CHAPTER 1

INTRODUCTION OF CASH MANAGEMENT

"Cash, like the blood stream in the human body, gives vitality and strength to a business
enterprises."
Though cash hold the smallest portion of total current assets. However,
"Cash is both the beginning and end of working capital cycle cash, inventories, receivables
and cash."
It is the cash, which keeps the business going. Hence, every enterprises has to hold necessary
cash for its existence Moreover,
"Steady and healthy circulation of cash throughout the entire business operations is the basis
of business solvency."
Nowadays nonavailability and high cost of money have created a serious problemfor
industry. Nevertheless, cash like any other asset of a company is treated as a tool of profit.
Further,
"Today the emphasis is on the right amount of cash, at the right time, at the right place and at
the right cost."
In the words of R.R. Bari, "Maintenance of surplus cash by a company unless there are
special reasons for doing so, is regarded as a bad sigh of cash management."
MEANING AND DEFINITION:
The term cash management refersto the management of cash resource in such a way that
generally accepted business objectives could be achieved. In this context, the objectives of a
firm can be unified as bringing about consistency between maximum possible profitability
and liquidity of a firm.
Cash management may be defined as the ability of a management in recognizing the
problems related with cash which may come across in future course of action, finding
appropriate solution to curb such problems if they arise, and finally delegating these solutions
to the competent authority for carrying them out The choice between liquidity and if
profitability creates a state of confusion.

It is cash management that can provide solution to this dilemma.Cash management may be
regarded as an art that assists in establishing equilibrium between liquidity and profitability to
ensure undisturbed functioning of a firm towards attaining its li business objectives.
Cash itself is not capable of generating any sort of income on its own. It rather is the prime
requirement of income generating sources and functions. Thus, a firm should go forminimum
possible balance of cash, yet maintaining its adequacy for the obvious reason of firm's
solvency.
Cash management deals with maintaining sufficient quantity of cash in such a way that the
quantity denotes the lowest adequate cash figure to meet business obligations.
Cash management involves managing cash flows (into and out of the firm), within the firm
and the cash balances held by a concern at a point of time.
The words,'managing cash and the cash balances' as specified above does not mean
optimization of cash and near cash items butalso point towards providing a protective shield
to the business obligations.
"Cash management is concerned with minimizing unproductive cash balances, investing
temporarily excess cash advantageously and to make the best possible arrangement for
meeting planned and unexpected demands on the firms'cash."

GENERAL PRINCIPLES OF CASH MANAGEMENT:

Harry Gross has suggested certain general principles of cash management that, essentially add
efficiency to cash management. These principles reflecting cause and effectrelationship
having universal applications give a scientific outlook to the subject of cash
management.
While, the application of these principles in accordance with the changing conditions and
business environment requiring high degree of skill and tact which places cash management
in the category of art. Thus, we can say that cash management like any other subject of
management is both science and art for it has wellestablished principles capable of being
skillfully modified as per the requirements.

The principles of management are follows as:

1.Determinable Variations of Cash Needs
A reasonable portion of funds, in the form of cash is required to be kept aside to overcome the
period anticipated as the period of cash deficit. This period may either be short and temporary
or last for a longer duration of time. Normal and regular payment of cash leads to small
reductions in the cash balance at periodic intervals. Making this payment to different
employees on different days of a week can equalize these reductions.
Another technique for balancing the level of cash is to schedule in cash disbursements to
creditors during that period when accounts receivables collected amounts to a large sum but
without putting the goodwill at stake.
2.Contingency Cash Requirement
There may arise certain instances, which fall beyond the forecast of the management. These
constitute unforeseen calamities, which are too difficult to be provided for in the normal
course of the business. Such contingencies always demand for special cashrequirements that
was not estimated and provided for in the cash budget. Rejections of wholesale product, large
amount of bad debts, strikes, lockouts etc. are a few among these contingencies.
Only a prior experience and investigation of other similar companies prove helpful as a
customary practice. A practical procedure is to protect the business from such calamities like
bad-debt losses, fire etc. by way of insurance coverage.
3.Availability of External Cash
Another factor that is of great importance to the cash management is the availability of funds
from outside sources. There resources aid in providing credit facility to the firm,which
materialized the firm's objectives of holding minimum cash balance. As such if a firm
succeeds in acquiring sufficient funds from external sources like banks or private financers,
shareholders, government agencies etc., the need for rnaintaining cash reserves diminishes.

4. Maximizing Cash Receipts

Every financial manager aims at making the best possible use of cash receipts. Again,cash
receipts if tackled prudently results in minimizing cash requirements of a concern. For
thispurpose, the comparative cost of granting cash discount to customer and the policy of
charging interest expense for borrowing must be evaluated on continuous basis to determine
the futility of either of the alternative or both of them during that particular period for
maximizing cash receipts.

(A)Concentration Banking:
Under this system, a company establishes banking centers for
collection of cash in different areas. Thereby, the company
instructs its customers of adjoining areas to send their payments to those centers. The
collection amount is thendeposited with the local bank by these centers as early as possible.
Whereby, the collected funds are transferred to the company's central bank accounts operated
by the head office.
(B)Local Box System:
Under this system, a company rents out the local post offices boxes of different cities and the
customers are asked to forward their remittances to it. These remittances are picked by the
authorized lock bank from these boxes to be transferred to the company's central bank
operated by the head office.
(C)Reviewing Credit Procedures:
It aids in determining the impact of slow payers and bad debtors on cash. The accounts of
slow paying customers should be reviewed to determine the volume of cash tied up. Besides
this, evaluation of credit policy must also be conducted for introducing essential amendments.
As a matter of fact, too strict a credit policy involves rejections of sales. Thus,curtailing the
cash inflow. On the other hand, too lenient, a credit policy would increase the number of slow
payments and bad debts again decreasing the cash inflows.
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(D)Minimizing Credit Period:

Shortening the terms allowed to the customers would definitely accelerate the cash inflow
side byside revising the discount offered would prevent the customers from using the credit
for financing their own operations profitably.
(E)Others:
Introducing various procedures for special handling of large to very large remittances or
foreign remittances such as, persona! pick up of large sum of cash using airmail, special
delivery and simitar techniques to accelerate such collections.
5. Minimizing Cash Disbursements
The motive of minimizing cash payments is the ultimate benefit derived from maximizing
cash receipts. Cash disbursement can be brought under control by preventing fraudulent
practices, serving time draft to creditors of large sum, making staggered payments to creditors
and for payrolls etc.
6. Maximizing CashUtilization
Although a surplus of cash is a luxury, yet money is costly. Moreover, proper and optimum
utilization of cash always makes way forachievement of the motive of maximizing cash
receipts and minimizing cash payments. At times, a concern finds itself with funds in excess
of its requirement, which lay idle without bringing any return to it. At the same time, the
concern finds it unwise to dispose it, as the concern shall soon need it. In such conditions,
efforts should be made in investing these funds in some interest bearing securities.There are
certain basic strategies suggested by Gitman, which prove evidently helpful in managing cash
if employed by the cash management.
They are:
"Pay accounts payables as late as possible without damaging the firm's credit rating, but take
advantage of the favourable cash discount, if any.Turnover, the inventories as quickly as
possible, avoiding stock outs that might resultin shutting down the productions line or loss of
sales.Collect accounts receivables as early as possible without losing future loss sales because

of high pressure collections techniques. Cash discounts, if they are economicallyjustifiable,

may be used to accomplish this objective."
FUNCTION OF CASH MANAGEMENT:
"Cash management is concerned with minimizing unproductive cash balances,investing
temporarily excess cash advantageously and to make the best possible arrangementsfor
meeting planned and unexpected demands on the firm's cash."
Cash Management must aim to reduce the required level of cash but minimize the risk of
being unable to discharge claims against the company as they arise. All these aims and
motives of cash management largely depend upon the efficient and effective functioning of
cash management. Cash management functions can be studied under five heads, namely, cash
planning, managing cash flow, controlling cash flow, optimizing the cash level and investing
idle cash.
All these functions are discussed below in details:
1.Cash Planning
Good planning is the very foundation of attaining success. For any management decision,
planning is the foremost requirement.
"Planning is basically an intellectual process, a menfal pre-disposition to do things in an
orderly way, to think before acting and to act in the light of facts rather than of a guess."
Cash planning is a technique, which comprises of planning for and controlling of cash. It is a
management process of forecasting the future need of cash, its available resources and
various uses for a specified period. Cash planning, thus, deals at length with formulation of
necessary cash policies and procedures in order to carry on business continuously and on
sound lines. A goodcash planning aims at providing cash, not only for regular but also for
irregular and abnormal requirements.
2.Managing Cash Flows
The heading simply suggests an idea of managing properly the flow of cash coming inside the
business i.e. cash inflow and cash moving out of the business i.e. cash outflow. These twoare
said to be properly managed only, if a firm succeeds in accelerating the rate of cash inflow
together with minimizing the cash outflow. As observed expediting collections,avoiding
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unnecessary inventories, improving control over payments etc. contribute to better

management of cash. Whereby, a business can conserve cash and thereof would require lesser
cash balance for its operations.
3. Controlling the Cash Flows
As forecasting is not an exact science because it is based on certain assumptions. Therefore,
cash planning will inevitably be at variance with the results actually obtained. For this reason,
control becomes an unavoidable function of cash management. Moreover, cash controlling
becomes essential as it increases the availability of usable cash from within the enterprise. As
it is obvious that greater the speed of cash flow cycle, I greater would be the number of times
a firm can convert its goods and ' services into cash and so lesser will be the cash requirement
to finance the desired volume of business during that period. Furthermore, every enterprise is
in possession of some hidden cash, which if traced out substantially decreases the cash
requirement of the enterprise.
4. Optimizing the Cash Level
A financial manager should concentrate on maintaining sound liquidity position i.e. cash
level. All his efforts relating to planning, managing and controlling cash should be diverted
towards maintaining an optimum level of cash. The foremost need of maintaining optimum
level of cash is to meet the necessary requirements and to settle the obligations well in time.
Optimization of cash level may be related to establishing equilibrium between risk and the
related profit expected to be earned by the company.
5.Investing Idle Cash
Idle cash or surpluscash refers to the excess of cash inflows over cash outflows, which do not
have any specific operations or any other purpose to solve currently. Generally, a firm is
required to hold cash for meeting working needs facing contingencies and to maintain as well
as develop goodwill of bankers.The problem of investing this excess amount of cash arise
simply because it contributes nothing towards profitability of the firm as idle cash precisely
earns no returns. Further permanent disposal of such cash is not possible, as the concern may
again need this

cash after a short while. But, if such cash is deposited with the bank, it definitely would earn a
nominal rate of interest paid by the bank. A much better returns than the bank interest can be
expected if a company deploys idle cash in marketable securities. There are yet another group
of enterprise that neither invest in marketable securities nor willing to get interest instead they
prefer to deposit excess cash for improving relations with banks by helping them in meeting
bank requirements for compensating balances for services and loans.
MOTIVES OF HOLDING CASH:
Every business transaction whether carried on credit or on cash basis ultimately results in
either cash inflow or cash outflows. The pivotal point in present day financial management is
to maximize cash generation and to minimize cash outflows in relation to the cash inflows.
Keynes postulated three motives for holding cash:
1. Transaction Motive,
2. Precautionary Motive, and
3. Speculative Motive.
1. Transaction Motive
It refers to holding of cash for meeting routine cash requirements and financing transactions
carried on by the business in the normal course of action. This motive requires cash for
payment of various obligations like purchase of raw materials, the payment of usage and
salaries, dividend, income tax, various other operating expenses etc. However, there exists
regular and counter inflow of cash in the business by way of return on investments, sales etc.
However, cash receipts and cash payments do not perfectly synchronies with each other.
Therefore, a firm requires an additional cash balance during the periods when payments are in
excess of cash receipts. Thus transaction motive stresses on holding cash to meet anticipated
obligations that are not counter balanced by cash receipts due to disparity of timings.
2. Precautionary Motive
Under precautionary motive, the need to hold cash arises for
meeting any unforeseen, unpredicted contingencies or unexpected disbursements. Such
motives provide a cushion to withstand unexpected cash requirements arising spontaneously
at short notice due to various causes.In this regard, two factors largely influence
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theprecautionary cash balance, degree of predictability and availability of short-term credit. If

a cash management succeeds in estimating the cash requirements adequately, it escapes from
maintaining big cash balance for emergency. Likewise, if a management is capable and
efficient enough to borrow the required cash from short-term creditors small balance would
be held and vise-versa. Ready borrowing power is the best antidote to emergency cash drains
and facilitates release of available cash resources for remunerative
3.Speculative Motive
The speculative motive finds its origin out of the desire of an enterprise to avail itself the
benefits of the opportunities arising at unexpected moments that do not happen to exist in the
normal course of business. This motive represents a positive and aggressive approach.
Reasonable cash reserve is maintained by concerns for exploiting profitable opportunities like
bulk purchase of raw materials at discounted prices, purchasing securities when interest rates
are expected to fall, postpone purchase of raw material if decline in prices is anticipated, etc.
4. Compensation Motive
Such motives require holding cash balance in case the concern enters into some loan
agreement with the bank. Bank provides a great variety ofservices to its customers. For some
of such services it charges commission or fee. While for other an indirect compensation is
demanded by it by asking its customers to keep a minimum bank balance sufficient to earn a
return equal to cost of services provided by it. Such balances are termed as compensating
balances.

CHAPTER 2
RECEIVABLE MANAGEMENT
Analysis of Receivable Management
INTRODUCTION:
Management of trade credit is commonly known as Management of Receivables. Receivables
are one of the three primary components of working capital, the other being inventory and
cash, the other being inventory and cash. Receivables occupy second important place after
inventories and thereby constitute a substantial portion of current assets in several firms. The
capital invested in receivables is almost of the same amount as that invested in cash and
inventories. Receivables thus, form about one third of current assets in India. Trade credit is
an important market tool. As, it acts like a bridge for mobilization of goods from production
to distribution stages in the field of marketing. Receivables provide protection to sales from
competitions. It acts no less than a magnet in attracting potential customers to buy the product
at terms and conditions favourable to them as well as to the firm. Receivables management
demands due consideration not financial executive not only because cost and risk are
associated with this investment but also for the reason that each rupee can contribute to firm's
net worth.
MEANING AND DEFINITION:
When goods and services are sold under an agreement permitting the customer to pay for
them at a later date, the amount due from the customer is recorded as accounts receivables;
So, receivables are assets accounts representing amounts owed to the firm as a result of the
credit sale of goods and services in the ordinary course of business. The value of these claims
is carried on to the assets side of the balance sheet under titles such as accounts receivable,
trade receivables or customer receivables.
This term can be defined as
"debt owed to the firm by customers arising from sale of goods or services in ordinary course
of business."
According to Robert N. Anthony,
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"Accounts receivables are amounts owed to the business enterprise, usually by its customers.
Sometimes it is broken down into trade accounts receivables; the former refers to amounts
owed by customers, and the latter refers to amounts owed by employees and others".
Generally, when a concern does not receive cash payment in respect of ordinary sale of its
products or services immediately in order to allow them a reasonable period of time to pay for
the goods they have received. The firm is said to have granted trade credit. Trade credit thus,
gives rise to certain receivables or book debts expected to be collected by the firm in the near
future. In other words, sale of goods on credit converts finished goods of a selling firm into
receivables or book debts, on their maturity these receivables are realized and cash is
generated.
According to prasanna Chandra,
"The balance in the receivables accounts would be; average daily credit sales x average
collection period."
The book debts or receivable arising out of credit has three dimensions

It involves an element of risk, which should be carefully assessed. Unlike cash sales

credit sales are not risk less as the cash payment remains unreceived.
It is based on economics value. The economic value in goods and services passes to
the buyer immediately when the sale is made in return for an equivalent economic

value expected by the seller from him to be received later on.

It implies futurity, as the payment for the goods and services received by the buyer is
made by him to the firm on a future date

The customer who represent the firm's claim or assets, from whom receivables or book-debts
are to be collected in the near future, are known as debtors or trade debtors. A receivable
originally comes into existence at the very instance when the sale is affected. But the funds
generated as a result of these ales can be of no use until the receivables are actually collected
in the normal course of the business.
Receivables may be represented by acceptance; bills or notes and the like due from others at
an assignable date in the due course of the business. As sale of goods is a contract, receivables
too get affected in accordance with the law of contract e.g. Both the parties (buyer and seller)
must have the capacity to contract, proper consideration and mutual assent must be present to
pass the title of goods and above all contract of sale to be enforceable must be in writing.
Moreover, extensive care is needed to be exercised for differentiating true sales form what
may appear to be as sales like bailment, sales contracts, consignments etc.
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Receivables, as are forms of investment in any enterprise manufacturing and selling goods on
credit basis, large sums of funds are tied up in trade debtors. Hence, a great deal of careful
analysis and proper management is exercised for effective and efficient management of
Receivables to ensure a positive contribution towards increase in turnover and profits.
Instruments Indicating Receivables
Harry Gross has suggested three general instruments in a concern that provide proof of
receivables relationship. They are briefly discussed below: Open Book Account
This is an entry in the ledger of a creditor, which indicates a credit transaction.
It is no evidence of the existences of a debt under the Sales of Goods.
Negotiable Promissory Note
It is an unconditional written promise signed by the maker to pay a definite
sum of money to the bearer, or to order at a fixed or determinable time. Promissory
notes are used while granting an extension of time for collection of receivables, and
debtors are unlikely to dishonor its terms.
Increase in Profit
As receivables will increase the sales, the sales expansion would favorably
raise the marginal contribution proportionately more than the additional costs
associated with such an increase. This in turn would ultimately enhance the level of
profit of the concern.
Meeting Competition
A concern offering sale of goods on credit basis always falls in the top priority
list of people willing to buy those goods. Therefore, a firm may resort granting of
credit facility to its customers in order to protect sales from losing it to competitors.
Receivables acts as an attracting potential customers and retaining the older ones at
the same time by weaning them away firm the competitors.
Augment Customer's Resources

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Receivables are valuable to the customers on the ground that it augments their resources.
It is favoured particularly by those customers, who find it expensive and cumbersome to
borrow from other resources. Thus, not only the present customers but also the Potential
creditors are attracted to buy the firm's product at terms and conditions favourable to
them.
Speedy Distribution
Receivables play a very important role in accelerating the velocity of distributions. As a
middleman would act quickly enough in mobilizing his quota of goods from the productions
place for distribution without any hassle of immediate cash payment.As, he can pay the full
amount after affecting his sales. Similarly, the customers would hurry for purchasing their
needful even if they are not in a position to pay cash instantly. It is for these receivables are
regarded as a bridge for the movement of goods form production to distributions among the
ultimate consumer. ;
Figure No.6.1

Miscellaneous
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The usual practice companies may resort to credit granting for various other reasons like
industrial practice, dealers relationship, status of buyer, customers requirements, transits
delay etc. In nutshell, the overall objective of making such commitment of funds in the name
of accounts receivables aims at generating a large flow of operating revenue and earning
more than what could be possible in the absence of such commitment. Figure 6.1 further
provides an easy explanation to the purpose for which they are maintained.
Cost of Maintaining Receivables
Receivables are a type of investment made by a firm. Like other investments, receivables too
feature a drawback, which are required to be maintained for long that it known as credit
sanction. Credit sanction means tie up of funds with no purpose to solve yet costing certain
amount to the firm. Such costs associated with maintaining receivables are detailed below: 1. Administrative Cost
If a firm liberalizes its credit policy for the good reasons of either maximizing sales or
minimizing erosion of sales, it incurs two types of costs:
(A) Credit Investigation and Supervision Cost.
As a result of lenient credit policy, there happens to be a substantial increase in the number of
debtors. As a result the firm is required to analysis and supervises a large volume of accounts
at the cost of expenses related with acquiring credit information either through outside
specialist agencies or form its own staff.
(B) Collection Cost
A firm will have to intensify its collection efforts so as to collect the outstanding bills
especially in case of customers who are financially less sound. It includes additional expenses
of credit department incurred on the creation and maintenance of staff, accounting records,
stationary, postage and other related items.
2. Capital Cost
There is no denying that maintenance of receivables by a firm leads to blockage of its
financial resources due to the tie log that exists between the date of sale of goods to the
customer and the date of payment made by the customer. But the bitter fact remains that the
firm has to make several payments to the employees, suppliers of raw materials and the like
even during the period of time lag. As a consequence, a firm is liable to make arrangements
14

for meeting such additional obligations from sources other than sales. Thus, a firm in the
course of expanding sales through receivables makes way for additional capital costs.
3. Production and Selling Cost
These costs are directly proportionate to the increase in sales volume. In other words,
production and selling cost increase with the very expansion in the quantum of sales. In this
respect, a firm confronts two situations; firstly when the sales expansion takes place within
the range of existing production capacity, in that case only variable costs relating to the
production and sale would increase. Secondly, when the production capacity is added due to
expansion of sales in excess of existing production capacity. In such a case incremental
production and selling costs would increase both variable and fixed costs.
4. Delinquency Cost
This type of cost arises on account of delay in payment on customer's part or the failure of the
customers to make payments of the receivables as and when they fall due after the expiry of
the credit period. Such debts are treated as doubtful debts. They involve: 1. Blocking of firm's funds for an extended period of time,
2.Costs associated with the collection of overheads, remainders legal expenses and on
initiating other collection efforts.
5. Default Cost
Similar to delinquency cost is default cost. Delinquency cost arises as a result of customers
delay in payments of cash or his inability to make the full payment from the firm of the
receivables due to him. Default cost emerges a result of complete failure of a defaulter
(customer) to pay anything to the firm in return of the goods purchased by him on credit.
When despite of all the efforts, the firm fails to realize the amount due to its debtors because
of him complete inability to pay for the same. The firm treats such debts as bad debts, which
are to be written off, as cannot be recovers in any case.

FACTORS AFFECTING THE SIZE OF RECEIVABLES:

15

The size of receivables is determined by a number of factors for receivables being a major
component of current assets. As most of them varies from business the business in
accordance with the nature and type of business. Therefore, to discuss all of them would
prove irrelevant and time consuming. Some main and common factors determining the level
of receivable are presented by way of diagram in figure given below and are discuses below :

16

Stability of Sales
Stability of sales refers to the elements of continuity and consistency in the sales. In other
words the seasonal nature of sales violates the continuity of sales in between the year. So, the
sale of such a business in a particular season would be large needing a large a size of
receivables. Similarly, if a firm supplies goods on installment basis it will require a large
investment in receivables.
Terms of Sale
A firm may affect its sales either on cash basis or on credit basis. As a matter of fact credit is
the soul of a business. It also leads to higher profit level through expansion of sales. The
higher the volume of sales made on credit, the higher will be the volume of receivables and
vice-versa.
The Volume of Credit Sales
It plays the most important role in determination of the level of receivables. As the terms of
trade remains more or less similar to most of the industries. So, a firm dealing with a high
level of sales will have large volume of receivables.
Credit Policy
A firm practicing lenient or relatively liberal credit policy its size of receivables will be
comparatively large than the firm with more rigid or signet credit policy. It is because of two
prominent reasons:

A lenient credit policy leads to greater defaults in payments by financially weak

customers resulting in bigger volume of receivables.

A lenient credit policy encourages the financially sound customers to delay payments
again resulting in the increase in the size of receivables.

Terms of Sale
The period for which credit is granted to a customer duly brings about increase or decrease in
receivables. The shorter the credit period, the lesser is the amount of receivables. As short
term credit ties the funds for a short period only. Therefore, a company does not require
holding unnecessary investment by way of receivables.

17

Cash Discount

Cash discount on one hand attracts the customers for payments before the lapse of credit
period. As a tempting offer of lesser payments is proposed to the customer in this system, if a
customer succeeds in paying within the stipulated period. On the other hand reduces the
working capital requirements of the concern. Thus, decreasing the receivables management.
Collection Policy
The policy, practice and procedure adopted by a business enterprise in granting credit,
deciding as to the amount of credit and the procedure selected for the collection of the same
also greatly influence the level of receivables of a concern. The more lenient or liberal to
credit and collection policies the more receivables are required for the purpose of investment.
Collection Collected
If an enterprise is efficient enough in encasing the payment attached to the receivables within
the stipulated period granted to the customer. Then, it will opt for keeping the level of
receivables low. Whereas, enterprise experiencing undue delay in collection of payments will
always have to maintain large receivables.
Bills Discounting and Endorsement
If the firm opts for discounting its bills, with the bank or endorsing the bills to the third party,
for meeting its obligations. In such circumstances, it would lower the level of receivables
required in conducting business.
Quality of Customer
If a company deals specifically with financially sound and credit worthy customers then it
would definitely receive all the payments in due time. As a result the firm can comfortably do
with a lesser amount of receivables than in case where a company deals with customers
having financially weaker position.
Miscellaneous
There are certain general factors such as price level variations, attitude of management type
and nature of business, availability of funds and the lies that play considerably important role
in determining the quantum of receivables.

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PRINCIPLES OF CREDIT MANAGEMENT:

Joseph L. Wood is of the opinion,
"The purpose of any commercial enterprise is the earning of profit, credit in itself is utilized
to increase sale, but sales must return a profit."
The primary objective of management or receivables should not be limited to expansion of
sales but should involve maximization of overall returns on investment. So, receivables
management should not be confined to mere collection or receivables within the shortest
possible period but is required to focus due attention to the benefit-cost trade-off relating to
numerous receivables management.
In order to add profitability, soundness and effectiveness to receivables management, an
enterprise must make it a point to follow certain well-established and duly recognized
principles of credit management.
"The first of these principles relate to the allocation of authority pertaining to credit and
collections of some specific management. The second principle puts stress on the selection of
proper credit terms. The third principles emphasizes a through credit investigation before a
decision on granting a credit is taken. And the last principle touches upon the establishment
of sound collection policies and procedures."
In the light of this quotation the principles of receivables management can be stated
as: 1. Allocation or Authority
The determination of sound and effective credit collection policies management. The
efficiency of a credit management in formulation and exestuation of credit and collection
policies largely depends upon the location of credit department in the organizational structure
f the concern. The aspect of authority allocation can be viewed under two concepts. As per
the first concept, it is placed under the direct responsibility of chief finance officer for it
being a function primarily financed by nature. Further, credit and collection policies lay
direct influence on the solvency of the firm.
"For these reasons the credit and collection function should be placed under the direct
supervision of the individuals who are responsible for the firm's financial position."
There are other who suggest that business firms should strictly enforce upon their sales
departments the principles that sales are insolate until the value thereof is realsied Those
favoring this aspect plead to place the authority of allocation under the direct charge of the
19

marketing executive or the sales department. To conclude

"the reasonability to administer credit and collections policies may be assigned either to a
financial executive or to a marketing executive or to both of them jointly depending upon the
organizational structure and the objectives of the firm."
2. Selection of Proper Credit Terms
The receivables management of an enterprise is required to determine the terms and
conditions on the basis of which trade credit can be sanctioned to the customers are of vital
importance for an enterprise. As the nature of the credit policy of an enterprise is decided on
the basis of components of credit policy. These components include; credit period, cash
discount and cash discount period. In practice, the credit policy of firms, vary within the
range of lenient and stringent. A firm that tends to grant long period credits and its debtors
include even those customers whose financial position is doubtful. Such a firm is said to be
following lenient credit policy. Contrary to this, a firm providing credit sales for a relatively
short period of time that too on highly selective basis only to those customers who are
financially strong and have proven their credit worthiness is said to be following stringent
credit policy.
3. Credit Investigation
A firm if desires to maintain effective and efficient receivables management of receivables
must undertake a thorough investigation before deciding to grant credit to a customer. The
investigation is required to be carried on with respect to the credit worthiness and financial
soundness of the debtors, so as to prevent the receivables for falling into the category of bad
debts later on at the time of collection. Credit investigation is not only carried on beforehand.
But in the case of firms practicing liberal credit policy such investigation may be required to
be conducted when a debtors fails to make payments of receivables due on him even after the
expiry of credit sale so as to save doubtful debts from becoming bad debts.
4. Sound Collection Policies and Procedures
Receivables management is linked with a good degree of risk. As a few debtors are slow
payers and some are non-payers. How-so-ever efficient and effective a receivables
management may be the element of risk cannot be avoided altogether but can be minimized
20

to a great extent, it is for this reason the essence of sound collection policies and procedures
arises. A sound collection policy aims at accelerating collection form slow payer and
reducing bad debts losses. As a good collection polices ensures prompt and regular collection
by adopting collection procedures in a clear-cut sequence.
OBJECTIVES OF CREDIT MANAGEMENT:
The objective of receivables management is to promote sales and profit until that is reached
where the return on investment in further finding of receivable is less than the cost of funds
raised to finance that additional credit (i.e., cost of capital). The primary aim of receivables
management vet in minimizing the value of the firm while maintaining a reasonable balance
between risk (in the form of liquidity) and profitability. The main purpose of maintain
receivables is not sales maximization not is for minimization of risk involved by way of bad
debts. Had the main objective being growth of sales, the concern, would have opened credit
sales for all sort of customers. Contrary to this, if the aim had been minimization of risk of
bad debts, the firm would not have made any credit sale at all. That means a firm should
indulge in sales expansion by way of receivables only until the extent to which the risk
remains within an acceptably manageable limit.
All in all, the basic target of management of receivables is to enhance the overall return on
the optimum level of investment made by the firm in receivables. The optimum investment is
determined by comparing the benefits to be derived from a particular level of investment
with the cost of maintaining that level. The costs involve not only the funds tied up in
receivables, but also losses from accounts that do not pay. The latter arises from extending
credit too leniently.
A brief inference of objectives of management of receivables may be given as under:

To attain not maximum possible but optimum volume of sales.

To exercise control over the cost of credit and maintain it on a minimum

possible

level.

To keep investments at an optimum level in the form or receivables.

To plan and maintain a short average collection period.

Granting of credit and its proper and effective management is not possible without
involvement of any cost. These costs are credit administrative expenses bad debts losses,
opportunity costs etc. As mentioned before these costs cannot be possibly eliminated
altogether but should essentially be regulated and controlled. Elimination of such costs
21

simply mean reducing the cost of zero i.e. no credit grant is permitted to the debtors. In that
case firm would no doubt escape form incurring there costs yet the other face of coin would
reflect that the profits foregone on account of expected rise in sales volume made on credit
amounts much more than the costs eliminated. Thus, a firm would fail to materialize the
objective of increasing overall return of investment. The period goal of receivables
management is to strike a golden mean among risk, liquidity and profitability turns out to be
effective marketing tool. As it helps in capturing sales volume by winning new customers
besides retaining to old ones.
ASPECT OF CREDIT POLICY:
The discharge of the credit function in a company embraces a number of activities for which
the policies have to be clearly laid down. Such a step will ensure consistency in credit
decisions and actions. A credit policy thus, establishes guidelines that govern grant or reject
credit to a customer, what should be the level of credit granted to a customer etc. A credit
policy can be said to have a direct effect on the volume of investment a company desires to
make in receivables.
To improve profitability one can resort to lenient credit policy as a booster of sales, but the
implications are: 1. Changes of extending credit to those with week credit rating.
2. Unduly long credit terms.
3. Tendency to expand credit to suit customer's needs; and
4. Lack of attention to over dues accounts.
DETERMINATION OF CREDIT POLICY:
The evaluation of a change in a firm's credit policy involves analysis of:
1. Opportunity cost of lost contribution.

22

2. Credit administration cost and risk of bad-debt losses.

Above Figure shows that contrary relationship that exists between the two costs. If a
company adopts stringent credit policy, there occurs considerable reduction in the level of
profitability (shown by curve AB) by the liquidity position stands story (represented by CD
Curve). However, the firm losses in terms of contribution due to higher opportunity cost
resulting form lost sales. Yet, the credit administrative cost & risk of bad debt losses are quite
low. Contrary to this, a company resorting to liberal credit policy has it profitability curve AB
rising above liquidity curve CD disclosing that its profitability level is quiet high but the
problem of liquidity becomes evident as a result of heavy investment in receivables due to
increased sales. Besides this, the opportunity costs of such a firm declines as the firm raptures
lost contribution. But the credit administrative costs increase as more accounts are to be
handled and also there is rise in risk of bad debt losses. The point E in the figure denotes the
state of equilibrium between profitability curve (AB) and Liquidity curve (CD) depicting that
the operating profits are maximum. So, point E provides the firm with an appropriate credit
policy determined by tradeoff between opportunity costs and credit administrative cost and
bad debt losses.
As a matter of fact, point E may not necessarily be representative of optimum credit policy.
Optimum credit policy does not mean the point at which balance between liquidity and
profitability can be maintained. Instead, an optimum credit policy is one that maximizes the
firm's is achieved when marginal rate of return i.e. incremental rate of return on investment
becomes equal to marginal cost of capital i.e. incremental cost of funds used to finance the
investment. The incremental rate of return is obtained by dividing incremental investment in
receivables. While the incremental cost of funds, is the rate of return expected by firm
granting the credit. This rate of return is not equal to borrowing rate. As in case of firm
following loose credit policy, higher rate of return means higher risk of invest in A/c's
receivables due to slow paying and defaulting accounts.
To sum up, in order to achieve the goal of maximizing the value of the firm the evaluation of
investment in receivables accounts should involve the following four steps:
1. Estimation of incremental operating profit,
2. Estimation of incremental investment in accounts receivables,
23

3. Estimation of the incremental rate of return of investment,

4. Comparison of incremental rate of return with the required rate of return.
The reality, it is rather a different task to establish an optimum credit policy as the best
combination of variables of credit policy is quite difficult to obtain. The important variables
of credit policy should be identified before establishing an optimum credit policy. The three
important decisions variables of credit policy are:
1. Credit terms,
2. Credit standards, and
3. Collection policy.
1. Credit Terms
Credit terms refer to the stipulations recognized by the firms for making credit sale of the
goods to its buyers. In other words, credit terms literally mean the terms of payments of the
receivables. A firm is required to consider various aspects of credit customers, approval of
credit period, acceptance of sales discounts, provisions regarding the instruments of security
for credit to be accepted are a few considerations which need due care and attention like the
selection of credit customers can be made on the basis of firms, capacity to absorb the bad
debt losses during a given period of time. However, a firm may opt for determining the credit
terms in accordance with the established practices in the light of its needs. The amount of
funds tied up in the receivables is directly related to the limits of credit granted to customers.
These limits should never be ascertained on the basis of the subjects own requirements, they
should be based upon the debt paying power of customers and his ledger record of the orders
and payments. There are two important components of credit terms which are detailed
below:-

24

(A) Credit period and

(B) Cash discount terms
(A) Credit period
According to Martin H. Seiden, "Credit period is the duration of time for which trade credit is
extended. During this time the overdue amount must be paid by the customers."
The credit period lays its multi-faced effect on many aspects the volume of investment in
receivables; its indirect influence can be seen on the net worth of the company. A long period
credit term may boost sales but its also increase investment in receivables and lowers the
quality of trade credit. While determining a credit period a company is bound to take into
consideration various factors like buyer's rate of stock turnover, competitors approach, the
nature of commodity, margin of profit and availability of funds etc.
The period of credit diners form industry to industry. In practice, the firms of same industry
grant varied credit period to different individuals. as most of such firms decide upon the
period of credit to be allowed to a customer on the basis of his financial position in addition
to the nature of commodity, quality involved in transaction, the difference in the economic
status of customer that may considerably influence the credit period.
,
The average collection period will get extended, as the customers will be granted more time
to repay credit obligation. Determining the options credit period, therefore, involves locating
the period where marginal profit and increased sales are exactly off set by the cost of carrying
the higher amount of accounts receivables.
(B) Cash Discount Terms
The cash discount is granted by the firm to its debtors, in order to induce them to make the
payment earlier than the expiry of credit period allowed to them. Granting discount means
reduction in prices entitled to the debtors so as to encourage them for early payment before
the time stipulated to the i.e. the credit period. According to Theodore N. Beckman,
"Cash discount is a premium on payment of debts before due date and not a compensation for
the so called prompt payment,'
25

Grant of cash discount beneficial to the debtor is profitable to the creditor as well. A customer
of the firm i.e. debtor would be realized from his obligation to pay Soon that too at
discounted prices. On the other hand, it increases the turnover rate of working capital and
enables the creditor firm to operate a greater volume of working capital. It also prevents
debtors from using trade credit as a source of working capital.
Cash discount is expressed is a percentage of sales. A cash discount term is accompanied by
(a) the rate of cash discount,
(b) the cash discount period, and
(c) the net credit period.
For instance, a credit term may be given as "1/10 Net 30" that mean a debtor is granted 1
percent discount if settles his accounts with the creditor before the tenth day starting from a
day after the date of invoice. But in case the debtor does not opt for discount he is bound to
terminate his obligation within the credit period of thirty days.
2. Credit Standards
Credit standards refers to the minimum criteria adopted by a firm for the purpose of short
listing its customers for extension of credit during a period of time. Credit rating, credit
reference, average payments periods a quantitative basis for establishing and enforcing credit
standards. The nature of credit standard followed by a firm can be directly linked to changes
in sales and receivables. In the opinion of Van Home,
"There is the cost of additional investment in receivables, resulting from increased sales and
a slower average collection period.

3. Collection Policy
Collection policy refers to the procedures adopted by a firm (creditor) collect the amount of
from its debtors when such amount becomes due after the expiry of credit period. R.K.
Mishra States,
"A collection policy should always emphasize promptness, regulating and systematization in
collection efforts. It will have a psychological effect upon the customers, in that; it will make
them realize the obligation of the seller towards the obligations granted. "
The requirements of collection policy arises on account of the defaulters i.e. the customers
26

not making the payments of receivables in time. As a few turnouts to be slow payers and
some other non-payers. A collection policy shall be formulated with a whole and sole aim of
accelerating collection from bad-debt losses by ensuring prompt and regular collections.
Regular collection on one hand indicates collection efficiency through control of bad debts
and collection costs as well as by inducing velocity to working capital turnover. On the other
hand it keeps debtors alert in respect of prompt payments of their dues. A credit policy is
needed to be framed in context of various considerations like short-term operations,
determinations of level of authority, control procedures etc. Credit policy of an enterprise
shall be reviewed and evaluated periodically and if necessary amendments shall be made to
suit the changing requirements of the business. It should be designed in such a way that it coordinates activities of concerns departments to achieve the overall objective of the business
enterprises. finally, poor implementation of good credit policy will not produce optimal
results.
CONTROL OF RECEIVABLES:
Control or receivables largely depends upon the system of credit control practiced by a
business enterprise. It becomes a part of organization obligation to obtain full and relevant
information complete in all respect before deciding upon the right customer for the right
amount of credit grant. Whenever an order is placed by an applicant financial position and
credit worthiness becomes essential. Only after ensuring the degree of safety an order should
be accepted and delivered.
A firm is expected to prepare sales invoice and credit notes as early as possible; side by side it
should also ensure that they are dispatched at specified regular intervals for effective control
of receivables. It is always considered good on the part of rim it is keep as separate ledger for
the accounts of based and doubtful debtors. Such segregation not only helps in easy
assessment of the position of bad and doubtful debtors in relation to the totaldebtor's position.
A considerable amount of reduction in debtors can be achieved by offering cash discount to
the customers.
Even in case of export sales, segregation of credit sales into separate ledger adds
effectiveness to control of receivables. Sometimes large contracts, payable by installments,
involve credit for several years. The price fixed in these cases should be sufficiently high
notonly to cover export credit insurance, but also to cover a satisfactory rate of interest on the
27

diminishing balances of debt expected to the outstanding during the credit period.
There are two methods of controlling accounts receivables, which are traditional in nature;
days sales outstanding and ageing schedule. Though they are popularly used but they suffer
from a serious deficiency. Both these methods are based on aggregation of sales and
receivables due to which the changes in the pattern of payment cannot be easily detected. In
order to overcome this drawback of traditional methods, a firm can make use of payments
pattern approach.

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CHAPTER 3
INVENTORY MANAGEMENT
Inventories occupy the most strategic position in the structure of working capital of
most business enterprises. It constitutes the largest component of current asset in
most business enterprises. In the sphere of working capital, the efficient control of
inventory has passed the most serious problem to the cement mills because about
two-third of the current assets of mills are blocked in inventories. The turnover of
working capital is largely governed by the turnover of inventory. It is therefore quite
natural that inventory which helps in maximize profit occupies the most significant
place among current assets
Meaning and Definition of Inventory
In dictionary meaning of inventory is a detailed list of goods, furniture etc. Many
understand the word inventory, as a stock of goods, but the generally accepted
meaning of the word goods in the accounting language, is the stock of finished
goods only. In a manufacturing organization, however, in addition to the stock of
finished goods, there will be stock of partly finished goods, raw materials and stores.
The collective name of these entire items is inventory.
(i) The term inventory refers to the stockpile of production a firm is offering for
sale and the components that make up the production. The inventory means
aggregate of those items of tangible personal property which: are held for sale in
ordinary course of business.
(ii) are in process of production for such sales.
(iii) they are to be currently consumed in the production of goods or services to be
available for sale.
Inventories are expandable physical articles held for resale for use in manufacturing
a production or for consumption in carrying on business activity such as
merchandise, goods purchased by the business which are ready for sale. It is the
inventory of the trader who dies not manufacture it.
Finished Goods:
Goods being manufactured for sale by the business which are ready for sale.
Materials:
29

Articles such as raw materials, semi-finished goods or finished parts, which the
business plans to incorporate physically into the finished production.
Supplies:
Article, which will be consumed by the business in its operation but will not
physically as they are a part of the production.
Management of Inventories
Inventories consist of raw materials, stores, spares, packing materials, coal,
petroleum products, works-in-progress and finished products in stock either at the
factory or deposits. It is most important component of current assets in the cement
industry and was 42 per cent of total current assets for sample companies as on
March 31, 2004. In other industries too it is very important component of total
investment. The maintenance of inventory means blocking of funds and so it
involves the interest and opportunity cost to the firm. In many countries specially in
Japan great emphasis is placed on inventory management. Efforts are made to
minimize the stock of inputs and outputs by proper planning and forecasting of
demand of various inputs and producing only that much quantity which can be sold
in the market.
Objectives of Inventory Management
The primary objectives of inventory management are:
1. To minimize the possibility of disruption in the production schedule of a firm for
want of raw material, stock and spares.
2. To keep down capital investment in inventories.So it is essential to have necessary
inventories. Excessive inventory is an idle resource of a concern. The concern
should always avoid this situation.
The investment in inventories should be just sufficient in the optimum level. The
major dangers of excessive inventories are:

the unnecessary tie up of the firms funds and loss of profit.

excessive carrying cost, and

the risk of liquidity.

The excessive level of inventories consumes the funds of business, which cannot be
used for any other purpose and thus involves an opportunity cost. The carrying cost,
such as the cost of shortage, handling insurance, recording and inspection, are also
increased in proportion to the volume of inventories. This cost will impair the
30

concern profitability further.

Inventory Control
Inventory control is concerned with the acquisition, storage, handling and use of
inventories so as to ensure the availability of inventory whenever needed, providing
adequate provision for contingencies, deriving maximum economy and minimizing
wastage and losses.
Hence Inventory control refers to a system, which ensures the supply of required
quantity and quality of inventory at the required time and at the same time prevent
unnecessary investment in inventories.It is one of the most vital phase of material
management. Reducing inventories without impairing operating efficiency frees
working capital that can be effectively employed elsewhere. Inventory control can
make or break a company. This explains the usual saying that inventories are the
graveyard of a business. Designing a sound inventory control system is in a large
measure for balancing operations. It is the focal point of many seemingly conflicting
interests and considerations both short range and long range.
An efficient inventory management, therefore, requires the company to maintain
inventories at an optimum level where inventory costs are minimum and at the same
time there is no stock out which may result in loss of sale or stoppage of production.
This necessitates the determination of the minimum and maximum level of
inventories.

Minimum Level
The minimum level of inventories of their reorder point may be determined on the
following bases:
(i) Consumption during lead-time.
(ii) Consumption during lead-time plus safety stock.
(iii) Stock out costs.
(iv) Customers irritation and loss of goodwill and production hold costs.
To continue production during Lead Time it is essential to maintain some
inventories. Lead Time has been defined as the interval between the placing of an
order (with a supplier) and
the time at which the goods are available to meet the consumer needs.There are
sometimes fluctuations in the lead-time and/ or in the consumption rate. If no
31

provision is made for these variations, stock out may take place-causing disruption
in the production schedule of the company. The stock, which takes care to the
fluctuation in demand, varies in lead-time and consumption rate is known as safety
stock. Safety stock may be defined as the minimum additional inventory, which
serves as a safety margin or buffer or cushion to meet an unanticipated increase in
usage resulting from an unusually high demand and or an uncontrollable late receipt
of incoming inventory. It can be determined on the basis of the consumption rate,
plus other relevant factor such as transport bottleneck, strikes or shutdowns.
For each type of inventory a maximum level is set that demand presumably will not
exceed as well as a minimum level representative a margin of safety required to
prevent out of stock condition. The minimum level also governs the ordering point.
An order to sufficient size is placed to bring inventory to the maximum point when
the minimum level is reached.
Maximum Level
The upper limit beyond which the quantity of any item is not normally allowed to
rise is known as the Maximum Level. It is the sum total of the minimum quantity,
and ECQ. The fixation of the maximum level depends upon a number of factors,
such as, the storage space available, the nature of the material i.e. chances of
deterioration and obsolescence, capital
outlay, the time necessary to obtain fresh supplies, the ECQ, the cost of storage and
government restriction.
Re-Order Level
Also known as the ordering level the reorder level is that level of stock at which a
purchase requisition is initiated by the storekeeper for replenishing the stock. This
level is set between the maximum and the minimum level in such a way that before
the material ordered for are received into the stores, there is sufficient quantity on
hand to cover both normal and abnormal circumstances. The fixation of ordering
level depends upon two important factors viz, the maximum delivery period and the
maximum rate of consumption.
Re-Order Quantity
The quantity, which is ordered when the stock of an item falls to the reorder level, is
know as the reorder quantity or the EOQ or the economic lot size. Although it is not
a stock level as such, the reorder quantity has a direct bearing upon the stock level in
as much as it is necessary to consider the maximum and minimum stock level in
32

determining the quantity to be ordered. The re-order quantity should be such that,
when it is added to the minimum quantity, the maximum level is not exceeded. the
re-order quantity depends upon two important factors viz, order costs and inventory
carrying costs. It is, however, necessary to remember that the ordering cost and
inventory carrying cost are opposed to each other. Frequent purchases in small
quantities, no doubt reduce carrying cost, but the ordering costs such as the cost
inviting tenders of placing order and of receiving and inspection, goes up. If on the
other hand purchases are made in large quantities, carrying costs, such as, the
interest on capital, rent, insurance, handling charges and losses and wastage, will be
more than the ordering costs. The EOQ is therefore determined by balancing these
opposing costs.

Economy Order Quantity

The EOQ refers to the order size that will result in the lowest total of order and
carrying costs for an item of inventory. If a firm place unnecessary orders it will
incurunneeded order costs. If a firm places too few order, it must maintain large
stocks of goods and will have excessive carrying cost. By calculating an economic
order quantity, the firm identifies the number of units to order that result in the
lowest total of these two costs.
Reorder Point
The reorder point is the level of inventory at which the firm places an order in the
amount of EOQ. If the firm places the order when the inventory reaches the reorder
point, the new goods will arrive before the firm runs out of goods to sell.In
designing reorder point subsystem, three items of information are needed as inputs
to the subsystem.
2. Usage rate-- This is the rate per day at which the item is consumed in production
or sold to customers. It is expressed in units. It may be calculated by dividing annual
sales by 365 days. If the sales are 50,000 units the usage rate is 50,000/365 = Units
per day.
3. Lead time-- This is the amount of time between placing an order and receiving
goods. This information is usually provided by the purchasing department. The time
to allow for an order to arrive may be estimated from a check of the companys
record and the time taken in the past for different suppliers to fill orders.
33

4. Safety stock-- The minimum level of inventory may be expressed in terms of

several days sales. The level can be calculated by multiplying the usage rate and
time in the number of days that the firm wants to hold as a protection against
shortages.
Re-order point = (Usage rate)(Lead time + Days of safety) = (Lead Time x
Consumption rate) + Safety stock.
Pricing of Raw Materials
When issues are made out of various lots purchased at varying prices, the problem
arises as to which of the receipt price should be adopted for valuing the materials
requisitions.
1. First in first out Materials received first will be issued first. The price of the
earliest consignment is taken first and when that consignment is exhausted the price
of the next consignment is adopted and so on. This method is suitable in times of
falling prices, because the material charge to production will be high while the
replacement cost of materials will be low.
2. Last in first out
Materials received last will be issued first. The price of the last consignment is taken
first and when that consignment is exhausted the price of the second last
consignment is adopted and so on. In timing of rising prices this method will show a
charge to production, which is closely related to current price levels provided that
the last purchase is made recently.
3. Weighted average cost method Under this method, material issued is priced at the
weighted average cost of material in stock:
WAC = Value of material in stock/Quantity in stock.
4. Standard price method
Under this method a standard price is predetermined. The price of issues
predetermined for a stated period taken into account all the factors affecting price
such as anticipated market trends, transportation charges, and normal quantity of
purchase. Standard prices are determined for each material and material requisition
are priced at standards irrespective of the actual purchase price. Any difference
between the standard and actual price results in materials price variance.
5. Current price
34

According to this method, material issued is priced at their replacement or realizable

price at the time of issue. So thecost at which identical material could be purchased
from themarket should be ascertained and used for valuing material issues.
Perpetual Inventory System
maintenance of inventory control on a continuous basis.After the material are
received into the stores, the storekeeper will arrange for the storing of each item in
the allotted rack, bin, shelf or other receptacles and attach a card to each bin for the
purpose of making entries there-in, relating to the receipts, issues and balance. The
bin card or the locker card, this becomes a perpetual inventory record for each item
of stores. If the stores balance is recorded on continuous basis after every receipt and
issue, the record is said to be one of perpetual inventory and the method of recording
is called the perpetual inventory system. Thus the perpetual inventory is a method of
recording store balance after every receipt and issue to facilitate regular checking
and to obviate closing down for stock locking As a perpetual inventory record, the
bin card records the receipt, issues and the balance of every item of stores only in
physical quantities, and not in value. This feature of the bin card is in accordance
with the accepted principle that the storekeeper true to his designation, should be
responsible for the safe keeping of the items of stores entrusted to him, and his
accounting for stores should always be in physical quantities and not in value. The
perpetual inventory system includes continues stock taking also. Stocktaking or
stock verification is done mainly with a view to finding out whether the book
balances as revealed by the stock records agree with the physical or the ground
balance. Although, therefore, stock Another method of inventory control is the
verification is one of the tools of inventory control, and is done for exercising
control over the stock of every item, is an integral part of material control for the
purpose of preparing the B/S, the physical verification of stock must be done at the
end of year.Such verification at the end of the year is known as the periodical stock
taking as against the continuous stocktaking, which is done throughout the year. The
periodic stock taking method usually adopted by concerns which cannot maintain
perpetual inventory records due to the nature of the items which are usually stored in
open yards and not in bins and as a such, bin cards cannot be employed for them, or
do not want to maintain such records and employ stock verification staff to do the
work of stock checking throughout the year. Under this method of stocktaking, the
verification of the whole of the stock and its valuation are accomplished only once at
35

the close of the financial year and difference in stock is adjusted only once. As such,
the stock in hand would tend to be accurate for the balance sheet purposes. It is also
possible to find out slow moving items. Nevertheless, the periodic inventory has its
own disadvantage. In the first place, it becomes necessary to close down the factory
on the day of stock taking. Secondly, discrepancies in stock cannot be corrected by
an executive action immediately as and when they occur. Thirdly, since all the items
are checked only once in a particular day, a surprise verification will not be possible.
Lastly, reason for the discrepancies cannot be found out because of the long interval
between two consecutive verifications.
These disadvantages of the periodical inventory system are overcome in the case
of the perpetual inventory system. Under this method of continuous stock
verification the purpose of verification is carried on throughout the year by a
specially trained staff. This duty is to verify a few selected items in details so that
each item is checked up a number of times during the year. The day and time of
checking not being known to the staff, they are taken by a surprise. As such, not
only secrecy of the items to be verified cannot maintained, a manipulation of
every type can be prevented. Discrepancies are located, reasons are ascertained,
the necessary adjustment are made in the accounting records, and correlative
action is taken then and there to prevent their recurrence. The advantages of a
continuous stocktaking where perpetual inventory records are maintained may
thus be summarized as follows:
(i) The elaborate and costly work involved in periodic stock taking can be
avoided.
(ii) The stock verification can be done without the necessity of closing down the
factory.
(iv) The preparation of interim financial statement becomes possible.
Discrepancies are easily located, and corrected immediately.

(v) It ensure a reliable check on the stores.

(vi) It exercises a moral influence on the stores staff.

36

(vii) Fast and slow moving items can be distinguished and the fixation of proper
stock levels prevents not only over-stocking, but under-stocking also.
(viii) A perpetual inventory record of the nature of the bin cards enables the
storekeeper to keep an eye on the stock levels, and replenish the stock of every
item whenever the limit falls to the reorder level.

37

Conclusion

BIBILOGRAPHY

(i)