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Solution 1:

Operating cycle of XYZ Ltd.

1. Raw material (Average Raw Material/Total Purchase x 360)

(80 / 600 ) x 360 = 49 Days

2. Work-in-progress (Average Work-in-progress/Total cost of goods sold) x 360

(85 / 2100) x 360 = 15 Days

3. Finished Goods (Average Finished goods/Total cost of goods sold) x 360

(180 / 2100) x 360 = 31 Days

4. Debtors (Average Debtors/Total Sales) x 360

(350 / 3000) x 360 = 43 Days

5. Creditors (Average Creditor/Total Purchase) x 360

(90 / 600) x 360 = 55 Days

Net Operating Cycle = 49 days + 15 days + 31 days + 43 days – 55 days

= 138 Days – 55 Days = 83 Days

Comments: For XYZ Ltd., the working capital c) The finished goods stock is below average.
cycle is below the industry average, including a This may be due to a high demand for the firm's
lower investment in net current assets. goods or to efficient stock control. A low
However, the following points should be noted finished goods stock can, however, reduce sales
about the individual elements of working since it can cause delivery delays.
capital.
d) Debts are collected more quickly than
a) The stock of raw materials is considerably average. The company might have employed
higher than average. So there is a need for stock good credit control procedure or offer cash
control procedure to be reviewed. discounts for early payments.

b) The value of creditors is also above average; Operating cycle:


this indicates that XYZ Ltd. is delaying the
payment of creditors beyond the credit period. The operating cycle is the average period of
Although this is an additional source of finance, time required for a business to make an initial
it may result in a higher cost of raw materials or outlay of cash to produce goods, sell the goods,
and receive cash from customers in exchange
loss of goodwill among the suppliers.
for the goods.
This is useful for estimating the amount of requirements, which may offset some or all of
working capital that a company will need in the cash outlay needed to buy the acquire.
order to maintain or grow its business.

A company with an extremely short operating


cycle requires less cash to maintain its
operations, and so can still grow while selling at
relatively small margins. Conversely, a business
may have fat margins and yet still require
additional financing to grow at even a modest
pace, if its operating cycle is unusually long. If a
company is a reseller, then the operating cycle
does not include any time for production - it is
simply the date from the initial cash outlay to
the date of cash receipt from the customer.

The following are all factors that influence the


duration of the operating cycle:

• The payment terms extended to the company


by its suppliers. Longer payment terms shorten
the operating cycle, since the company can
delay paying out cash.

• The order fulfillment policy, since a higher


assumed initial fulfillment rate increases the
amount of inventory on hand, which increases
the operating cycle.

• The credit policy and related payment terms,


since looser credit equates to a longer interval
before customers pay, which extends the
operating cycle. Thus, several management
decisions (or negotiated issues with business
partners) can impact the operating cycle of a
business. Ideally, the cycle should be kept as
short as possible, so that the cash requirements
of the business are reduced.

Examining the operating cycle of a potential


acquire can be particularly useful, since doing so
Solution 2:
can reveal ways in which the acquirer can alter
the operating cycle to reduce cash
A firm should finance its working capital pay interest, incur losses on discounted bills,
requirements for both short term financing and and they can be self-sufficient in their financing.
long term
3. Issue Equities and Debentures:
financing. Working capital refers to the funds
needed by a business to conduct its daily In extreme cases when the business is really
operations, such as payment of wages, short of funds, or when the company is
purchase of raw material, covering overhead investing in a large-scale venture, they might
costs and offering credit services. Working decide to issue debentures or bonds to the
capital can be subdivided into two areas: general public or in some cases even equity
regular working capital that provides a steady stock. Of course, this will be done only by
base for overall business objectives; and short- conglomerates and only in cases when there is a
term working capital used to facilitate the day- need for a huge quantum of funds.
to-day business operations. Sources of finance Short-Term Loans
for working capital include bank loans, retained
earnings, credit from suppliers, long-term loans Short-term loans are loans that are to be repaid
from financial institutions, or proceeds from within a year from the time they are borrowed.
sale of assets. Savings banks, cooperatives and the
government through the Small Business
Long-Term Loans Administration are some of the institutions that
A loan is the amount of money that is given to offer these loans. Bank overdraft is one such
an individual or a company on the agreement source of business finance. A bank overdraft is a
withdrawal made by a business that exceeds
they will repay the amount borrowed in a
period that exceeds 12 months and at the amount of balance in its bank account,
predetermined interest rates.Long-term loans although the amount of money does not exceed
are usually secured against certain assets and a set limit.
are offered by commercial banks, the 1. Overdraft Agreement:
government and financial institutions. This type
of loan provides the long-term working capital By entering into an overdraft agreement with
for the business. the bank, the bank will allow the business to
borrow up to a certain limit without the need
1. Long-Term Loan from a Bank: for further discussion. The bank might ask for
Many companies opt for a full-fledged long security in the form of collateral and they might
term loan from a bank that allows them to meet charge daily interest at a variable rate on the
all their working capital needs for two, three or outstanding debt. However, if the business is
confident of making the repayments quickly,
more years.
then an overdraft agreement is a
2. Retain Profits: Rather than making dividend
payments to shareholders or investing in new valuable source of financing, and one that many
ventures, many businesses retain a portion of companies resort to.
their profits so that they may use it for working 2. Accounts Receivable Financing:
capital. This way they do not have to take loans,
Many banks and non-banking financial
institutions provide invoice discounting
facilities. The company takes the commercial
bills to the bank which makes the payment
minus a small fee. Then, on the due date the
bank collects the money from the customer.
This is another popular method of financing
especially among small traders. Businesses that
offer large terms of credit can carry on their
operations without having to wait for the
customers to settle their bills.

3. Customer Advances:

There are many companies that insist on the


customer making an advance payment before
selling them goods or providing a service. This is
especially true while dealing with large orders
that take a long time to fulfill. This method also
ensures that the company has some funds to
channelize into its operations for fulfilling those
orders.

4. Selling Goods on Installment:

Many companies, especially those that sell


television sets, fans, radios, refrigerators,
vehicles and so on, allow customers to make
their payments in installments. Since many of
these items have become modern day
essentials, their customers might not come
from well-to-do backgrounds or the cost of the
product might be too prohibitive for immediate
payment. In such a case, instead of waiting for a
large payment at the end, they allow the
customers to make regular monthly payments.
This ensures that there is a constant flow of
funds coming into the business that does not
choke up the accounts receivable numbers.

Solution 3:
Corporate Restructuring means any change in a new entity is created. Here, the acquired
the business capacity or portfolio that is carried company transfers its assets, liabilities and
out by inorganic route or any change in the shares to the acquiring company for cash or
capital structure of a company that is not in the exchange of shares. For example, merger of
ordinary course of its business or any change in Hindustan Computers Ltd, Hindustan
the ownership of a company or control over its Instruments Ltd, Indian Software Company Ltd
management or a combination of any two or all and Indian Reprographics Ltd into an entirely
of the above. Types of Corporate Restructuring new company called HCL Ltd. Acquisitions and
Takeovers: An acquisition may be defined as an
• Mergers / Amalgamation act of acquiring effective control by one
• Acquisition and Takeover company over assets or management of
another company without any combination
• Divestiture ofcompanies. Thus, in an acquisition two or
more companies may remain independent,
• Demerger (spin off / split up / split off)
separate legal entities, but there may be a
• Reduction of Capital change in control of the companies. When an
acquisition is ‘forced’ or ‘unwilling’, it is called a
• Joint Ventures takeover.

• Buy back of Securities Divestiture: Divestiture means an out sale of all


or substantially all the assets of the company or
Merger / Amalgamation: A merger is a
any of its business undertakings / divisions,
combination of two or more businesses into
usually for cash (or for a combination of cash
one business. Laws in India use the term
and debt) and not against equity shares. In
‘amalgamation’ for merger. Amalgamation is
short, divestiture means sale of assets, but not
the merger of one or more companies with
in a piecemeal manner.
another or the merger of two or more
companies to form a new company, in such a Divestiture is normally used to mobilize
way that all assets and liabilities of the resources for core business or businesses of the
amalgamating companies become assets and company by realizing value of non-core
liabilities of the amalgamated company. business assets.

• Merger through Absorption:- An absorption is Demerger:Demerger is a form of corporate


a combination of two or more companies into restructuring in which an entity’s business
an ‘existing company’. All companies except operations are segregated into one or more
one lose their identity in such a merger. components.
Forexample, absorption of Tata Fertilisers Ltd
(TFL) by Tata Chemicals Ltd. (TCL). Demerger can take three forms:

• Merger through Consolidation:- A • Spin-off


consolidation is a combination of two or more
• Split-up
companies into a ‘new company’. In this form of
merger, all companies are legally dissolved and • Split-off
Reduction of Capital: Reduction of Capital is a
process by which a company is allowed to
extinguish or reduce liability on any of its shares
in respect of share capital not paid up, or is
allowed to cancel any paid-up share capital
which is post or is allowed to pay-off any paid –
up capital which is in excess of its requirements.

Joint Venture: Joint Venture is an arrangement


in which two or more companies (called joint
venture partners) contribute to the equity
capital of a new company (called joint venture)
in pre-decided proportion. For e.g. Maruti
Suzuki

Buy back of Securities: When a company is


holding excess cash, which it does not require in
the medium term (say three to five years); it is
prudent for the company to return this excess
cash to its shareholders. Buy-back of securities
is one of the methods used to return the excess
cash to its shareholders

Solution 4:
MBOs involve the acquisition by existing event that borrowed funds alone are
corporate management of a company's shares insufficient, the management team may offer
or operations. As the existing management equity to a collaborative sponsor, such as a
team typically has a limited amount of cash buyout fund or partner.
available, MBOs generally require that funds be
raised to acquired an operation. For this reason,
an MBO may take the form of an LBO. In the

S. No. LBO MBO


1 Outside firm purchases Executive of the same firm purchases
2 SPV is created No SPV is created
3 Shareholders lose the share Only promoters sell the shares
Another set of promoters manage the
4 Managers and Promoters become one and the same
company

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