as permanent working capital and
the extra working capital needed to adapt to changing production and sales activity is called
temporary working capital.

10

RESEARCH METHODOLOGY

STATEMENT OF OBJECTIVES:

Primary objective
Secondary objective

NEED OF THE STUDY:

Working capital management plays a vital role in any organization and one
should have a thorough knowledge about the working capital position.
In view of this context, I have undertaken this study and it would be a great
advantage to the company also, to know its working capital position.

SCOPE OF THE STUDY:

The scope of the study is confined to the analysis of solvency & profitability position of
the company. The data collected from both primary and secondary data.
Primary data
Primary data has been collected through personal interviews with finance department and the
executive
Secondary data
Secondary data collected from the records like B/S, income statement and necessary records.

Disclosed fully. This is set back while drawing the conclusion.

The study is based on 5 annual financial reports only.

11

The information from annual reports is insufficient to calculate few ratios.

Limited time does not allowed to do more analysis.

PERIOD OF THE STUDY:The period of the study was four months from January to April 2008, During the period
all the required data was collected through secondary sources and analyzed with the help of
financial tools of analysis. It includes data collection analysis of data and interpretation.

TOOLS APPLIED IN THE STUDY: Working capital ratios

Liquidity ranking
Operating cycle
Analysis of current assets and current liabilities.

METHODOLOGY:The objective of the study is to analyze the working capital position of the company for
the past five years from and to achieve those objective the following methodology was adopted.
Firstly to find out liquidity and solvency position of the company through working capital
ratios.
Secondly to study the Liquidity position of the company by using liquidity ranking
method.
Thirdly to estimate the working capital requirement of the company by using Operating
cycle.
Finally Analysis of current assets and current liabilities.

LIMITATAIONS OF THE STUDY:1

The analysis was confined to a period of five years during

Financial statement of prepare on the basis of certain accounting concepts in conventions

any change in methods are procedures of accounting will limit the utility of financial
statements.
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ROLE OF FINANCIAL MANAGER IN WORKING CAPITAL MANAGEMENT

1

Working capital management requires must of the finance manager time as it

represent a large position of investment is assets

Working capital management requires much of the finance management time as it

represent larger position of investment in assets.

Action should be taken to curtail unnecessary investment in current assets.

All precaution should be taken for the effective and efficient management of
working capital.

Larger firms have to manage their current assets and current liabilities very
carefully and should see that the work should be done properly in order to achieve
predetermined organizational goals.

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FINANCING CURRENT ASSETS

LEVEL OF CURRENT ASSETS REQUIRED
An important WC policy decision is concerned with the level of investment in current
assets. Under a flexible policy or conservative policy the investments in current assets is high.
This means that the firm maintains a huge balance of cash and marketable securities carries a
large amount of inventories and grants generous amount of credit to customers, which leads to
high level of debtors.
Under a restrictive policy or aggressive policy the investment in current assets is low.
Determining the optimum level of current assets involves a tradeoff between costs that rise
and fall with current assets. The former are referred as carrying costs and the latter as shortage
costs. Carrying costs are mainly in the nature of cost of financing a higher level of current assets.
Shortage costs are mainly in the form of disruption in production schedule, loss of sale, and loss
of customer goodwill, etc. Normally the total cost curve is flatter around the optimal level. Hence
it is difficult to precisely find the optimal level.

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CURRENT ASSETS FINANCING POLICY

After establishing the level of current assets, we further need to decide what mix of long-term
capital and short-term debt should the firm employ to support it current assets. Three kind of
financing can be distinguished; long term financing, short term financing and spontaneous
financing.
Sources of long term financing are shares, debentures, preference share, retained earnings
and debt from financial institution, sources of short term finance include bank loans, commercial
papers and factoring receivables, whereas, spontaneous source of finance refers to the automatic
sources of short term funds like creditors, bills payable and other outstanding expenses.
The firms to finance its WC requirements may use one of the following three strategies:
Strategy A: Only long-term sources are used to finance its entire WC requirements.
When the WC requirements are less then the peak level the balance is invested in liquid
assets like cash and marketable securities.
However it leads to inefficient management of funds as you may have to pay
high interest or you could invest it in other places where you could earn good returns.
Strategy B: Long-term financing is used to meet the fixed asset requirements,
permanent WC requirement and a portion of fluctuating WC requirement. During
seasonal upswings, short- term financing is used, during seasonal down swings surplus is
invested in liquid assets. This is also called the conservative approach.
This is the middle route, where at least

you

know that you normally wouldnt

fall short of WC. However you could still make better use of your funds.

15

 Strategy C: Long-term financing is used

to meet the fixed asset requirements

and permanent WC requirement while

short

term

financing is used to finance the fluctuating

needs.
This is a little riskier strategy, as you
not always be able to arrange for WC
when you need and hence may cause a considerable

may
finance

as

and

loss in terms of money,

reputation, etc.
Under the aggressive approach, the firm finances a part of its permanent current assets with
short term financing. Sometimes they may even finance a part of their fixed assets with shortterm sources.

Matching Approach / Hedging Approach: It

involves

matching the expected life of assets with the expected life of

the source of funds raised to finance assets ex: a ten year

loan

may

be used to finance machinery with an expected life of ten

years.
Using long-term finance for short-term assets is

expensive,

as the funds will not be fully utilized. Similarly, financing long term assets with short term
financing is costly as well as inconvenient as arrangement for the new short term financing will
have to be made on a continuing basis. However, it should be noted that exact matching is not
possible because of the uncertainty about the expected life of assets.
COST OF FINANCING:
In developed countries it has been observed that the rate of interest is related to the maturity of
the debt. This relationship between the maturity of debt and its cost is called the term structure
of interest rates. The curve related to it is called the yield curve, which is generally upward
sloping. Longer the maturity period, higher is the rate of interest.
16

The liquidity preference theory justifies the high rate of interest on debt with long
maturity period. No moneylender would want to take high risk of giving loan, which will be paid
after a long period of time, and hence, the only way to induce him or her to give loan would be to
pay high interest rate, thus, short term financing is desirable from the point of view of return.

Flexibility: It is easier to repay short-term loans and hence if the firm were of the opinion that
it would require lesser funds in near future, it would be better to go in for short-term sources.

Risk Of Financing: Long- term sources though expensive are less risky as you are always
assured of at least the minimum funds required by you, on the other hand you may not always be
able to get finance from short-term sources which in turn could hamper the functioning of your
business. Also though the return on equity is always higher in case of aggressive policy, it is
much more costly.

OPTIMAL CASH BALANCE

17

Cash balance is maintained for transaction purposes and an additional amount may be
maintained as a buffer or safety stock. It involves a tradeoff between the costs and the risk.
If a firm maintains a small cash balance, it has to sell its marketable securities and
probably buy them later more often, than if it holds a large cash balance. More the number of
transactions more will be the trading cost and vice-versa; also, lesser the cash balance, less will
be the number of transaction and vice-versa. However the opportunity cost of maintaining the
cash rises, as the cash balance increases.

WHY DOES A FIRM NEED CASH?

i.

Transaction motive: firm needs cash for transaction purpose.

ii.

Precautionary motive: The magnitude and time of cash inflows and outflows is
always uncertain and hence the firms need to have some cash balances as a buffer.

18

iii.

Speculative motive: All firms want to make profits from fluctuations in commodity
prices, security prices, interest rates and foreign exchange rates .A cash rich firm is in a
better position to exploit such bargains. Hence, the firm with such speculative leanings
may carry additional liquidity.

The firm must decide the quantum of transactions and precautionary balances to be held,
which depends upon the following factors:
The expected cash inflows and outflows based on the cash budget and
forecasts, encompassing long/short range cash needs of the firm.
The degree of deviation between the expected and actual net cash flow.
The maturity structure of the firms liabilities.
The firms ability to borrow at a short notice, in case of emergency.
The philosophy of management regarding liquidity and risk of insolvency
The efficient planning and control of cash.

CASH PLANNING
Cash planning is a technique to plan for and control the use of cash. The forecast may be based
on the present operations or the anticipated future operations.
Normally large, professionally managed firms do it on a daily or weekly basis, whereas,
medium size firms do it on a monthly basis. Small firms normally do not do formal cash
planning, in case they do it; its on a monthly basis.
As the firm grows and its operation becomes complex, cash planning becomes inevitable
for them.

19

CASH FORECASTING AND BUDGETING:

A cash budget is a summary statement of the firms expected cash inflows and outflows over
a projected time period.
It helps the financial manager to determine the future cash needs, to arrange for it and to
maintain a control over the cash and liquidity of the firm. If the cash flows are stable, budgets
can be prepared monthly or quarterly, if they are unstable they can be prepared daily or weekly.
Cash budgets are helpful in:
Estimating cash requirements
Planning short term financing
Scheduling payments in connection with capital expenditure
Planning purchases of materials
Developing credit policies
Checking the accuracy of long- term forecasts.

Short Term Forecasting Methods

Two most commonly used methods of short- term forecasting are:
i.
ii.

The receipt and payment method

The adjusted net income method

The receipt and payment method is used for forecasting limited periods, like a week or a month,
whereas, the adjusted net income method is used for longer durations. The cash flows can be
compared with budgeted income and expense items if the receipts and payment approach is
followed. On the other hand the adjusted net income method is appropriate in showing the
companys working capital and future financing needs.

20

OBSERVATIONS REGARDING WORKING CAPITAL MANAGEMENT IN

SMALL SCALE INDUSTRIES
Since it was a matter relating to finance, not everybody revealed all the aspects of
working capital management. However an effort was put in to get the maximum out of them .The
following conclusion can be made on the basis of information gathered:
Most of them are not very professionally managed and hence they are really not aware of
their working capital policy as to whether it is aggressive or conservative. Basically they are not
very conscious about it. However now they have started realizing the importance of cost of
money and have started planning their cash.

Cash management:
They are facing problems managing their cash as their cash is mainly stuck in debts and
inventory, to overcome this they try and discount the bill with the bank as soon as possible, deal
only on cash basis and keep the credit period to the minimum.

Receivables management:
They try to match the credit they get with the credit period they give, for efficient
management, as is in the case of Girnar packaging. (Matching approach)
Debtors take unusually long time to repay and hence most of their funds are blocked in
there. They need efficient receivable management system. Since they are SSIs it is
practically difficult for them to have contract for payment period over which they can
charge interest, also there is more personal relation with their customers and they
normally wouldnt take immediate action if the payment is not made on time.

21

Inventory management:
Though most of them are not very professionally managed, some of them are now
practicing JIT and are aware of the EOQ concept. They have realized the need to reduce
blockage of funds in inventory and are working towards it.
Trying to reduce the lead time and servicing the orders as fast as possible is the only
way out for them.

Financing for WC:

Their main source of their cash has been bank loans. Many of them have taken bank
loans at very high interest rates. At times they give 200% collateral as is in the case of
Shivam packaging. Thus they are paying a high cost of cash and hence need better cash
management.
Many of them take cash credit to finance their fluctuating WC needs
Cash credit limit is fixed on the basis of sundry debtors and stock hypothecated. Hence
collateral is very important for obtaining bank loans.
Obtaining bank finance is not only about past performance and future projections but
also about developing trust-based relationship with the bankers. This makes obtaining
loans easier.

22

INVESTMENT OF SURPLUS FUNDS

INVESTMENT IN MARKETABLE SECURITIES

The excess amount of cash held by the firm to meet its variable cash requirements and
future contingencies should be temporarily invested in marketable securities for earning
returns. In choosing among the alternative securities the firm should examine three basic
features of security:
Safety: The firm has to invest in a security, which has a low default risk. However
it should be noted that, higher the default risk, higher the return on security and viceversa.
Maturity: Maturity refers to the time period over which interest and principle are
to be paid. The price of long-term securities fluctuates more widely with the change
in interest rates, then the price of short-term security. Over a period of time interest
rates have a tendency to change, and hence, long-term securities are considered to be
riskier, thus less preferred.
Marketability: If the security can be sold quickly and at a high price it is
considered to be a highly liquid or marketable. Since the firm would need the
invested money in near future for meeting its WC requirements, it would invest in
security, which is readily marketable. Normally securities with low marketability
have high yields and vice-versa.

23

TYPE OF MARKETABLE SECURITIES

The choice in this case is restricted to the govt. treasury bills and commercial bank deposits.
Treasury bills: It represents short-term obligations of govt. that have maturities
like 91 days, 182 days and 364 days. They are instead sold at a discount and
redeemed at par value. Though the return on them is low they appeal for the
following reasons:
i.

Can be transacted easily as they are issued in bearer form.

ii.

There is a very active secondary market for treasury bills and the Discount
and Finance House of India is a major market maker.

iii.

They are virtually risk- free.

Commercial bank deposits: The firm can deposit its excess cash with
commercial banks for a fixed interest rate, which further depends on the period of
maturity. Longer the period, higher the rate .It is the safest short run investment
option for the investors. If the firm wishes to withdraw its funds before maturities, it
will lose on some interest.

OTHER OPTIONS FOR INVESTING SURPLUS FUNDS

Ready Forwards: A commercial bank or some other organization may do a

ready forward deal with a firm interested in deploying surplus funds on shortterm basis. Here, the bank sells and repurchases the same securities (this means
that the company, in turn, buys and sells securities) at prices determined before
hand. Hence, the name ready forward. The return in ready forward deal is closely
24

linked to money market conditions, which is tight during the peak season as well
as the time of year closing.

Commercial paper: It represents short term unsecured promissory notes

issued by firms that are generally considered to be financially strong .It has a
maturity period of 90 or 180 days. It is sold at a discount and redeemed at par. It is
either directly placed with the investor or sold through dealers. Its main benefit is
that it offers high interest rate, while its main drawback is that it does not have a
developed secondary market.

Inter-corporate deposits: A deposit made by a company with another,

normally up to a period of six months is referred to as an inter-corporate deposit.
They are usually of three types:
i.

Call deposits: It is withdraw able by lender on giving a days notice.

However in practice, the lender has to wait for at least three days.

ii.

Three-month deposits: These deposits are taken by the borrowers to tide

over a short-term inadequacy.

iii.

Six- month deposits: Normally lending companies do not extend deposits

beyond this time frame. Such deposits are usually made with first class
borrowers.

The lending company has to assured about the credit worthiness of the borrowing company, as it
is an unsecured loan. In addition it must fulfill the following requirements as stipulated by
section 370 of the COMPANYS ACT:
1. Company cannot lend more than 10 % of its net worth to any
single company.
25

2. The total lending of a company cannot exceed 30% of its net

worth without the prior approval of the central govt. and a special
resolution permitting such excess lending.

Bill discounting: A company may also deploy its surplus funds to

discount/purchase the bills the way a bank does. As bills are self-liquidating
instruments, bill discounting may be considered superior to lending in the intercorporate deposit market. While participating in bill discounting a company should:
i.

Ensure that the bills are trade bills

ii.

Try to go for bills backed by letter of credit rather than open bills as
the former are more secure because of the guarantee provided by the
buyers bank.

26

MANAGEMENT OF DEBTORS
Cash flow can be significantly enhanced if the amounts owing to a business are collected
faster. Slow payment has a crippling effect on business, in particular on small businesses that can
least afford it. If you don't manage debtors, they will begin to manage your business as you
will gradually lose control due to reduced cash flow and, of course, you could experience an
increased incidence of bad debt.
The following measures will help manage your debtors:
Make sure that the control of credit gets the priority it deserves.
Establish clear credit practices as a matter of company policy.
Make sure that these practices are clearly understood by staff, suppliers and customers.
Be professional when accepting new accounts, and especially larger ones.
Check out each customer thoroughly before you offer credit. Use credit agencies, bank
references, industry sources etc.
Establish credit limits for each customer... and stick to them.
Continuously review these limits when you suspect tough times are coming or if
operating in a volatile sector.
Keep very close to your larger customers.
27

 Invoice promptly and clearly.

Consider charging penalties on overdue accounts.
Consider accepting credit /debit cards as a payment option.
Monitor your debtor balances and ageing schedules, and don't let any debts get too
large or too old.
Debtors due over 90 days unless within agreed credit terms should generally demand immediate
attention.
A customer who does not pay is not a customer. Here are a few ideas that may help you in
collecting money from debtors:
Develop appropriate procedures for handling late payments.
Track and pursue late payers.
Get external help if your own efforts fail. .
In difficult circumstances, take what you can now and agree terms for the remainder. It
lessens the problem.
When asking for your money, be hard on the issue - but soft on the person. Don't
give the debtor any excuses for not paying.

Goal Of Credit Management

To manage the credit in such a way that sales are expanded to an extent to which the risk
remains within an acceptable limit. Hence for maximizing the value, the firm should manage its
credit to:

28

 Obtain optimum not maximum value of sales.

Control the cost of credit and keep it at minimum.
Maintain investment in debtors at optimum level.

FINANCE IN WORKING CAPITAL

After determining the level of Working Capital, the firm has to decide how it is to be financed.
The need for finance arises mainly because the investment in working capital/current assets, that
is, raw material, work-in-progress, finished goods and receivables typically fluctuates during the
year. Although long-term funds partly finance current assets and provide the margin money for
working capital, such working capitals are virtually exclusively supported by short term sources.
The main sources of working capital financing are namely, Trade credits, Bank credits and
commercial bankers.

1. Trade Credit

29

Trade credit refers to the credit extended by the supplier of goods and services in the normal
course of business of the firm. According 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. It is an informal agreement between the
buyer and the seller. Such 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 extend credits indiscriminately. Their decision as well as the quantum is based on
a consideration of factors such as earnings record over a period of time, liquidity position of the
firm and past record of payment.

Advantages
i

It is easily, almost automatically available.

ii

It is flexible and spontaneous source of finance.

iii

The availability and the magnitude of trade credit is related to the size of operation of the
firm in terms of sales/purchases.

iv

It is also an informal, spontaneous source of finance.

Trade credit is free from restrictions associated with formal/negotiated source of

finance/credit.

2 Bank Credit
Bank credit is primarily institutional source of working capital finance in India. In fact, it
represents the most important source for financing of current assets. Working Capital finance is
provided by banks in five ways:
a

Cash Credit / Overdrafts: Under cash credit/ overdraft agreement of bank

finance, the bank specifies a predetermine borrowing/credit limit. The burrower
can borrow up to the stipulated credit. Within the specified limit, any number of
drawings is possible to the extent of his requirements periodically. Similarly,
repayment can be made whenever desired during the period. The interest is
determined on the basis of the running balance/amount actually utilized by the
burrower and not on the sanctioned limit. However, a minimum charge may be
30

payable on the unutilized balance irrespective of the level of borrowing for

availing of the facility. This type of financing is highly attractive to the burrowers
because, firstly, it is flexible in that although borrowed funds are repayable on
demand, and, secondly, the burrower has the freedom to draw the amount in
advance as a when required while the interest liability is only on the amount
actually outstanding. However, cash credit/overdraft is inconvenient to the banks
and hampers credit planning. It was the most popular method of bank financing of
working capital in India till the early nineties. With the emergence of the new
banking since mid-nineties, cash credit cannot at present exceed 20% of the
maximum permissible bank finance (MPBF)/credit limit to any borrower.
b

Loans: 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. As a form of financing,
loans imply a financial discipline on the part of the borrowers. From a modest
beginning in the early nineties, at least 80% of MPBF must be in form of loans in
India.

Bills Purchased/Discounted: This arrangement is of relatively recent origin in

India. With introduction of the New Bill Market Scheme in 1970 by RBI, bank
credit is being made available through discounting of usance bills by banks. The
RBI envisaged the progressive use of bills as an instrument of credit as against the
prevailing practice of using the widely-prevalent cash credit arrangement for
financing working capital. The cash credit arrangement gave rise to unhealthy
practices. As the availability of bank credit was unrelated to production needs,
borrower enjoyed facilities in excess of their legitimate needs. Moreover, it led to
double financing. This was possible because credit was taken from different
agencies for financing the same activity. This was done, for example, 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 diversion of credit to other purposes.
Before discounting he bill, the bank satisfies itself about the credit worthiness of the
31

drawer and the genuineness of the bill. To popularize the scheme, the discount rates
are fixed at lower rates than those of cash credit. The discounting banker asks the
drawer of the bill to have his bill accepted by the drawee bank before discounting it.
The later grants acceptance against the cash credit limit, earlier fixed by it, on the
basis of the borrowing value 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 exceeding 90 days. On acceptance of the bill by the purchaser, the seller
offers it to the bank for discount/purchase. On 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/RBI. However, this form of financing is not popular in the country.
d)

Term Loans for Working Capital:

Under this arrangement, banks

advance loans for 3-7 years payable in yearly or half-yearly installments.

a

Letter of Credit :

While the other forms of bank credit are direct forms of

financing in which banks provide 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 provided 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/extends credit to the purchaser, the bank gives a
guarantee and bears risk only in case of default by the purchaser.

3 Mode of Security
a

Hypothecation: Under this mode of security, the banks provide credit to borrowers
against the security of movable property, usually inventory of goods. The goods
32

hypothecated, however, 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. Although the bank does not have physical
possession of the goods, it has the legal right to sell the goods to realize the outstanding
loan. Hypothecation facility is normally is not available to new borrowers.
b

Pledge: Pledge, 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. An, essential perquisite of pledge, therefore, is that the
goods are in the custody of the bank. The borrower, who offers the security is, called a
paw nor (pledger), while the bank is called the Pawnee (pledgee). The lodging of
goods by the pledger to the pledgee is a kind of bailment. Therefore, pledge creates some
liabilities for the bank. It must take reasonable care of goods pledged with it. In case of
non-payment of the loans, the bank enjoys the right to sell the goods.

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. Lien can be of two types: (i) particular lien, and (ii)
general lien. Particular lien is a right to retain goods until a claim pertaining to theses
goods is fully paid. On the other hand, general lien can be applied till all dues of the
claimant are paid. Banks usually enjoy general lien.

Mortgage: It is the transfer of a legal/equitable interest in specific immovable 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 favor the transfer takes place is the mortgagee.
The instrument of transfer is called the mortgage deed. Mortgage is, thus, conveyance of
interest in the mortgaged property. The mortgage interest in the property is terminated as
soon as the debt is paid. Mortgage are taken as an additional security for working capital
credit b banks.

Charge: Where immovable 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 have a charge on the property
and all the provisions of simple mortgage will apply to such a charge. The provision are
as follows:

33

A charge is not the transfer of interest in the property though it is security for
payment. But mortgage is a transfer of interest in the property.

A charge may be created by the act of parties or by the operation of law. But a
mortgage can be created only by the act of parties.

A charge need not be made in writing but a mortgage deed must be attested.

Generally, a charge cannot be enforced against the transferee for consideration

without notice. In a mortgage, the transferee of the mortgage property can
acquire the remaining interest in the property, if any is left.

4 Reserve Bank of India Framework for Regulation of Bank Credit

After mid-nineties, the framework for regulation of bank credits has been relaxed
permitting banks greater flexibility in tune with the emergence of new banking in the country,
focusing on viability and profitability in contrast to the earlier thrust on social/development
banking. The notable features of the framework/regulation related to fixation of norms for
bank lending to industry. The norms are:
a

Inventory and Receivable Norms: The norms refer to the maximum level for
holding inventories and receivables in each industry. Raw materials were expressed as so
many months consumptions; WIP as so many months cost of production; finished goods
and receivables as so many months of cost of sales and sales respectively. These norms
represent the maximum levels of holding inventory and receivables in each industry.
Borrowers were not expected to hold more than that level. The fixation of these norms
was, thus, intended to reduce the dependency of industry on bank credit.

Lending Norms/Approach to Lending/MPBF: According 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 vitally significant. It takes into account all
the current assets requirements of borrowers total operational needs and not merely
inventories or receivables; it also takes into account all the other sources of finance at his

34

command. Another merit of the approach is that it invariably ensures a positive current
ratio and, thus, keeps under check any tendency to overtrade with borrowed funds.
c

Forms of Financing/Style of Credit: In 1995, a mandatory limit on cash credit

and a loan system of delivery of bank credit was introduced. The cash-credit limit was
initially limited to 60% of the MPBF. The balance 40% could be availed of as short term
loans. The cash credit limit sanctions are currently 20% and loan component 80%.

Information and Reporting System : The main components of the information

and reporting system are four, namely,

Quarterly Information System: Form I. Its contents are (i) production and
sales estimates for the current and the next quarter, and (ii) current assets and
current liabilities estimates for the next quarter.

Quarterly Information System: Form II. It 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 quarter.

Half-yearly Operating Statement: Form III. The actual operating

performances for the half-year ended against the estimates are given in this.

Half-yearly Operating Statement: Form IIIB. The estimates as well as the

actual sources and uses of funds for the half-year ended are given.

5 Commercial Papers
Commercial Paper (CP) is a short term unsecured negotiable instrument, consisting of usance
promissory notes with a fixed maturity. It is issued on a discount on a face value basis but it can
also be issued in interest bearing form. A CP when issued by a company directly to the investor is
called a direct paper. The companies announce current rates of CPs of various maturities, and
investors can select those maturities which closely approximate their holding period. When CPs
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 level. The maturities
of CPs can be tailored within the range to specific investments.
a) Advantages
-

CP is a simple instrument and hardly involves any documentation.

35

It is flexible in terms of maturities which can be tailored to match the cash flow of
the issuer.

A well rated company can diversify its sort-term sources of finance from banks to
money market at cheaper cost.

The investors can get higher returns than what they can get from the banking
system.

Companies which are able to raise funds through CPs have better financial
standing.

The CPs are unsecured and there are no limitations on the end-use of funds raised
through them.

As negotiable/transferable instruments, they are highly liquid.

b) Framework of Indian CP Market

The CPs emerged as sources of short-term financing in the early nineties. They are regulated by
RBI. The main element of present framework are given below.

CPs can be issued for periods ranging between 15 days and one year. Renewal of CPs is
treated as fresh issue.

The minimum size of an issue is Rs.25 lakh and the minimum unit of subscription is Rs.5
lakh.

The maximum amount that a company can raise by way of CPs is 100% of the working
capital limit.

A company can issue CPs only if it has a minimum tangible net worth of Rs.4 crore, a
fund-based working limit of Rs.4 crore or more, at least a credit rating of P2 (Crisil ), A2
( Icra ), PR-2 ( Care ) and D-2 ( Duff & Phelps ) and its borrowal account is classified as
standard asset.

The CPs should be issued in the form of usance promissory notes, negotiable by
endorsement and deliver at a discount rate freely determined by the issuer. The rate of
discount also includes the cost of stamp duty (0.25 to 0.5%), rating charges (0.1 to 0.2%),
dealing bank fee (0.25%) and stand by facility (0.25%).

36

The participants/investors in CPs can be corporate bodies, banks, mutual funds, UTI,
LIC, GIC, and NRIs on non-repatriation basis. The Discount and Finance House of India
(DFHI) also participates by quoting its bid and offer prices.

The holder of CPs would present them for payment to the issuer on maturity.

c) Effective

Cost/Interest Yield

As the CPs are issued at discount and redeemed at it face value, their effective pre-tax
cost/interest yield
= { (Face Value Net amount realized) / (Net amount realized) }x{(360) / (Maturity period) }
where net amount realized = Face value discount issuing and paying agent (IPA) charges that
is, stamp duty, rating charges, dealing bank fee and fee for stand by facility.

6 Factoring
Factoring provides resources to finance receivables as well as facilitates the collection of
receivables. Although such services constitute a critical segment of the financial services
scenario in the developed countries, they appeared in the Indian financial scene only in the early
nineties as a result of RBI initiatives. There are two bank sponsored organizations which provide
such services: (i) SBI Factors and Commercial Services Ltd., and (ii) Can bank Factors Ltd. The
first private sector factoring company, Foremost Factors Ltd. Started operations since the
beginning of 1997.
a

Definition : Factoring can broadly be defined as an agreement in which receivables

arising out of sales or goods/services are sold by a firm ( client ) to the factor ( a
financial intermediary ) as a result of which the title of the goods/services represented by
the said receivables passes on to the factor. Henceforth, the factor becomes responsible
for all credit control, sales accounting and debt collection from the buyer. In a full service
factoring concept (without resource facility), if any of the debtor fails to pay the dues as a
result of his financial inability/insolvency/bankruptcy, the factor has to absorb the losses.

37

Mechanism: Credit sales generate the factoring business in the ordinary course of
business dealings. Realization of credit sales is the main function of factoring services.
Once a sale transaction is completed, the factor steps in to realize the sales. Thus the
factor works between the seller and the buyer and sometimes with the sellers bank
together.

Functions of a Factor : Depending on the type/form of factoring, the main functions

of a factor, in general terms, can be classified into five categories:

Financing facility/trade debts :

The unique feature of factoring is that a factor purchases the book debts of his
client at a price and the debts are assigned in favor of the factor who is usually
willing to grant advances to extent of, say, 80% of the assigned debts. Where the
debts are factored with recourse, the finance provided would become refundable
by the client in case of non-payment of the buyer. However, where the debts are
factored without recourse, the factors obligation to the seller becomes absolute
on the due date of the invoice whether or not the buyer makes the payment.

ii) Maintenance/administration of sales ledger:

The factor maintains the clients sales ledger. In addition, the factor also maintains
a customer-wise record of payments spread over a period of time so that any
change in the payment pattern can be easily identified.
iii) Collection facility of accounts receivable:
The factor undertakes to collect the receivables on the behalf of the client
relieving him of the problems involved 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 savings in manpower, time
and efforts.

iv) Credit Control and Credit Restriction:

The factor in consultation with the client fixes credit limits for approved
customers. Within these limits, the factor undertakes to purchase all trade debts of
38

the customer without resource. In other words, the factor assumes the risk of
default in payment by the customer. Operationally, 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 value of goods sold by the client to the customer.
v) Advisory Services:
These services are a spin-off of the close relationship between a factor and a
client. By virtue of their specialized knowledge and experience in finance and
credit dealings and access to extensive credit information, factors can provide a
variety of incidental advisory services to their clients.
vi

Cost of Services:
The factors provide various services at a charge. The charge for collection and
sales ledger administration is in the form of a commission expressed as a value of
debt purchased. It is collected in advance. The commission for short term
financing as advance part-payment is in the form of interest charge for the period
between the date of advance payment and the date of collection date. It is also
known as discount charge.

39

FINANCIAL STATEMENTS
Financial statement is a collection of data organized according to logical and consistent
accounting procedure to convey an under-standing of some financial aspects of a business firm.
It may show position at a moment in time, as in the case of balance sheet or may reveal a series
of activities over a given period of time, as in the case of an income statement. Thus, the term
financial statements generally refers to the two statements
(1) The position statement or Balance sheet.
(2) The income statement or the profit and loss Account.
OBJECTIVES OF FINANCIAL STATEMENTS:
According to accounting Principal Board of America (APB) states
The following objectives of financial statements: 1. To provide reliable financial information about economic resources and obligation of a
business firm.
2. To provide other needed information about charges in such economic resources and obligation.
3. To provide reliable information about change in net resources (recourses less obligations)
missing out of business activities.
4. To provide financial information that assets in estimating the learning potential of the
business.

40

LIMITATIONS OF FINANCIAL STATEMENTS:Though financial statements are relevant and useful for a concern, still they do not present a final
picture a final picture of a concern. The utility of these statements is dependent upon a number of
factors. The analysis and interpretation of these statements must be done carefully otherwise
misleading conclusion may be drawn.
Financial statements suffer from the following limitations: 1. Financial statements do not given a final picture of the concern. The data given in these
statements is only approximate. The actual value can only be determined when the business is
sold or liquidated.
2. Financial statements have been prepared for different accounting periods, generally one year,
during the life of a concern. The costs and incomes are apportioned to different periods with a
view to determine profits etc. The allocation of expenses and income depends upon the personal
judgment of the accountant. The existence of contingent assets and liabilities also make the
statements imprecise. So financial statement are at the most interim reports rather than the final
picture of the firm.
3. The financial statements are expressed in monetary value, so they appear to give final and
accurate position. The value of fixed assets in the balance sheet neither represent the value for
which fixed assets can be sold nor the amount which will be required to replace these assets. The
balance sheet is prepared on the presumption of a going concern. The concern is expected to
continue in future. So fixed assets are shown at cost less accumulated depreciation. Moreover,
there are certain assets in the balance sheet which will realize nothing at the time of liquidation
but they are shown in the balance sheets.
4. The financial statements are prepared on the basis of historical costs or original costs. The
value of assets decreases with the passage of time current price changes are not taken into
account. The statement are not prepared with the keeping in view the economic conditions. the
balance sheet loses the significance of being an index of current economic realities. Similarly, the
profitability shown by the income statements may be represent the earning capacity of the
41

concern.
5. There are certain factors which have a bearing on the financial position and operating result of
the business but they do not become a part of these statements because they cannot be measured
in monetary terms. The basic limitation of the traditional financial statements comprising the
balance sheet, profit & loss A/c is that they do not give all the information regarding the financial
operation of the firm. Nevertheless, they provide some extremely useful information to the extent
the balance sheet mirrors the financial position on a particular data in lines of the structure of
assets, liabilities etc. and the profit & loss A/c shows the result of operation during a certain
period in terms revenue obtained and cost incurred during the year. Thus, The financial position
and operation of the firm.

FINANCIAL STATEMENT ANALYSIS

It is the process of identifying the financial strength and weakness of a firm from the available
accounting data and financial statements. The analysis is done.

42

ESTIMATION OF WORKING CAPITAL REQUIREMENT

(AN EXAMPLE)

AVERAGE PERIOD OF ESTIMATE

ELEMENTS

CREDIT

COMING YEAR

Purchase of materials

6 weeks

2,60,000

Wages

1.5 weeks

1,95,000

Rent

2 months

48,000

Salaries

1 month

36,000

Office expense

2 weeks

45,500

2 months

60,000

FOR

Admin. o/h

Factory

o/h

(Includes

depreciation 20%)
Sales
Cash
Credit

14,000
7 weeks

6,50,000
43

Raw materials are in stock for 4 weeks

FG are in stock for 1 month

Process time 15 days

Factory overheads and wages accrue evenly

FG are valued at cost of production

Minimum cash balance required is 40,000

Assumptions:
1) Production and sales are evenly distributed throughout the year
2) Raw materials are issued to production right in the beginning, whereas wages and
overheads are incurred evenly.
3) 15 days is taken as 2 weeks
1) 1year = 52 weeks

SOLUTION:Budgeted P/L

ELEMENT

YEARLY

WEEKLY

Raw Material

2,60,000

5,000

Wages

1,95,000

3,750

44

Prime Cost

4,55,000

8,750

Overheads

60,000

1,154

Cost Of Goods Sold

5,15,000

9,904

Calculation of Working Capital Requirement

CURRENT ASSETS

RS.

RS.

(A) Stock
Raw Material
20,000
(2,60,000/52 *4)
Finished Goods
39,616

59,616

(515,000/52*4)
(B) WIP
Raw Material
10,000
(2,60,000/52*2)

45

Wages
3,750
(1,95,000/52*2*0.5)
Overheads
1,154

14904

(60,000/52 *2*0.5)
(C) Debtors
87,500
(6,50,000/52*7)
(D) Cash

40,000

TOTAL C.A.

2,02,020

(-)CURRENT LIABILITIES

(A) Creditors
Raw materials
30,000
(2,60,000/52*6)
(B)Wages
5,625
(1,95,000/52*1.5)

46

(C) Administration overheads

Rent (48,000/52*8)

7,385

Salary (36,000/52*4)

2,769

Office expense (45,500/52*2)

1,780

11,904

(D) Factory overheads

9,235
60,00/52*8)
TOTAL C.L.

56,570

WC reqd.(CA-CL)

1,45,260

CURRENT RATIO:
CURRENT RATIO = CURRENT ASSETS / CURRENT LIABILITIES
For the calculation this ratio

Current assets include inventories, sundry debtors, cash and bank balances and
loans & advances

Current liabilities include Current liabilities and provisions.

CALCULATION OF CURRENT RATIO

Year

2011

2012

2013
47

Current Assets

81.29

83.12

13,6.57

Current Liabilities

27.42

20.58

33.48

Current Ratio

2.96:1

4.03:1

4.08:1

Interpretation:As we know that ideal current ratio for any firm is 2:1. If we see the current ratio of the
company for last three years it has increased from 2011 to 2013. The current ratio of
company is more than the ideal ratio. This depicts that companys liquidity position is
sound. Its current assets are more than its current liabilities.

QUICK RATIO (OR) ACID TEST RATIO:

This is the ratio of liquid assets to current liabilities. Is shows a firms ability to meet
current liabilities with its most liquid or quick assets. The standard ratio 1:1 is considered ideal
ratio for a concern. Liquid assets are those, which can be easily converted in to cash within a
short period of time without loss of value. This ratio can be calculated by using the formula:
LIQUID RATIO = LIQUID ASSETS / CURRENT LIABILITIES
For the calculation of this ratio
A liquid asset of quick asset includes Sundry Debtors, Cash and Bank balance and Loan &
Advances.
48

Current liabilities include Current Liabilities and Provisions.

CALCULATION OF QUICK RATIO

Year

2011

2012

2013

Quick Assets

44.14

47.43

61.55

Current Liabilities

27.42

20.58

33.48

Quick Ratio

1.6 : 1

2.3 : 1

1.8 : 1

CASH RATIO:Generally receivables are more liquid the inventories, but there may be dough regarding
their reliability in time. Hence only absolute liquid assets such as Cash in hand, Cash at bank,
Marketable Securities are ideal taken into consideration 1:2 is considered as ideal ratio. This ratio
also called absolute Liquid Ratio.
This ratio is shown as:CASH RATIO = ABSOLUTE LIQUID ASSETS / CURRENT LIABITIE

NET WORKING CAPITAL RATIO:The difference between current assets and current liabilities including short term bank borrowing
is called Net Working Capital or Net Current Assets.Net Working Capital in sometimes used as a
measure of a firms liquidity. It is considered that, between two firms, the one having the larger
Net Working Capital has the greater the ability to meet its current obligation. This is not
necessarily so the measure of liquidity is a relationship, rather than the difference between
Current Assets and Current Liabilities. Net Working Capital however, measures the firms
49

potential reservoir of funds. It can be related to net assets.

NET WORKING CAPITAL = NET WORKING CAPITAL / NET ASSETS.

CONCLUSION
The relative liquidity of a firms assets structure is measured by the current ratio. The
greater this ratio the less risky as well a less profitable the firm will be and vice-versa. Also the
relative liquidity of a firms financial structure can be measured by short- term financing to total
financing ratio. The lower this ratio, less risky as well a less profitable the firm will be and viceversa.
Thus, in shaping its WC policy, the firm should keep in mind these two dimensions ;
relative assets liquidity (level of current assets) and relative finance liquidity (level of shortterm financing).
50

Working capital is always estimated in advance since that much many since required.

BIBOLOGRAPHY

www.workingcapital.com
www.financeinfo.com
www.financecapitalinfo.com
www.moneycontrol.com

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