Project Report - Working Capital Management

WORKING CAPITAL - Meaning of Working

Capital

Capital required for a business can be classified under two main categories via,

1) Fixed Capital

2) Working Capital

Every business needs funds for two purposes for its establishment and to carry out its day-
to-day operations. Long terms funds are required to create production facilities through purchase
of fixed assets such as p&m, land, building, furniture, etc. Investments in these assets represent
that part of firm’s capital which is blocked on permanent or fixed basis and is called fixed
capital. Funds are also needed for short-term purposes for the purchase of raw material, payment
of wages and other day – to- day expenses etc.

These funds are known as working capital. In simple words, working capital
refers to that part of the firm’s capital which is required for financing short- term or current
assets such as cash, marketable securities, debtors & inventories. Funds, thus, invested in current
assts keep revolving fast and are being constantly converted in to cash and this cash flows out
again in exchange for other current assets. Hence, it is also known as revolving or circulating
capital or short term capital.

CONCEPT OF WORKING CAPITAL

There are two concepts of working capital:

1. Gross working capital

2. Net working capital

The gross working capital is the capital invested in the total current assets of the enterprises
current assets are those

Assets which can convert in to cash within a short period normally one accounting year.

CONSTITUENTS OF CURRENT ASSETS

1) Cash in hand and cash at bank

2) Bills receivables

3) Sundry debtors

4) Short term loans and advances.

5) Inventories of stock as:

a. Raw material

b. Work in process

c. Stores and spares

d. Finished goods

6. Temporary investment of surplus funds.

7. Prepaid expenses

8. Accrued incomes.

9. Marketable securities.
 In a narrow sense, the term working capital refers to the net working. Net working
capital is the excess of current assets over current liability, or, say:

NET WORKING CAPITAL = CURRENT ASSETS – CURRENT LIABILITIES.

Net working capital can be positive or negative. When the current assets exceeds the
current liabilities are more than the current assets. Current liabilities are those
liabilities, which are intended to be paid in the ordinary course of business within a
short period of normally one accounting year out of the current assts or the income
business.

CONSTITUENTS OF CURRENT LIABILITIES

1. Accrued or outstanding expenses.

2. Short term loans, advances and deposits.

3. Dividends payable.

4. Bank overdraft.

5. Provision for taxation , if it does not amt. to app. Of profit.

6. Bills payable.

7. Sundry creditors.

The gross working capital concept is financial or going concern concept whereas net working
capital is an accounting concept of working capital. Both the concepts have their own merits.

The gross concept is sometimes preferred to the concept of working capital for the following
reasons:
1. It enables the enterprise to provide correct amount of working capital at
correct time.

2. Every management is more interested in total current assets with which it

has to operate then the source from where it is made available.

3. It take into consideration of the fact every increase in the funds of the
enterprise would increase its working capital.

4. This concept is also useful in determining the rate of return on investments

in working capital. The net working capital concept, however, is also
important for following reasons:

• It is qualitative concept, which indicates the firm’s ability to meet to its

operating expenses and short-term liabilities.

• IT indicates the margin of protection available to the short term creditors.

• It is an indicator of the financial soundness of enterprises.

• It suggests the need of financing a part of working capital requirement out of

the permanent sources of funds.
CLASSIFICATION OF WORKING CAPITAL

Working capital may be classified in to ways:

o On the basis of concept.

o On the basis of time.

On the basis of concept working capital can be classified as gross working capital and
net working capital. On the basis of time, working capital may be classified as:

 Permanent or fixed working capital.

 Temporary or variable working capital

PERMANENT OR FIXED WORKING CAPITAL

Permanent or fixed working capital is minimum amount which is required to ensure effective
utilization of fixed facilities and for maintaining the circulation of current assets. Every firm has
to maintain a minimum level of raw material, work- in-process, finished goods and cash balance.
This minimum level of current assts is called permanent or fixed working capital as this part of
working is permanently blocked in current assets. As the business grow the requirements of
working capital also increases due to increase in current assets.

TEMPORARY OR VARIABLE WORKING CAPITAL

Temporary or variable working capital is the amount of working capital which is required to
meet the seasonal demands and some special exigencies. Variable working capital can further be
classified as seasonal working capital and special working capital. The capital required to meet
the seasonal need of the enterprise is called seasonal working capital. Special working capital is
that part of working capital which is required to meet special exigencies such as launching of
extensive marketing for conducting research, etc.

Temporary working capital differs from permanent working capital in the sense that is required
for short periods and cannot be permanently employed gainfully in the business.

And some special al is the amount of working capital which is required to meet the seasonal sets.

IMPORTANCE OR ADVANTAGE OF ADEQUATE WORKING CAPITAL

 SOLVENCY OF THE BUSINESS: Adequate working capital helps in

maintaining the solvency of the business by providing uninterrupted of production.

 Goodwill: Sufficient amount of working capital enables a firm to make prompt

payments and makes and maintain the goodwill.

 Easy loans: Adequate working capital leads to high solvency and credit standing
can arrange loans from banks and other on easy and favorable terms.

 Cash Discounts: Adequate working capital also enables a concern to avail cash
discounts on the purchases and hence reduces cost.

 Regular Supply of Raw Material: Sufficient working capital ensures regular

supply of raw material and continuous production.

 Regular Payment Of Salaries, Wages And Other Day TO Day

Commitments: It leads to the satisfaction of the employees and raises the morale of
its employees, increases their efficiency, reduces wastage and costs and enhances
production and profits.

 Exploitation Of Favorable Market Conditions: If a firm is having

adequate working capital then it can exploit the favorable market conditions such as
 purchasing its requirements in bulk when the prices are lower and holdings its inventories
for higher prices.

 Ability To Face Crises: A concern can face the situation during the depression.

 Quick And Regular Return On Investments: Sufficient working capital

enables a concern to pay quick and regular of dividends to its investors and gains
confidence of the investors and can raise more funds in future.

 High Morale: Adequate working capital brings an environment of securities,

confidence, high morale which results in overall efficiency in a business.

EXCESS OR INADEQUATE WORKING CAPITAL

Every business concern should have adequate amount of working capital to run its business
operations. It should have neither redundant or excess working capital nor inadequate nor
shortages of working capital. Both excess as well as short working capital positions are bad
for any business. However, it is the inadequate working capital which is more dangerous
from the point of view of the firm.

DISADVANTAGES OF REDUNDANT OR EXCESSIVE WORKING

CAPITAL

1. Excessive working capital means ideal funds which earn no profit for
the firm and business cannot earn the required rate of return on its
investments.

2. Redundant working capital leads to unnecessary purchasing and

accumulation of inventories.

3. Excessive working capital implies excessive debtors and defective credit

policy which causes higher incidence of bad debts.
 4. It may reduce the overall efficiency of the business.

5. If a firm is having excessive working capital then the relations with

banks and other financial institution may not be maintained.

6. Due to lower rate of return n investments, the values of shares may also
fall.

7. The redundant working capital gives rise to speculative transactions

DISADVANTAGES OF INADEQUATE WORKING CAPITAL

Every business needs some amounts of working capital. The need for working capital arises due
to the time gap between production and realization of cash from sales. There is an operating
cycle involved in sales and realization of cash. There are time gaps in purchase of raw material
and production; production and sales; and realization of cash.

Thus working capital is needed for the following purposes:

• For the purpose of raw material, components and spares.

• To pay wages and salaries

• To incur day-to-day expenses and overload costs such as office expenses.

• To meet the selling costs as packing, advertising, etc.

• To provide credit facilities to the customer.

• To maintain the inventories of the raw material, work-in-progress, stores and spares and
finished stock.

For studying the need of working capital in a business, one has to study the business under
varying circumstances such as a new concern requires a lot of funds to meet its initial
requirements such as promotion and formation etc. These expenses are called preliminary
expenses and are capitalized. The amount needed for working capital depends upon the size
of the company and ambitions of its promoters. Greater the size of the business unit,
generally larger will be the requirements of the working capital.

The requirement of the working capital goes on increasing with the growth and expensing of
the business till it gains maturity. At maturity the amount of working capital required is
called normal working capital.

There are others factors also influence the need of working capital in a business.

FACTORS DETERMINING THE WORKING CAPITAL REQUIREMENTS

1. NATURE OF BUSINESS: The requirements of working is very

limited in public utility undertakings such as electricity, water supply and railways
because they offer cash sale only and supply services not products, and no funds are
tied up in inventories and receivables. On the other hand the trading and financial
firms requires less investment in fixed assets but have to invest large amt. of working
capital along with fixed investments.

2. SIZE OF THE BUSINESS: Greater the size of the business, greater

is the requirement of working capital.

3. PRODUCTION POLICY: If the policy is to keep production steady by

accumulating inventories it will require higher working capital.

4. LENTH OF PRDUCTION CYCLE: The longer the

manufacturing time the raw material and other supplies have to be carried for a longer
in the process with progressive increment of labor and service costs before the final
product is obtained. So working capital is directly proportional to the length of the
manufacturing process.
 5. SEASONALS VARIATIONS: Generally, during the busy season, a
firm requires larger working capital than in slack season.

6. WORKING CAPITAL CYCLE: The speed with which the working

cycle completes one cycle determines the requirements of working capital. Longer the
cycle larger is the requirement of working capital.

DEBTORS

CASH FINISHED GOODS

RAW MATERIAL WORK IN PROGRESS

7. RATE OF STOCK TURNOVER: There is an inverse co-relationship between

the question of working capital and the velocity or speed with which the sales are
affected. A firm having a high rate of stock turnover wuill needs lower amt. of
working capital as compared to a firm having a low rate of turnover.

8. CREDIT POLICY: A concern that purchases its requirements on credit and sales
its product / services on cash requires lesser amt. of working capital and vice-versa.

9. BUSINESS CYCLE: In period of boom, when the business is prosperous, there

is need for larger amt. of working capital due to rise in sales, rise in prices, optimistic
expansion of business, etc. On the contrary in time of depression, the business
contracts, sales decline, difficulties are faced in collection from debtor and the firm
may have a large amt. of working capital.
10. RATE OF GROWTH OF BUSINESS: In faster growing concern, we shall
require large amt. of working capital.

11. EARNING CAPACITY AND DIVIDEND POLICY: Some firms have more
earning capacity than other due to quality of their products, monopoly conditions, etc.
Such firms may generate cash profits from operations and contribute to their working
capital. The dividend policy also affects the requirement of working capital. A firm
maintaining a steady high rate of cash dividend irrespective of its profits needs
working capital than the firm that retains larger part of its profits and does not pay so
high rate of cash dividend.

12. PRICE LEVEL CHANGES: Changes in the price level also affect the working
capital requirements. Generally rise in prices leads to increase in working capital.

Others FACTORS: These are:

 Operating efficiency.

 Management ability.

 Irregularities of supply.

 Import policy.

 Asset structure.

 Importance of labor.

 Banking facilities, etc.

MANAGEMENT OF WORKING CAPITAL

Management of working capital is concerned with the problem that arises in attempting
to manage the current assets, current liabilities. The basic goal of working capital
management is to manage the current assets and current liabilities of a firm in such a way
that a satisfactory level of working capital is maintained, i.e. it is neither adequate nor
excessive as both the situations are bad for any firm. There should be no shortage of
funds and also no working capital should be ideal. WORKING CAPITAL
MANAGEMENT POLICES of a firm has a great on its probability, liquidity and
structural health of the organization. So working capital management is three dimensional
in nature as

1. It concerned with the formulation of policies with regard to profitability,

liquidity and risk.

2. It is concerned with the decision about the composition and level of

current assets.

3. It is concerned with the decision about the composition and level of

current liabilities.

WORKING CAPITAL ANALYSIS

As we know working capital is the life blood and the centre of a business. Adequate
amount of working capital is very much essential for the smooth running of the business.
And the most important part is the efficient management of working capital in right time.
The liquidity position of the firm is totally effected by the management of working
capital. So, a study of changes in the uses and sources of working capital is necessary to
evaluate the efficiency with which the working capital is employed in a business. This
involves the need of working capital analysis.

The analysis of working capital can be conducted through a number of devices, such as:
1. Ratio analysis.

2. Fund flow analysis.

3. Budgeting.

1. RATIO ANALYSIS

A ratio is a simple arithmetical expression one number to another. The technique of ratio
analysis can be employed for measuring short-term liquidity or working capital position
of a firm. The following ratios can be calculated for these purposes:

1. Current ratio.

2. Quick ratio

3. Absolute liquid ratio

4. Inventory turnover.

5. Receivables turnover.

6. Payable turnover ratio.

7. Working capital turnover ratio.

8. Working capital leverage

9. Ratio of current liabilities to tangible net worth.

2. FUND FLOW ANALYSIS

Fund flow analysis is a technical device designated to the study the source from which
additional funds were derived and the use to which these sources were put. The fund flow
analysis consists of:

a. Preparing schedule of changes of working capital

b. Statement of sources and application of funds.

It is an effective management tool to study the changes in financial position (working

capital) business enterprise between beginning and ending of the financial dates.

3. WORKING CAPITAL BUDGET

A budget is a financial and / or quantitative expression of business plans and polices to be

pursued in the future period time. Working capital budget as a part of the total budge ting
process of a business is prepared estimating future long term and short term working
capital needs and sources to finance them, and then comparing the budgeted figures with
actual performance for calculating the variances, if any, so that corrective actions may be
taken in future. He objective working capital budget is to ensure availability of funds as
and needed, and to ensure effective utilization of these resources. The successful
implementation of working capital budget involves the preparing of separate budget for
each element of working capital, such as, cash, inventories and receivables etc.

ANALYSIS OF SHORT – TERM FINANCIAL POSITION OR TEST OF

LIQUIDITY
The short –term creditors of a company such as suppliers of goods of credit and
commercial banks short-term loans are primarily interested to know the ability of a firm
to meet its obligations in time. The short term obligations of a firm can be met in time
only when it is having sufficient liquid assets. So to with the confidence of investors,
creditors, the smooth functioning of the firm and the efficient use of fixed assets the
liquid position of the firm must be strong. But a very high degree of liquidity of the
firm being tied – up in current assets. Therefore, it is important proper balance in regard
to the liquidity of the firm. Two types of ratios can be calculated for measuring short-
term financial position or short-term solvency position of the firm.

1. Liquidity ratios.

2. Current assets movements ‘ratios.

A) LIQUIDITY RATIOS

Liquidity refers to the ability of a firm to meet its current obligations as and when these
become due. The short-term obligations are met by realizing amounts from current,
floating or circulating assts. The current assets should either be liquid or near about
liquidity. These should be convertible in cash for paying obligations of short-term
nature. The sufficiency or insufficiency of current assets should be assessed by
comparing them with short-term liabilities. If current assets can pay off the current
liabilities then the liquidity position is satisfactory. On the other hand, if the current
liabilities cannot be met out of the current assets then the liquidity position is bad. To
measure the liquidity of a firm, the following ratios can be calculated:

1. CURRENT RATIO

2. QUICK RATIO

3. ABSOLUTE LIQUID RATIO

 1. CURRENT RATIO

Current Ratio, also known as working capital ratio is a measure of general liquidity and
its most widely used to make the analysis of short-term financial position or liquidity of
a firm. It is defined as the relation between current assets and current liabilities. Thus,

CURRENT RATIO = CURRENT ASSETS

CURRENT LIABILITES

The two components of this ratio are:

1) CURRENT ASSETS

2) CURRENT LIABILITES

Current assets include cash, marketable securities, bill receivables, sundry debtors,
inventories and work-in-progresses. Current liabilities include outstanding expenses,
bill payable, dividend payable etc.

A relatively high current ratio is an indication that the firm is liquid and has the ability
to pay its current obligations in time. On the hand a low current ratio represents that the
liquidity position of the firm is not good and the firm shall not be able to pay its current
liabilities in time. A ratio equal or near to the rule of thumb of 2:1 i.e. current assets
double the current liabilities is considered to be satisfactory.

CALCULATION OF CURRENT RATIO

(Rupees in crore)
 e.g.

Year 2006 2007 2008

Current Assets 81.29 83.12 13,6.57
Current Liabilities 27.42 20.58 33.48
Current Ratio 2.96:1 4.03:1 4.08:1

Interpretation:-

As we know that ideal current ratio for any firm is 2:1. If we see the current ratio of the
company for last three years it has increased from 2006 to 2008. The current ratio of
company is more than the ideal ratio. This depicts that company’s liquidity position is
sound. Its current assets are more than its current liabilities.

2. QUICK RATIO

Quick ratio is a more rigorous test of liquidity than current ratio. Quick ratio may be
defined as the relationship between quick/liquid assets and current or liquid liabilities.
An asset is said to be liquid if it can be converted into cash with a short period without
loss of value. It measures the firms’ capacity to pay off current obligations
immediately.

QUICK RATIO = QUICK ASSETS

CURRENT LIABILITES

Where Quick Assets are:

1) Marketable Securities

2) Cash in hand and Cash at bank.

3) Debtors.
 A high ratio is an indication that the firm is liquid and has the ability to meet its current
liabilities in time and on the other hand a low quick ratio represents that the firms’
liquidity position is not good.

As a rule of thumb ratio of 1:1 is considered satisfactory. It is generally thought that if

quick assets are equal to the current liabilities then the concern may be able to meet its
short-term obligations. However, a firm having high quick ratio may not have a
satisfactory liquidity position if it has slow paying debtors. On the other hand, a firm
having a low liquidity position if it has fast moving inventories.

CALCULATION OF QUICK RATIO

e.g. (Rupees in Crore)

Year 2006 2007 2008

Quick Assets 44.14 47.43 61.55
Current Liabilities 27.42 20.58 33.48
Quick Ratio 1.6 : 1 2.3 : 1 1.8 : 1

Interpretation :

A quick ratio is an indication that the firm is liquid and has the ability to meet its
current liabilities in time. The ideal quick ratio is 1:1. Company’s quick ratio is more
than ideal ratio. This shows company has no liquidity problem.

3. ABSOLUTE LIQUID RATIO

Although receivables, debtors and bills receivable are generally more liquid than
inventories, yet there may be doubts regarding their realization into cash immediately
or in time. So absolute liquid ratio should be calculated together with current ratio and
acid test ratio so as to exclude even receivables from the current assets and find out the
absolute liquid assets. Absolute Liquid Assets includes :

ABSOLUTE LIQUID RATIO = ABSOLUTE LIQUID ASSETS

 CURRENT LIABILITES

ABSOLUTE LIQUID ASSETS = CASH & BANK BALANCES.

e.g. (Rupees in Crore)

Year 2006 2007 2008

Absolute Liquid Assets 4.69 1.79 5.06
Current Liabilities 27.42 20.58 33.48
Absolute Liquid Ratio .17 : 1 .09 : 1 .15 : 1

Interpretation :

These ratio shows that company carries a small amount of cash. But there is
nothing to be worried about the lack of cash because company has reserve, borrowing
power & long term investment. In India, firms have credit limits sanctioned from banks
and can easily draw cash.

B) CURRENT ASSETS MOVEMENT RATIOS

Funds are invested in various assets in business to make sales and earn profits.
The efficiency with which assets are managed directly affects the volume of sales. The
better the management of assets, large is the amount of sales and profits. Current assets
movement ratios measure the efficiency with which a firm manages its resources. These
ratios are called turnover ratios because they indicate the speed with which assets are
converted or turned over into sales. Depending upon the purpose, a number of turnover
ratios can be calculated. These are :

1. Inventory Turnover Ratio

2. Debtors Turnover Ratio

3. Creditors Turnover Ratio

4. Working Capital Turnover Ratio

The current ratio and quick ratio give misleading results if current assets include high
amount of debtors due to slow credit collections and moreover if the assets include high
amount of slow moving inventories. As both the ratios ignore the movement of current
assets, it is important to calculate the turnover ratio.

1. INVENTORY TURNOVER OR STOCK TURNOVER

RATIO :

Every firm has to maintain a certain amount of inventory of finished goods so as

to meet the requirements of the business. But the level of inventory should neither
be too high nor too low. Because it is harmful to hold more inventory as some
amount of capital is blocked in it and some cost is involved in it. It will therefore
be advisable to dispose the inventory as soon as possible.

INVENTORY TURNOVER RATIO = COST OF GOOD SOLD

AVERAGE INVENTORY

Inventory turnover ratio measures the speed with which the stock is converted
into sales. Usually a high inventory ratio indicates an efficient management of
inventory because more frequently the stocks are sold ; the lesser amount of
money is required to finance the inventory. Where as low inventory turnover ratio
indicates the inefficient management of inventory. A low inventory turnover
implies over investment in inventories, dull business, poor quality of goods, stock
accumulations and slow moving goods and low profits as compared to total
investment.

AVERAGE STOCK = OPENING STOCK + CLOSING STOCK

(Rupees in Crore)
Year 2006 2007 2008
Cost of Goods sold 110.6 103.2 96.8
Average Stock 73.59 36.42 55.35
Inventory Turnover Ratio 1.5 times 2.8 times 1.75 times

Interpretation :

These ratio shows how rapidly the inventory is turning into receivable through
sales. In 2007 the company has high inventory turnover ratio but in 2008 it has reduced
to 1.75 times. This shows that the company’s inventory management technique is less
efficient as compare to last year.

2. INVENTORY CONVERSION PERIOD:

INVENTORY CONVERSION PERIOD = 365 (net working days)

INVENTORY TURNOVER RATIO

e.g.

Year 2006 2007 2008

Days 365 365 365
Inventory Turnover Ratio 1.5 2.8 1.8
Inventory Conversion Period 243 days 130 days 202 days

Interpretation :

Inventory conversion period shows that how many days inventories takes to
convert from raw material to finished goods. In the company inventory conversion
period is decreasing. This shows the efficiency of management to convert the inventory
into cash.

3. DEBTORS TURNOVER RATIO :

A concern may sell its goods on cash as well as on credit to increase its sales and
a liberal credit policy may result in tying up substantial funds of a firm in the form of
trade debtors. Trade debtors are expected to be converted into cash within a short
 period and are included in current assets. So liquidity position of a concern also
depends upon the quality of trade debtors. Two types of ratio can be calculated to
evaluate the quality of debtors.

a) Debtors Turnover Ratio

b) Average Collection Period

DEBTORS TURNOVER RATIO = TOTAL SALES (CREDIT)

AVERAGE DEBTORS

Debtor’s velocity indicates the number of times the debtors are turned over during
a year. Generally higher the value of debtor’s turnover ratio the more efficient is the
management of debtors/sales or more liquid are the debtors. Whereas a low debtors
turnover ratio indicates poor management of debtors/sales and less liquid debtors. This
ratio should be compared with ratios of other firms doing the same business and a trend
may be found to make a better interpretation of the ratio.

AVERAGE DEBTORS= OPENING DEBTOR+CLOSING DEBTOR

e.g.

Year 2006 2007 2008

Sales 166.0 151.5 169.5
Average Debtors 17.33 18.19 22.50
Debtor Turnover Ratio 9.6 times 8.3 times 7.5 times

Interpretation :

This ratio indicates the speed with which debtors are being converted or turnover
into sales. The higher the values or turnover into sales. The higher the values of debtors
 turnover, the more efficient is the management of credit. But in the company the debtor
turnover ratio is decreasing year to year. This shows that company is not utilizing its
debtors efficiency. Now their credit policy become liberal as compare to previous year.

4. AVERAGE COLLECTION PERIOD :

Average Collection Period = No. of Working Days

Debtors Turnover Ratio

The average collection period ratio represents the average number of days for
which a firm has to wait before its receivables are converted into cash. It measures the
quality of debtors. Generally, shorter the average collection period the better is the
quality of debtors as a short collection period implies quick payment by debtors and
vice-versa.

Average Collection Period = 365 (Net Working Days)

Debtors Turnover Ratio

Year 2006 2007 2008

Days 365 365 365
Debtor Turnover Ratio 9.6 8.3 7.5
Average Collection Period 38 days 44 days 49 days

Interpretation :

The average collection period measures the quality of debtors and it helps
in analyzing the efficiency of collection efforts. It also helps to analysis the credit
policy adopted by company. In the firm average collection period increasing year to
year. It shows that the firm has Liberal Credit policy. These changes in policy are due
to competitor’s credit policy.

5. WORKING CAPITAL TURNOVER RATIO :

 Working capital turnover ratio indicates the velocity of utilization of net
working capital. This ratio indicates the number of times the working capital is
turned over in the course of the year. This ratio measures the efficiency with
which the working capital is used by the firm. A higher ratio indicates efficient
utilization of working capital and a low ratio indicates otherwise. But a very
high working capital turnover is not a good situation for any firm.

Working Capital Turnover Ratio = Cost of Sales

Net Working Capital

Working Capital Turnover = Sales

Networking Capital

e.g.

Year 2006 2007 2008

Sales 166.0 151.5 169.5
Networking Capital 53.87 62.52 103.09
Working Capital Turnover 3.08 2.4 1.64

Interpretation :

This ratio indicates low much net working capital requires for sales. In
2008, the reciprocal of this ratio (1/1.64 = .609) shows that for sales of Rs. 1 the
company requires 60 paisa as working capital. Thus this ratio is helpful to forecast the
working capital requirement on the basis of sale.

INVENTORIES

(Rs. in Crores)
Year 2005-2006 2006-2007 2007-2008
Inventories 37.15 35.69 75.01

Interpretation :

Inventories is a major part of current assets. If any company wants to manage its
working capital efficiency, it has to manage its inventories efficiently. The graph shows
that inventory in 2005-2006 is 45%, in 2006-2007 is 43% and in 2007-2008 is 54% of
their current assets. The company should try to reduce the inventory upto 10% or 20%
of current assets.

CASH BNAK BALANCE :

(Rs. in Crores)

Year 2005-2006 2006-2007 2007-2008

Cash Bank Balance 4.69 1.79 5.05

Interpretation :

Cash is basic input or component of working capital. Cash is needed to keep the
business running on a continuous basis. So the organization should have sufficient cash
to meet various requirements. The above graph is indicate that in 2006 the cash is 4.69
crores but in 2007 it has decrease to 1.79. The result of that it disturb the firms
manufacturing operations. In 2008, it is increased upto approx. 5.1% cash balance. So
in 2008, the company has no problem for meeting its requirement as compare to 2007.

DEBTORS :

(Rs. in Crores)

Year 2005-2006 2006-2007 2007-2008

Debtors 17.33 19.05 25.94

Interpretation :
 Debtors constitute a substantial portion of total current assets. In India it constitute
one third of current assets. The above graph is depict that there is increase in debtors. It
represents an extension of credit to customers. The reason for increasing credit is
competition and company liberal credit policy.

CURRENT ASSETS :

(Rs. in Crores)

Year 2005-2006 2006-2007 2007-2008

Current Assets 81.29 83.15 136.57

Interpretation :

This graph shows that there is 64% increase in current assets in 2008. This increase
is arise because there is approx. 50% increase in inventories. Increase in current assets
shows the liquidity soundness of company.

CURRENT LIABILITY :

(Rs. in Crores)

Year 2005-2006 2006-2007 2007-2008

Current Liability 27.42 20.58 33.48

Interpretation :

Current liabilities shows company short term debts pay to outsiders. In 2008 the
current liabilities of the company increased. But still increase in current assets are more
than its current liabilities.
 NET WOKRING CAPITAL :

(Rs. in Crores)

Year 2005-2006 2006-2007 2007-2008

Net Working Capital 53.87 62.53 103.09

Interpretation :

Working capital is required to finance day to day operations of a firm. There

should be an optimum level of working capital. It should not be too less or not too
excess. In the company there is increase in working capital. The increase in working
capital arises because the company has expanded its business.

RESEARCH METHODOLOGY

The methodology, I have adopted for my study is the various tools, which basically analyze
critically financial position of to the organization:

I. COMMON-SIZE P/L A/C

II. COMMON-SIZE BALANCE SHEET

III. COMPARTIVE P/L A/C

IV. COMPARTIVE BALANCE SHEET

V. TREND ANALYSIS

VI. RATIO ANALYSIS

The above parameters are used for critical analysis of financial position. With the evaluation of
each component, the financial position from different angles is tried to be presented in well and
systematic manner. By critical analysis with the help of different tools, it becomes clear how the
financial manager handles the finance matters in profitable manner in the critical challenging
atmosphere, the recommendation are made which would suggest the organization in formulation
of a healthy and strong position financially with proper management system.

I sincerely hope, through the evaluation of various percentage, ratios and comparative
analysis, the organization would be able to conquer its in efficiencies and makes the desired
changes.

ANALYSIS OF FINANCIAL STATEMENTS

FINANCIAL STATEMENTS:

Financial statement is a collection of data organized according to logical and consistent

accounting procedure to convey an under-standing of some financial aspects of a business firm.
It may show position at a moment in time, as in the case of balance sheet or may reveal a series
of activities over a given period of time, as in the case of an income statement. Thus, the term
‘financial statements’ generally refers to the two statements

(1) The position statement or Balance sheet.

(2) The income statement or the profit and loss Account.

OBJECTIVES OF FINANCIAL STATEMENTS:

According to accounting Principal Board of America (APB) states

The following objectives of financial statements: -

1. To provide reliable financial information about economic resources and obligation of a

business firm.

2. To provide other needed information about charges in such economic resources and
obligation.

3. To provide reliable information about change in net resources (recourses less obligations)
missing out of business activities.

4. To provide financial information that assets in estimating the learning potential of the
business.

LIMITATIONS OF FINANCIAL STATEMENTS:

Though financial statements are relevant and useful for a concern, still they do not present a final
picture a final picture of a concern. The utility of these statements is dependent upon a number of
factors. The analysis and interpretation of these statements must be done carefully otherwise
misleading conclusion may be drawn.

Financial statements suffer from the following limitations: -

1. Financial statements do not given a final picture of the concern. The data given in these
statements is only approximate. The actual value can only be determined when the business is
sold or liquidated.

2. Financial statements have been prepared for different accounting periods, generally one year,
during the life of a concern. The costs and incomes are apportioned to different periods with a
view to determine profits etc. The allocation of expenses and income depends upon the personal
judgment of the accountant. The existence of contingent assets and liabilities also make the
statements imprecise. So financial statement are at the most interim reports rather than the final
picture of the firm.

3. The financial statements are expressed in monetary value, so they appear to give final and
accurate position. The value of fixed assets in the balance sheet neither represent the value for
which fixed assets can be sold nor the amount which will be required to replace these assets. The
balance sheet is prepared on the presumption of a going concern. The concern is expected to
continue in future. So fixed assets are shown at cost less accumulated deprecation. Moreover,
there are certain assets in the balance sheet which will realize nothing at the time of liquidation
but they are shown in the balance sheets.

4. The financial statements are prepared on the basis of historical costs Or original costs. The
value of assets decreases with the passage of time current price changes are not taken into
account. The statement are not prepared with the keeping in view the economic conditions. the
balance sheet loses the significance of being an index of current economics realities. Similarly,
the profitability shown by the income statements may be represent the earning capacity of the
concern.

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

FINANCIAL STATEMENT ANALYSIS

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

CALCULATIONS OF RATIOS

Ratios are relationship expressed in mathematical terms between figures, which are connected
with each other in some manner.

CLASSIFICATION OF RATIOS

Ratios can be classified in to different categories depending upon the basis of classification

The traditional classification has been on the basis of the financial statement to which the
determination of ratios belongs.

These are:-

• Profit & Loss account ratios

• Balance Sheet ratios

• Composite ratios

Project Description :
Title : Working Capital Management of ____________

Pages : 73

Category : Project Report for MBA

We made this project of various companies like Reliance Industries, Grasim

Industries, Dabur India Ltd. etc., its cost is Rs. 3499/- only without Synopsis and Rs.
3999/- only with synopsis. If you need this project, mail us at this id :
[email protected]
We will send you a hardcopy with hard binding and a softcopy in CD from courier.

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7

LIST OF CHARTS
Sr.
No.

Description /Name of the chart

Chart

No.

Page

No.

1 Working capital indices

4.1

23

2 Current assets indices

4.2

24

3 Current assets components

4.3

25

4 Current liability indices

4.4

27

5 Net operating cycle

4.5

30

6 Components of operating cycle

4.6

30

7 Working capital leverage

4.7
32

8 Components of working capital leverage

4.8

32

9 Working capital turnover ratio

5.1

36

10 Inventory turnover ratio

5.2

38

11 Receivable turnover ratio

5.3

39

12 Current assets turnover ratio

5.4

41

13 Current ratio

5.5

42

14 Quick ratio

5.6

43

15 Cash and bank balance to current liabilities

5.7

45

16 Account receivable indices

6.1

48

17 Average collection period

6.2

49

18 Inventory indices

6.3

51

19 Components of inventory

6.4

52

20 Inventory turnover ratio

6.5

53

21 Inventory holding period

6.6

53

22 Cash indices

6.7

56

23 Working capital loan

7.1

63

24 Interest on working capital loan

7.2

63
8

CHAPTER I

Working Capital Management

1) Introducti on
2) Need of working capital
3) Gross W.C. and Net W.C.
4) Types of working capital
5) Determi nants of working
capital
9

1.1) Introduction
Working capital management
Working capital management is concerned with the problems arise in attempting to manage the
current assets, the current liabilities and the inter relationship that exist between them. The term
current assets refers to those assets which in ordinary course of business can be, or, will be,
turned in to cash within one year without undergoing a diminution in value and without disrupting
the operation of the firm. The major current assets are cash, marketable securities, account
receivable and inventory. Current liabilities ware those liabilities which intended at there
inception to be paid in ordinary course of business, within a year, out of the current assets or
earnings of the concern. The basic current liabilities are account payable, bill payable, bank
over-draft, and outstanding expenses.
The goal of working capital management is to manage the firm s current assets and current
liabilities in such way that the satisfactory level of working capital is mentioned. The current
should be large enough to cover its current liabilities in order to ensure a reasonable margin of
the safety.
Definition:-
1.

According to Guttmann & Dougall-

Excess of current assets over current liabilities .

1.

According to Park & Gladson-

The excess of current assets of a business (i.e. cash, accounts receivables,

inventories) over current items owned to employees and others (such as salaries & wages
payable, accounts payable, taxes owned to government) .
1.2) Need of working capital management
The need for working capital gross or current assets cannot be over emphasized. As already
observed, the objective of financial decision making is to maximize the shareholders wealth. To
achieve this, it is necessary to generate sufficient profits can be earned will naturally depend
upon the magnitude of the sales among other things but sales can not convert into cash. There
is a need for working capital in the form of current assets to deal with the problem arising out of
lack of immediate realization of cash against goods sold. Therefore sufficient working capital is
necessary to sustain sales activity. Technically this

10

is refers to operating or cash cycle. If the company has certain amount of cash, it will be
required for purchasing the raw material may be available on credit basis. Then the company
has to spend some amount for labour and factory overhead to convert the raw material in work
in progress, and ultimately finished goods. These finished goods convert in to sales on credit
basis in the form of sundry debtors. Sundry debtors are converting into cash after expiry of
credit period. Thus some amount of cash is blocked in raw materials, WIP, finished goods, and
sundry debtors and day to day cash requirements. However some part of current assets may be
financed by the current liabilities also. The amount required to be invested in this current assets
is always higher than the funds available from current liabilities. This is the precise reason why
the needs for working capital arise
1.3) Gross working capital and Net working
capital
There are two concepts of working capital management

1.

Gross working capital

Gross working capital refers to the firm s investment I current assets. Current assets are the
assets which can be convert in to cash within year includes cash, short term securities, debtors,
bills receivable and inventory
.

2. Net working capital

Net working capital refers to the difference between current assets and current liabilities.
Current liabilities are those claims of outsiders which are expected to mature for payment within
an accounting year and include creditors, bills payable and outstanding expenses. Net working
capital can be positive or negative
Efficient working capital management requires that firms should operate with some amount of
net working capital, the exact amount varying from firm to firm and depending, among other
things; on the nature of industries.net working capital is necessary because the cash outflows
and inflows do not coincide. The cash outflows resulting from payment of current liabilities are
relatively predictable. The cash inflow are however difficult to predict. The more predictable the
cash inflows are, the less net working capital will be required.
The concept of working capital was, first evolved by Karl Marx. Marx used the term variable
capital means outlays for payrolls advanced to workers before the completion of work. He
compared this with constant capital which according to him is nothing but dead labour . This
variable capital is nothing
11

wage fund which remains blocked in terms of financial management, in work- in-process along
with other operating expenses until it is released through sale of finished goods. Although Marx
did not mentioned that workers also gave credit to the firm by accepting periodical payment of
wages which funded a portioned of W.I.P, the concept of working capital, as we understand
today was embedded in his variable capital .
1.4) Type of working capital
The operating cycle creates the need for current assets (working capital). However the need
does not come to an end after the cycle is completed to explain this continuing need of current
assets a destination should be drawn between permanent and temporary working capital.
1) Permanent working capital

The need for current assets arises, as already observed, because of the cash cycle. To carry on
business certain minimum level of working capital is necessary on continues and uninterrupted
basis. For all practical purpose, this requirement will have to be met permanent as with other
fixed assets. This requirement refers to as permanent or fixed working capital
2) Temporary working capital

Any amount over and above the permanent level of working capital is temporary, fluctuating or
variable, working capital. This portion of the required working capital is needed to meet
fluctuation in demand consequent upon changes in production and sales as result of seasonal
changes
Temporary

Amt. of W.C

Permanent

Time

12

Graph shows that the permanent level is fairly castanet; while temporary working capital is
fluctuating in the case of an expanding firm the permanent working capital line may not be
horizontal.
This may be because of changes in demand for permanent current assets might

be increasing to support a rising level of activity.

1.5) Determinants of working capital

The amount of working capital is depends upon a following factors

1.

Nature of business

Some businesses are such, due to their very nature, that their requirement of fixed capital is
more rather than working capital. These businesses sell services and not the commodities and
that too on cash basis. As such, no founds are blocked in piling inventories and also no funds
are blocked in receivables. E.g. public utility services like railways, infrastructure oriented project
etc. there requirement of working capital is less. On the other hand, there are some businesses
like trading activity, where requirement of fixed capital is less but more money is blocked in
inventories and debtors.
2.

Length of production cycle

In some business like machine tools industry, the time gap between the acquisition of raw
material till the end of final production of finished products itself is quit high. As such amount
may be blocked either in raw material or work in progress or finished goods or even in debtors.
Naturally there need of working capital is high.
3.

Size and growth of business

In very small company the working capital requirement is quit high due to high overhead, higher
buying and selling cost etc. as such medium size business positively has edge over the small
companies. But if the business start growing after certain limit, the working capital requirements
may adversely affect by the increasing size.
4.

Business/ Trade cycle

If the company is the operating in the time of boom, the working capital requirement may be
more as the company may like to buy more raw material, may increase the production and sales
to take the benefit of favorable market, due to increase in the sales, there may more and more
amount of funds blocked in stock and debtors etc. similarly in the case of depressions also,
working capital may be high as the sales terms of value and quantity may be reducing, there
may be unnecessary piling up of stack without getting sold, the receivable may not be recovered
in time etc.

Working Capital
Management Project
this is PROJECT done during MBA from Pune University for two months

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