An Introduction to Working Capital Management

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ACKNOWLEDGEMENT Words are indeed inadequate to convey my deep sense of gratitude to all those who have helped me in completing this summer project to the best of my ability. Being a part of this project has certainly been a unique and a very productive experience on my part. I am really thankful to Mr. P. J. PANDYA(General Manager) for making all kinds of arrangements to carry the project successfully and for guiding and helping me to solve all kinds of quarries regarding the project work. His systematic way of working and incomparable guidance has inspired the pace of the project to a great extent. I would also like to thank my mentor and project ± coordinator, Miss. Susheela C Chaurasia (Adm. Officer) for assigning me a project of such a great learning experience and acquainting me with real life project in finance. I am very grateful to Mr. Devang Desai for their useful guidance and advise. Last but not least I would like to thank all the employees of Excel Graphics Pvt Ltd. Who have directly or indirectly helped me with their moral support for the completion of my project.

(Chirag Patel)

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TABLE OF CONTENT SR. NO Y

PARTICULARS INTRODUCTION TO WORKING CAPITAL

PAGE NO 4

2

DETERMINANTS OF WORKING CAPITAL

6

3

WORKING CAPITAL IN TERMS OF FIVE COMPONENTS

7

4

8

5

DIFFERENT CONCEPT OF WORKING CAPITAL KINDS OF WORKING CAPITAL

6

SOURCES OF WORKING CAPITAL

10

7

LITERATURE REVIEW

11

8

ESTIMATION OF WORKING CAPITAL

13

9

COMPANY PROFILE

15

10

RESEARCH METHODOLOGY (a) OBJECTIVES (b) DATA COLLECTION (c) LIMITATION OF THE STUDY

9

18

11

SUGGETSTIONS

26

12

CONCLUSTION

26

13

BIBILOGRAPHY AND ANNEXTURE

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An Introduction to Working Capital Management Working capital means the part of the total assets of the business that change from one form to another form in the ordinary course of business operations.´ In a perfect world, there would be no necessity for current assets and liabilities because there would be no uncertainty, no transaction costs, information search costs, scheduling costs, or production and technology constraints. The unit cost of production would not vary with the quantity produced. Borrowing and lending rates shall be same. Capital, labour, and product market shall be perfectly competitive and would reflect all available information, thus in such an environment, there would be no advantage for investing in short term assets. However the world we live is not perfect. It is characterized by considerable amount of uncertainty regarding the demand, market price, quality and availability of own products and those of suppliers. There are transaction costs for purchasing or selling goods or securities. Information is costly to obtain and is not equally distributed. There are spreads between the borrowings and lending rates for investments and financing of equal risks. Similarly each organization is faced with its own limits on the production capacity and technologies it can employ there are fixed as well as variable costs associated with production goods. In other words, the markets in which real firm operated are not perfectly competitive. These real world circumstances introduce problem¶s which require the necessity of maintaining working capital. For example, an organization may be faced with an uncertainty regarding availability of sufficient quantity of crucial imputes in future at reasonable price. This may necessitate the holding of inventory, current assets. Similarly an organization may be faced with an uncertainty regarding the level of its future cash flows and insufficient amount of cash may incur substantial costs. This may necessitate the holding of reserve of short term marketable securities, again a short term capital asset. In corporate financial management, the term Working capital management´ (net) represents the excess of current assets over current liabilities.

Concept of working capital The word working capital is made of two words 1.Working and 2. Capital The word working means day to day operation of the business, whereas the word capital means monetary value of all assets of the business.

Working capital Working capital may be regarded as the life blood of business. Working capital is of major importance to internal and external analysis because of its close relationship with the current day-to-day operations of a business. Every business needs funds for two purposes. Long term funds are required to create production facilities through purchase of fixed assets such as plants, machineries, lands, buildings & etc Short term funds are required for the purchase of c
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raw materials, payment of wages, and other day-to-day expenses. It is otherwise known as revolving or circulating capital. It is nothing but the difference between current assets and current liabilities. i.e. Working Capital = Current Asset ± Current Liability. Businesses use capital for construction, renovation, furniture, software, equipment, or machinery. It is also commonly used to purchase inventory, or to make payroll. Capital is also used often by businesses to put a down payment down on a piece of commercial real estate. Working capital is essential for any business to succeed. It is becoming increasingly important to have access to more working capital when we need it. In simple words working capital is the excess of current Assets over current liabilities. Working capital has ordinarily been defined as the excess of current assets over current liabilities. Working capital is the heart of the business. If it is weak business cannot proper and survives. Sit is therefore said the fate of large scale investment in fixed assets is often determined by a relatively small amount of current assets. As the working capital is important to the company is important to keep adequate working capital with the company. Cash is the lifeline of company. If this lifeline deteriorates so does the company¶s ability to fund operation, reinvest do meet capital requirements and payment. Understanding Company¶s cash flow health is essential to making investment decision. A good way to judge a company¶s cash flow prospects is to look at its working capital management. The company must have adequate working capital as much as needed by the company. It should neither be excessive or nor inadequate. Excessive working capital cuisses for idle funds laying with the firm without earning any profit, where as inadequate working capital shows the company doesn¶t have sufficient funds for financing its daily needs working capital management involves study of the relationship between firm¶s current assets and current liabilities. The goal of working capital management is to ensure that a firm is able to continue its operation. And that is has sufficient ability to satisfy both maturing short term debt and upcoming operational expenses. The better a company managers its working capital, the less the company needs to borrow. Even companies with cash surpluses need to manage working capital to ensure those surpluses are invested in ways that will generate suitable returns for investors. The primary objective of working capital management is to ensure that sufficient cash is available to´ Meet day to day cash flow needs. Pay wages and salaries when they fall due Pay creditors to ensure continued supplies of goods and services. Pay government taxation and provider of capital ± dividends and ensure the long term survival of the business entity.

Concept of working capital > @ross Working Capital = Total of Current Asset > et Working Capital = Excess of Current Asset over Current Liability

Current Assets Current Liabilities > Cash in hand / at bank > Bills Receivable > Sundry Debtors c
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> > > > > > > > > >

Short term loans Investors/ stock Temporary investment Prepaid expenses Accrued incomes Bills Payable Sundry Creditors Ôutstanding expenses Accrued expenses Bank Ôver draft

Determinants of working capital Working capital requirements of a concern depends on a number of factors, each of which should be considered carefully for determining the proper amount of working capital. It may be however be added that these factors affect differently to the different units and these keeps varying from time to time. In general, the determinants of working capital which re common to all organization¶s can be summarized as under Nature of business eed for working capital is highly depends on what type of business, the firm in. there are trading firms, which needs to invest a lot in stocks, ills receivables, liquid cash etc. public utilities like railways, electricity, etc., need much less inventories and cash. Manufacturing concerns stands in between these two extends. Working capital requirement for manufacturing concerns depends on various factors like the products, technologies, marketing policies. Production policies Production policies of the organization effects working capital requirements very highly. Seasonal industries, which produces only in specific season requires more working capital some industries which produces round the year but sale mainly done in some special seasons are also need to keep more working capital. Size of business Size of business is another factor to determines the need for working capital Length of operating cycle Ôperating cycle of the firm also influence the working capital. Longer the orating cycle, the higher will be the working capital requirement of the organization. Credit policy Companies; follows liberal credit policy needs to keep more working capital with them. Efficiency of debt collecting machinery is also relevant in this matter. Credit availability form

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suppliers also effects the company¶s working capital requirements. A company doesn¶t enjoy a liberal credit from its suppliers will have to keep more working capital Business fluctuation Cyclical changes in the economy also influence the level of working capital. During boom period, the tendency of management is to pile up inventories of raw materials and finished goods to avail the advantage of rising prove. This creates demand for more capital. Similarly, during depression when the prices and demand for manufactured goods. Constantly reduce the industrial and trading activities show a downward termed. Hence the demand for working capital is low. Current asset policies The quantum of working capital of a company is significantly determined by its current assets. Policies. A company with conservative assets policy may operate with relatively high level of working capital than its sales volume. A company pursuing an aggressive amount assets policy operates with a relatively lower level of working capital. Fluctuations of supply and seasonal variations Some companies need to keep large amount of working capital due to their irregular sales and intermittent supply. Similarly companies using bulky materials also maintain large reserves¶ of raw material inventories. This increase the need of working capital. Some companies manufacture and sell goods only during certain seasons. Working capital requirements of such industries will be higher during certain season of such industries period. Other factors Effective co ordination between production and distribution can reduce the need for working capital. Transportation and communication means. If developed helps to reduce the working capital requirement.

Working capital in terms of five components 1. Cash and equivalents: - This most liquid form of working capital requires constant supervision. A good cash budgeting and forecasting system provides answers to key questions such as: Is the cash level adequate to meet current expenses as they come due? What is the timing relationship between cash inflow and outflow? When will peak cash needs occur? When and how much bank borrowing will be needed to meet any cash shortfalls? When will repayment be expected and will the cash flow cover it? 2. Accounts receivable: - Many businesses extend credit to their customers. If you do, is the amount of accounts receivable reasonable relative to sales? How rapidly are receivables being collected? Which customers are slow to pay and what should be done about them? 3. Inventory: - Inventory is often as much as 50 percent of a firm's current assets, so naturally it requires continual scrutiny. Is the inventory level reasonable compared with sales c


 

and the nature of your business? What's the rate of inventory turnover compared with other companies in your type of business? 4. Accounts payable:- Financing by suppliers is common in small business; it is one of the major sources of funds for entrepreneurs. Is the amount of money owed suppliers reasonable relative to what you purchase? What is your firm's payment policy doing to enhance or detract from your credit rating? 5. Accrued expenses and taxes payable: - These are obligations of your company at any given time and represent a future outflow of cash.

Two different concepts of working capital are :Y) Balance sheet or Traditional concept 2) Ôperating cycle concept.

Balance sheet or Traditional concept: It shows the position of the firm at certain point of time. It is calculated in the basis of balance sheet prepared at a specific date. In this method there are two type of working capital:Y) @ross working capital 2) et working capital Gross working capital:- It refers to the firm¶s investment in current assets. The sum of the current assets is the working capital of the business. The sum of the current assets is a quantitative aspect of working capital. Which emphasizes more on quantity than its quality, but it fails to reveal the true financial position of the firm because every increase in current liabilities will decrease the gross working capital. Net working capital:- It is the difference between current assets and current liabilities or the excess of total current assets over total current liabilities.

Working capital= current assets - current liabilities. Net working capital: - It is also can defined as that part of a firm¶s current assets which is financed with long term funds. It may be either positive or negative. When the current assets exceed the current liability, the working capital is positive and vice versa. Operating cycle concept:- The duration or time required completing the sequence of events right from purchase of raw material for cash to the realization of sales in cash is called the operating cycle or working capital cycle.

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Each component of working capital (namely inventory, receivables and payables) has two dimensions TIME and MÔEY. When the comes to managing working capital TIME IS MÔEY. If you can get money to move fester around the cycle (collect monies due from debtors more quickly) or reduce the amount of money tied up (i.e.., reduce inventory level relative to sales). The business will generate more cash or it will need to borrow less money to fund working capital. As a consequence, you could reduce the cost of bank interest or you will have additional freee4 money available to support addition sales growth or investment. Similarly, if you can negotiate improved terms with suppliers e.g. get longer credit or an increased credit limit, you festively create freed finance to help fund future sales a perusal of operational cycle reveals that the cash invested in operations are recycled back in to cash. However it takes time to reconvert the cash. Cash flows in cycle into around and out of a business it the business¶s lifeblood and every manager¶s primary task to help keep it flowing and to use the cash flow to generate profits. The shorter the period of operating cycle the larger will be the turnover of the funds invested in various purposes.

Kinds of working capital Working capital can be put in two categories: Y) Fixed or permanent working capital and 2) Fluctuating or temporary working capital c
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Fixed or permanent working capital The volume of investment in current assets an change over a period of time. But always there is minimum level of current assets that must be kept in order to carry on the business. This is the irreducible minimum amount needed for maintaining the operating cycle. It is the investment in current assets. This is permanently locked up in the business and therefore known as permanent working capital. Variable/temporary working capital It is the volume of working capital. This is needed over and above the fixed working capital in order to meet the unforced market changes and contingencies. In other words any amount over and about the permanent level of working capital is variable or fluctuating working capital. This type of working capital is generally financed from short ter souse of finance such as bank credit because this amount is not permanently required and is usually paid back during off season or after the contingency.

Sources of working capital The company can choose to finance its current assets by (a) Long term sources (b) Short term sources. Issue of shares It is the primary and most important sources of regular or permanent working capital. Issuing equity shares as it does not create and burden on the income of the concern. Retained earnings Retained earnings accumulated profits are a permanent sources of regular working capital. It creates not charge on future profits of the enterprises. Issue of debentures It creates a fixed charge on future earnings of the company. Company is obliged to pay interest. Long term debt Company can raise fund from accepting public deposits, debts from financial institutions like banks, corporations etc. the cost is higher than the other financial tools. Ôther sources sale of idle fixed assets, securities received from employees and customers are examples of other sources of finance. Short term sources of temporary working capital Temporary working capital is required to meet the day to day business expenditures. The variable working capital would finance from short term sources of funds. And only the period needed.

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Some sources of temporary working capital are given below; Commercial bank A commercial bank constitutes significant sources for short term or temporary working capital this will be in the form of short term loans, cash credit, and overdraft and though discounting the bills of exchanges. Public deposits Most of the companies in recent years depend on these sources to meet their short term working capital requirements ranging fro six month to three years. Various credits Trade credit, business credit papers and customer credit are other sources of short term working capital. Credit from suppliers, advances from customers, bills of exchanges, promissnotes, etc helps to raise temporary working capital Reserves and other funds Various funds of the company like depreciation fund. Provision for tax and other provisions kept with the company can be used as temporary working capital. The company should meet its working capital needs through both long term and short term funds. It will be appropriate to meet at least 2/3 of the permanent working capital equipments form long term sources, whereas the variables working capital should be financed from short term sources. Importance of Working Capital Ratios Ratio analysis can be used by financial executives to check upon the efficiency with which working capital is being used in the enterprise. The following are the important ratios to measure the efficiency of working capital. The following, easily calculated, ratios are important measures of working capital utilization.

Literature Review Many researchers have studied working capital from different views and in different environments. The following ones were very interesting and useful for our research (Eljelly, 2004) elucidated that efficient liquidity management involves planning and controlling current assets and current liabilities in such a manner that eliminates the risk of inability to meet due short-term obligations and avoids excessive investment in these assets. The relation between profitability and liquidity was examined, as measured by current ratio and cash gap (cash conversion cycle) on a sample of joint stock companies in Saudi Arabia using correlation and regression analysis. The study found that the cash conversion cycle was of more importance as a measure of liquidity than the current ratio that affects profitability. The size variable was found to have significant effect on profitability at the industry level. The results were stable and had important implications for liquidity management in various Saudi companies. First, it was clear that there was a negative relationship between profitability and liquidity indicators such as current ratio and cash gap in the Saudi sample examined. Second, c
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the study also revealed that there was great variation among industries with respect to the significant measure of liquidity. (Deloof, 2003) discussed that most firms had a large amount of cash invested in working capital. It can therefore be expected that the way in which working capital is managed will have a significant impact on profitability of those firms. Using correlation and regression tests he found a significant negative relationship between gross operating income and the number of days accounts receivable, inventories and accounts payable of Belgian firms. Ôn basis of these results he suggested that managers could create value for their shareholders by reducing the number of days¶ accounts receivable and inventories to a reasonable minimum. The negative relationship between accounts payable and profitability is consistent with the view that less profitable firms wait longer to pay their bills. (@hosh and Maji, 2003) in this paper made an attempt to examine the efficiency of working capital management of the Indian cement companies during Y 2 ± Y 3 to 200Y ± 2002. For measuring the efficiency of working capital management, performance, utilization, and overall efficiency indices were calculated instead of using some common working capital management ratios. Setting industry norms as target-efficiency levels of the individual firms, this paper also tested the speed of achieving that target level of efficiency by an individual firm during the period of study. Findings of the study indicated that the Indian Cement Industry as a whole did not perform remarkably well during this period. (Shin and Soenen, Y
) highlighted that efficient Working Capital Management (WCM) was very important for creating value for the shareholders. The way working capital was managed had a significant impact on both profitability and liquidity. The relationship between the length of et Trading Cycle, corporate profitability and risk adjusted stock return was examined using correlation and regression analysis, by industry and capital intensity. They found a strong negative relationship between lengths of the firm¶s net trading. Cycle and its profitability. In addition, shorter net trade cycles were associated with higher risk adjusted stock returns. (Smith and Begemann Y ) emphasized that those who promoted working capital theory shared that profitability and liquidity comprised the salient goals of working capital management. The problem arose because the maximization of the firm's returns could seriously threaten its liquidity, and the pursuit of liquidity had a tendency to dilute returns. This article evaluated the association between traditional and alternative working capital measures and return on investment (RÔI), specifically in industrial firms listed on the Johannesburg Stock Exchange (JSE). The problem under investigation was to establish whether the more recently developed alternative working capital concepts showed improved association with return on investment to that of traditional working capital ratios or not. Results indicated that there were no significant differences amongst the years with respect to the independent variables. The results of their\ stepwise regression corroborated that total current liabilities divided by funds flow accounted for most of the variability in Return on Investment (RÔI). The statistical test results showed that a traditional working capital leverage ratio, current liabilities divided by funds flow, displayed the greatest associations with return on investment. Well known liquidity concepts such as the current and quick ratios registered insignificant associations whilst only one of the newer working capital c
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concepts, the comprehensive liquidity index, indicated significant associations with return on investment. All the above studies provide us a solid base and give us idea regarding working capital management and its components. They also give us the results and conclusions of those researches already conducted on the same area for different countries and environment from different aspects. Ôn basis of these researches done in different countries, we have developed our own methodology for research.

ESTIMATION OF WORKING CAPITAL MANGEMENT Operating cycle approach The need of working capital arises mainly because of them gap between the production of goods and their actual realization after sales. This gap is technically referred as the operating cycle´ or the cash cycle´ of the business. If it were possible to complete the entire job instantaneously, there would be no need for current asset (working capital) but since it is not possible, every business organization is forced to have current asset and hence operating cycle. It may be divided into four stages. Y. Raw materials and stores storage space. 2. Work in process stage. 3. Finished goods inventory stage. 4. Debtor¶s collection stage, Duration of operating cycle The duration of the operating cycle is equal to sum of the duration of these stages less the credit period allowed by the suppliers of the firm. In symbol ÔC= R+W+F+D-C WHERE ÔC= Duration of the Ôperating Cycle R= Raw materials and storage space periods W= work in process periods. F= finished goods storage periods D= debtor collection period C= Creditors collection period.

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The component of the operating cycles has already been calculated in ratio Analysis´ which are as follow.

R=

Average stock of raw material -------------------------------------------------------Average raw material consumption per day

F=

Average stock of stores -------------------------------------------------------Average stores consumption per day

W=

Average work in process inventory -------------------------------------------------------Average cost of production per day

D=

Average book debts --------------------------------------------------Average credit sales per day `

C=

Average trade credit ---------------------------------------------------Average trade credit purchase per day

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INTRODUCTION OF THE COMPANY Location Excel @raphics Pvt. Ltd. Factory Address: Excel Estate, P.B.o. Y
, Vashier, Valsad-3 00Y. @ujarat, India.

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Excel graphics is set up by late Shree Prabhabhai..Desai in Y . Excel comes under small scale industries and located at Excel Estate in Valsad. It is also include following companies: Y. Excel Process Pvt. Ltd. 2. Excel Shine Pvt. Ltd. 3. Vashudhara Canning Pvt. Ltd. 4. Lunar Motor Pvt. Ltd. The company aspiring with the mission state "QUALITY IS EVERY BÔDY'S RESPÔSIBILITY" Y 4 the year to be cherished in the company in the memory of all Indians when our country is become independent. About 5Y years ago the company is jointly started Excel and saw the birth of EXCEL PRÔCESS work at mumbai. Thank to pioneering effort of late Shree P..Desai and late [email protected]. Excel specially at that time was producing high quality brass name plate. Brass was stylish and decorative but it was expensive as well. so their had to be suitable alternative. So in Y 53 excel pioneered the process of aluminium anodizing. It was not easy. The name plate are expensive due to high cost of brass. The ever changing needs of industry expert developed the tools and machine by their constant R&D effort. Due to continues quality consciousness and developing techniques excel graphics got the industry award since than the company fulfil the requirement of different industry

EXCEL CONCERNS COMPANY Excel @raphics Pvt.Ltd Excel Process Pvt.Ltd Excel Alugraphics Pvt.Ltd

COMPETITORS ew Krishna metal art, Valsad Shaino @raph @ndlav, Valsad Mehta @raphs, Pune ational Process, @ujarat

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ABOUT THE COMPANY ame of the company: Excel @raphics Pvt. Ltd Corporate office

: B-5 Mahal Industries Estate Mahakali Caves Road, Andheri(E) Mumbai- 3 India

Unit Located

: Excel Estate P. Ô. Box no. Y
Vashier Valsad

Type

: Private Limited Company

Banker

: ICIC bank, Valsad UCÔ bank, Juan Thana M.@ Road Valsad

Phone o

: (0232) 222, 220 

Web Site

: www.xlgraphic.com

PRODUCT PROFILE DIFFERET TYPES ÔF PRÔDUCT Y. Aluminium anodized nameplate 2. Identification plates 3. Industrial electronics fascia panels 4. Forged logo in diamond cut and other finishes 5. Crystal dome stickers . Aluminium components . Aluminium exuded heat sinks
. Decals and vine/ stickers . Stickers and labels of various engineering plastics Y0. Signboards and Heroics YY. Speaker mess brills in CRCS c
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RESEARCH METHODOLOGY OBJECTIVES:Y. 2. 3. 4.

To study day to day working capital of the company To study the financial position of the company To apply theoretical knowledge into practical field To check the profitability of the company 

DATA COLLECTION:Primary source of data Primary data are those data collected at the first hand and not been collected earlier. Data was collected by discussion with the company manager and staff of excel graphics Pvt. Ltd. Secondary source of data Sources of secondary data are as follows Annual report of the company Books Company website LIMITATION OF THE STUDY:Y. The company executives were able to give valuable time only for a few days a week, hence the required information could not be obtained. 2. Some secret, which company can not share with us, is not covered in study.        

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NET OPERATING CYCLE:Raw material storage period+ Average consumption period+ finished goods storage period + Average collection period ± Average payment period

OPERATING CYCLE PERIOD:c   ;      c   ;