WORKING CAPITAL MANAGEMENT

Introduction:

Working capital is the life blood and nerve centre of a business. Just as circulation of blood is

essential in the human body for maintaining life, working capital is very essential to maintain

the smooth running of a business. No business can run successfully with out an adequate

amount of working capital.

Working capital refers to that part of firm’s capital which is required for financing short term or

current assets such as cash, marketable securities, debtors, and inventories. In other words

working capital is the amount of funds necessary to cover the cost of operating the enterprise.

Meaning:

Working capital means the funds (i.e.; capital) available and used for day to day operations

(i.e.; working) of an enterprise. It consists broadly of that portion of assets of a business

which are used in or related to its current operations. It refers to funds which are used during

an accounting period to generate a current income of a type which is consistent with major

purpose of a firm existence.

Objectives of working capital:

Every business needs some amount of working capital. It is needed for following purposes-

• For the purchase of raw materials, components and spares.

• To pay wages and salaries.

• To incur day to day expenses and overhead costs such as fuel, power, and office expenses

etc.

• To provide credit facilities to customers etc.

Factors that determine working capital:

The working capital requirement of a concern depend upon a large number of factors such as

? Size of business

? Nature of character of business.

? Seasonal variations working capital cycle

? Operating efficiency

? Profit level.

? Other factors.

Sources of working capital:

The working capital requirements should be met both from short term as well as long term

sources of funds.

? Financing of working capital through short term sources of funds has the benefits of lower

cost and establishing close relationship with banks.

? Financing of working capital through long term sources provides the benefits of reduces risk

and increases liquidity

Types of working capital:

Working capital an be divided into two categories-

Permanent working capital:

It refers to that minimum amount of investment in all current assets which is required at all

times to carry out minimum level of business activities.

Temporary working capital:

The amount of such working capital keeps on fluctuating from time to time on the basis of

business activities.

Advantages of working capital:

• It helps the business concern in maintaining the goodwill.

• It can arrange loans from banks and others on easy and favorable terms.

• It enables a concern to face business crisis in emergencies such as depression.

• It creates an environment of security, confidence, and over all efficiency in a business.

• It helps in maintaining solvency of the business.

Disadvantages of working capital:

• Rate of return on investments also fall with the shortage of working capital.

• Excess working capital may result into over all inefficiency in organization.

• Excess working capital means idle funds which earn no profits.

• Inadequate working capital can not pay its short term liabilities in time.

Management of working capital:

A firm must have adequate working capital, i.e.; as much as needed the firm. It should be

neither excessive nor inadequate. Both situations are dangerous. Excessive working capital

means the firm has idle funds which earn no profits for the firm. Inadequate working capital

means the firm does not have sufficient funds for running its operations. It will be interesting

to understand the relationship between working capital, risk and return. The basic objective of

working capital management is to manage firms current assets and current liabilities in such a

way that the satisfactory level of working capital is maintained, i.e.; neither inadequate nor

excessive. Working capital some times is referred to as “circulating capital”. Operating cycle

can be said to be t the heart of the need for working capital. The flow begins with conversion

of cash into raw materials which are, in turn transformed into work-in-progress and then to

finished goods. With the sale finished goods turn into accounts receivable, presuming goods

are sold as credit. Collection of receivables brings back the cycle to cash.

The company has been effective in carrying working capital cycle with low working capital

limits. It may also be observed that the PBT in absolute terms has been increasing as a year to
year basis as could be seen from the above table although profit percentage turnover may be

lower but in absolute terms it is increasing. In order to further increase profit margins, SSL can

increase their margins by extending credit to good customers and also by paying the creditors

in advance to get better rates.

WORKING CAPITAL AND RATIO ANALYSIS

Ratio Analysis is one of the important techniques that can be used to check the efficiency with

which working capital is being managed by a firm. The most important ratios for working

capital management are as follows

Net Working Capital:

There are two concepts of working capital namely gross working capital and net working

capital. Net working capital is the difference between current assets and current liabilities. An

analysis of the net working capital will be very help full for knowing the operational efficiency

of the company. The following table provides the data relating to the net working capital of

SSL.

NET WORKING CAPITAL = CURRENT ASSETS-CURRENT LIABILITIS

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Working capital turnover ratio:

This is also known as sales to working capital ratio and usually represented in times. This

establishes the relationship of sales to net working capital. This ratio indicates -heather or not

working capital has been effectively utilized in making sales. In case if a company can achieve

higher volume of sales with relatively small amount of working capital, it is an indication of the

operating efficiency of the company. It is calculated as follows-

RATIO ANALYSIS

INTRODUCTION:

Ratio Analysis is a powerful tool o financial analysis. Alexander Hall first presented it in 1991 in

Federal Reserve Bulletin. Ratio Analysis is a process of comparison of one figure against other,

which makes a ratio and the appraisal of the ratios of the ratios to make proper analysis about

the strengths and weakness of the firm’s operations. The term ratio refers to the numerical or

quantitative relationship between two accounting figures. Ratio analysis of financial statements

stands for the process of determining and presenting the relationship of items and group of

items in the statements.

Ratio analysis can be used both in trend analysis and static analysis. A creditor would like to

know the ability of the company, to meet its current obligation and therefore would think of

current and liquidity ratio and trend of receivable.

Major tool of financial are thus ratio analysis and Funds Flow analysis.Financial analysis is the

process of identifying the financial strength and weakness of the firm by properly establishing

relationship between the items of the balance sheet and the profit account

The financial analyst may use ratio in two ways. First he may compare a present ratio with the

ratio of the past few years and project ratio of the next year or so. This will indicate the trend

in relation that particular financial aspect of the enterprise. Another method of using ratios for

financial analysis is to compare a financial ratio for the company with for industry as a whole,

or for other, the firm’s ability to meet its current obligation. It measures the firm’s liquidity.

The greater the ratio, the greater the firms liquidity and vice-versa.

A ratio can be defined as a numerical relationship between two numbers expressed in terms of
(a) proportion (b) rate (c) percentage. It is also define as a financial tool to determine an

interpret numerical relationship based on financial statement yardstick that provides a

measure of relation ship between two variable or figures.

Meaning and Importance:

Ratio analysis is concerned to be one of the important financial tools for appraisal of financial

condition, efficiency and profitability of business. Here ratio analysis id useful from following

objects.

1. Short term and long term planning

2. Measurement and evaluation of financial performance

3. Stud of financial trends

4. Decision making for investment and operations

5. Diagnosis of financial ills

6. providing valuable insight into firms financial position or picture

ADVANTAGES& DISADVANTAGES OF RATIO ANALYSIS

Advantages:

The following are the main advantages derived of ratio analysis, which are obtained from the

financial statement via Profit & Loss Account and Balance Sheet.

a) The analysis helps to grasp the relationship between various items in the financial

statements.

b) They are useful in pointing out the trends in important items and thus help the

management to forecast

c) With the help of ratios, inter firm comparison made to evolve future market strategies.

d) Out of ratio analysis standard ratios are computed and comparison of actual with standards

reveals the variances. This helps the management to take corrective action.

e) The communication of that has happened between two accounting the dates are revealed

effective action.
f) Simple assessments of liquidity, solvency profitability efficiency of the firm are indicted by

ratio analysis. Ratios meet comparisons much more valid.

Disadvantages:

Ratio analysis is to calculate and easy to understand and such statistical calculation stimulation

thinking and develop understanding.

But there are certain drawbacks and dangers they are.

i) There is a trendy to use to ratio analysis profusely.

ii) Accumulation of mass data obscured rather than clarifies relationship.

iii) Wrong relationship and calculation can lead to wrong conclusion.

1. In case of inter firm comparison no two firm are similar in size, age and product unit.(For

example :one firm may purchase the asset at lower price with a higher return and another firm

witch purchase the asset at asset at higher price will have a lower return)

2. Both the inter period and inter firm comparison are affected by price level changes. A

change in price level can affect the validity of ratios calculated for different time period.

3. Unless varies terms like group profit, operating profit, net profit, current asset, current

liability etc., are properly define, comparison between two variables become meaningless.

4. Ratios are simple to understand and easy to calculate. The analyst should not take decision

should not take decision on a single ratio. He has to take several ratios into consideration.

IMPORTANCE OF RATIO ANALYSIS

In the preceding discussion in the form, we have illustrated the compulsion and implication of
important ratios that can be calculated from the Balance Sheet and Profit & Loss account of a

firm. As a tool of financial management, they are of crucial significance. The importance of

ratio analysis lies in the fact and enables the drawing of inferences regarding the performance

of a firm. Ration analysis is a relevant in assessing the performance of a firm in respect of the

following aspect.

LIQUTDITY Vs PROFITABILITY

INTRODUCTION

Financial analysis is the process of identifying the financial strengths and weakness of the firm

by properly establishing relationship between the items of the balance sheet and profit loss

account. Management should particularly interest in knowing financial strengths and weakness

of the firm to make their best use and to be able to spot out financial weakness of the firm to

take a suitable corrective actions.

Financial analysis is the starting point of making plans, before using any sophisticated

forecasting and planning procedures.

Major tools of financial analysis are ratio analysis and funds flow analysis. Financial analysis is

the process of identifying the financial strengths and weakness of the firm by properly

establishing relationship between the items of the balance sheet and the profit and loss

account.

Meaning and importance

Ratio analysis is concerned to be one of the important financial tools for appraisal of financial

condition, efficiency and profitability of business. Here ratio analysis is useful from following

objectives.

1. Short term and long term planning.

2. Measurement and evaluation of financial performance.

3. Study of financial trends.

4. Decision making for investment and operations.

5. Diagnosis of financial ills.

6. Providing valuable insight into firm’s financial position or picture.

Ratios

1. Current Ratio

2. Quick Ratio

3. Absolute Quick Ratio

4. Net Profit Ratio

5. Debtors Turnover Ratio

6. Inventory Turnover Ratio

CURRENT RATIO

The current ratio is calculated by dividing current assets by current liabilities.

Current ratio = current assets/current liabilities

The current ratio is a measure of the firm’s short-term solvency. It indicates the availability of

current assets in rupees for every one rupee of current liabilities. A ratio of greater than one

means that the firm has more current assets than current liabilities claims against them. A

standard ratio between them is 2:1.

QUICK RATIO:
This ratio establishes a relationship between quick of liquid assets and current liabilities. It is

an absolute measure of liquidity management of the concern. An asset is liquid if it can be

converted in to cash immediately or reasonably soon without a loss of value, if ignores totally

the stocks. Because inventories normally require some time for realizing into cash: their value

also has a tendency to fluctuate. The standard quick ratio is 1:1.

Quick Ratio = Quick Assets/Current Liabilities

Absolute quick ratio:

Since cash is the most liquid assets necessary to examine the ratio of cash and its equivalent

to current liabilities. Trade investment or marketable securities are equivalent of cash.

Therefore, they may be included in the consumption of absolute quick ratio.

Absolute quick ratio = Absolute Quick Assets/Current Liabilities

Net Profit Ratio:

As every business is to earn profit, this ratio is very important because it measures the

profitability of sales. A business may yield high gross income but low net income because of

increasing operating and non-operating expenses. This situation can easily be detected by

calculating this ratio.

The profits used for this purpose may be profits after/before tax. To obtain this ratio, the

figure of net profits after tax is divided by the figure of net profits after tax is divided by the

figure of sales the ratio is also known as sales margin as we can ascertain with its help the

margin which the sales leave later deducting all the expenses. The unit of expression is

percentage, as is the case with profitability ratios.

CASH MANAGEMENT

Introduction:

Cash management is one of the key areas of working capital management. Cash is the liquid

current asset. The main duty of the finance manager is to provide adequate cash to all

segments of the organization. The important reason for maintaining cash balances is the

transaction motive. A firm enters into variety of transactions to accomplish its objectives which

have to be paid for in the form of cash.

Meaning of cash:

The term “cash” with reference to cash management used in two senses. In a narrower sense

it includes coins, currency notes, cheques, bank drafts held by a firm. n a broader sense it also

includes “near-cash assets” such as marketable securities and time deposits with banks.

Objectives of cash management:

There are two basic objectives of cash management. They are-

? To meet the cash disbursement needs as per the payment schedule.

? To minimize the amount locked up as cash balances.

Basic problems in Cash Management:

Cash management involves the following four basic problems.

? Controlling level of cash

? Controlling inflows of cash

? Controlling outflows of cash and

? Optimum investment of surplus cash.

Determining safety level for cash:

The finance manager has to take into account the minimum cash balance that the firm must

keep to avoid risk or cost of running out of funds. Such minimum level may be termed as

“safety level of cash”. The finance manager determines the safety level of cash separately both

for normal periods and peak periods. Under both cases he decides about two basic factors.

They are-

Liquidity:

This can be ensured by investing money in short term securities including sha\ort term fixed

deposits with banks.

Yield:

Most corporate managers give less emphasis to yield as compared to security and liquidity of

investment. So they prefer short term government securities for investing surplus cash.

Maturity:

It will be advisable to select securities according to their maturities so the finance manager can

maximize the yield as well as maintain the liquidity of investments.

.
RECEIVABLES MANAGEMENT

Introduction:

Receivables constitute a significant portion of the total assets of the business. When a firm

seller goods or services on credit, the payments are postponed to future dates and receivables

are created. If they sell for cash no receivables created.

Meaning:

Receivable are asset accounts representing amounts owed to the firm as a result of sale of

goods or services in the ordinary course of business.

Purpose of receivables:

Accounts receivables are created because of credit sales. The purpose of receivables is directly

connected with the objectives of making credit sales. The objectives of credit sales are as

follows-

? Achieving growth in sales.

? Increasing profits.

? Meeting competition.

Factors affecting the size of Receivables:

The main factors that affect the size of the receivables are-

? Level of sales.

? Credit period.

? Cash discount.

Costs of maintaining receivables:

The costs with respect to maintenance of receivables are as follows-

Capital costs:

This is because there is a time lag between the sale of goods to customers and the payment by

them. The firm has, therefore to arrange for additional funds to meet its obligations.

Administrative costs:
Firm incur this cost for manufacturing accounts receivables in the form of salaries to the staff

kept for maintaining accounting records relating to customers.

Collection costs:

The firm has to incur costs for collecting the payments from its credit customers.

Defaulting costs:

The firm may not able to recover the over dues because of the inability of customers. Such

debts treated as bad debts.

Receivables management:

Receivables are direct result of credit sale. The main objective of receivables management is to

promote sales and profits until that point is reached where the ROI in further funding of

receivables is less than the cost of funds raised to finance that additional credit (i.e.; cost of

capital). Increase in receivables also increases chances of bad debts. Thus, creation of

receivables is beneficial as well as dangerous. Finally management of accounts receivable

means as the process of making decisions relating to investment of funds in this asset which

result in maximizing the over all return on the investment of the firm.
DEBTORS TURNOVER RATIO: -

Debtors constitute an important constituent of current assets and therefore the quality of the

debtors to a great extent determines a firm’s liquidity. It shows how quickly receivables or

debtors are converted into cash. In other words, the DTR is a test of the liquidity of the

debtors of a firm. The liquidity of firm’s receivables can be examined in two ways they are DTR

and Average Collection Period