Working Capital Concepts

Working Capital Management – An Analysis

CONTENTS

1. Intr Introd oduc ucti tion on 2. Concept Of Working capital 3. Features Of Working Capital 4. Ne Need For Working Capital 5. Types Of Working Capital 6. Determinants Of Working Capital 7. Optimum Working Capital 8. Management Of Working Capital 9. Manage Managemen mentt OF Compon Component entss OF Workin Working g Capita Capitall 10. Optimum Credit Policy 11. Conclusion

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Anal nalys ysiis of Worki rking Capi apital tal for Durga urgap pur Ste Steel plant ant

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Working Capital Management – An Analysis

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INTRODUCTION : Business Capital is broadly divided into two groups: Fixed Capital and Working Capital. Fixed Capital refers to the funds invested in fixed assets of a firm in the form of land, building, machinery etc. Working Capital refers to the funds invested in the current assets of a firm such as raw materials, work-in-progress, work-in-progress, finished goods, receivables, receivables, cash cash etc. From the viewpoint of manufacturing process, working capital means that part of  capita capital, l, which which is require required d to keep keep the flow of produc productio tion n smooth smooth and continuous. The main point of difference between the fixed capital and working capital is that : Fixed assets are of long run duration and are not converted within a period of one year, whereas the current assets are converted into cash within a period of one year or less. Hence, the problem of fixed assets belongs to the field of capital budgeting, while the problems of current assets belong to the field of working capital management. Workin Working g Capita Capital, l, being being lifeblood  for any enterp enterpris rise, e, its manag managem ement ent becomes a crutial exercise for the Financial Manager of a firm. The need of working capital is directly linked to the growth of the firm. Working Capital is as essential as fixed assets in the successful operation of a production unit. In the past, only the problems of the management of fixed capital were given given importa importance nce in the exerc exercise ise of financi financial al manage managemen ment. t. But in the prese present nt scenar scenario, io, lookin looking g to the increa increasin sing g import importanc ance e of the workin working g capita capitall in any busin business ess unit, unit, the exercis exercise e of manage manageme ment nt of workin working g capital has become as much important for a financial manager as the management of fixed capital. Some authors go the extent of saying that financial management means working capital management. Even if this extreme view is regarded as unacceptable, there is no doubt that a large part of a financial manager’s time and energy is used up in attending to the problems of working capital management. The exercise of working capital management management covers the following points to be considered: 1. Estima Estimating ting the the worki working ng capit capital al needs needs 2. Procur Procurem ement ent of of workin working g capit capital al 3. Optimu Optimum m utilisa utilisatio tion n of working working capit capital al Before discussing about the management of working capital, first of all, let’s have a brief idea about the concept of Working Capital.

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Working Capital Management – An Analysis

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CONCEPTS OF WORKING CAPITAL : Working Capital, in the simple words, means the capital invested in the current assets. However it has been variously defined as : “Wor “Worki king ng Capi Capita tall mean means s the the curr curren entt asse assets ts of a comp compan any y that that are are changed in the ordinary course of business from one form to another, as for for exam example ple,, from from cash cash to inve invent ntor orie ies, s, inve invent ntor orie ies s to rece receiv ivab able les, s, receivables into cash.” “Working Capital is descriptive of that capital which is not fixed. But the more common use of working capital is to consider it as the difference between the book value of the current assets and current liabilities.” Thus, there are two different opinions about the meaning of the term working capital. (1) Accord According ing to one school school of though thought, t, workin working g capita capitall repres represent ents s all curren currentt assets assets of the Compan Company. y. They They believ believe e that that workin working g capit capital al represents those assets, which change their form during the process of  production. Working Capital = Total Current Assets

(2) According According to the other school of thought, thought, working capital capital is the excess excess of current assets over current liabilities. Working Capital = Current Assets – Current Liabilities

Curren Currentt assets assets includ include e cash, cash, accoun accounts ts receiv receivab able, le, notes notes receiv receivabl able, e, advances on contracts, inventories etc. Current liabilities include accounts payable, notes payable, accrued expenses, temporary loans etc. Under  this concept an attempt is made to measure net working capital of the Company. To avoid the confusion involved in the interpretation of working capital, the total current assets are described as gross working capital , while the excess of total current assets over total current liabilities are described as net working capital. Thus, there are two concepts of working capital: 1. Gross Working Working Capita Capitall i.e. Total Current Current assets assets 2. Net Working Working Capita Capitall i.e. Current Current assets assets – Current Current liabilities liabilities Gross working capital concept focuses attention on two aspects of current assets management:

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Working Capital Management – An Analysis

a. What is the the optimum optimum level level of invest investment ment in current current assets assets? ? b. How should should current current assets assets be be finance financed? d? Net Net work workin ing g capi capita tall is a qual qualita itativ tive e conc concep ept. t. It indic indicat ates es the the liqu liquid idity ity position of the firm and suggests the extent to which the working capital needs may be financed by permanent sources of funds. It indicates how much current assets are covered by current liabilities. The net working capital concept also covers the question of judicious mix of long-term and short-term funds for financing the current assets. Both gross and net working capital concepts are equally important for the efficient management of working capital.

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Working Capital Management – An Analysis

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FEATURES OF WORKING CAPITAL : The features of the working capital distinguishing it from the fixed capital are as follows: 

Short Term needs

Working capital is used to acquire current assets, which get converted into cash in a short period. The duration of working capital depends on the length of production process, the time that elapses in the sale and the waiting period of the cash receipt.

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Circular Movement

Working capital is constantly converted into cash, which again turns into working capital. This process of conversion goes on continuously. It moves in a circular way. That is why working capital is also described as circulating capital.

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An element of permanency

Though working capital is a short-term capital, it is required always and forever. It is required to run the production activity of the firm smoothly and uninterruptedly. So long as the production continues, the firm will constantly remain in need of working capital.

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Fluctuating

Though Though the require requireme ment nt of workin working g capit capital al is felt perman permanent ently, ly, its requ requir irem emen entt fluc fluctu tuat ates es more more wide widely ly than than the the fixe fixed d capi capita tal. l. The The requirement working capital varies directly with the level of production. The portion of working capital that changes with production, sale, price etc. is called variable working capital.

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Liquidity

Working capital is more liquid than fixed capital. It can be converted into cash within a short period and without much loss. A firm in need of  cash can get it through the conversion of its working capital by insisting on quick recovery of its bills receivable and by expediting sales of its products. It is due to this trait of working capital that the firms with a larger amount of working capital feel more secure.

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Working Capital Management – An Analysis

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Less Risky

Investment in the working capital is less risky as it is a short-term investment. Working capital involves more of physical risk only and that also is limited. It involves financial or economic risk to a much less extent because variations of the product prices are less severe generally. It is also free from technological changes as it gets converted into cash again and again.

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Working Capital Management – An Analysis

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NEED FOR WORKING CAPITAL : The need of working capital to run the day to day business of a firm can not be ignored. We will hardly find a business firm, which does not require any amount of working capital. The firm has to maintain an adequate level of current assets to generate sales. The current assets are required, as the sales generated by the firm do not convert into cash immediately. There is always an operating cycle involved in conversion of sales into cash.

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Operating Cycle:

Operating Cycle is the time duration required to convert sales, after the conv conver ersi sion on of reso resour urce ces s into into inve invent ntor orie ies, s, into into cash cash.. It is the the time time interval between the cash collections from sale of the product and cash payments for resources acquired by the firm. It also refers to the time interval over which the working capital should be obtained in order to carry out the firm’s operations. The operating cycle of a manufacturing company involves three phases: •

•

•

Acquisition of resources such as raw materials, labour, power  and fuel etc. Manufacture of the product which includes conversion of raw material into work-in-progress into finishes goods Sale of the product either for cash or on credit. Credit sales create account receivable for collection

Cash Collection of  receivables

Purchase of Raw Material Raw Material

Accounts Receivable s

Work-in-Progress Sales

Figure 1

Finished Goods

Operating Cycle

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Working Capital Management – An Analysis

These phases of operating cycle affect the firm’s cash flows : both cash inflows inflows and cash cash out flows. flows. Howeve Howeverr these these cash cash flows flows are neithe neither  r  synchronised nor certain. They are not synchronised because most of  the time the cash outflows occurs before cash inflows. Cash inflows are not certain certain because because sale sale and collec collectio tions, ns, which which gives gives rise rise to cash cash inflows inflows are difficult to forecast forecast accurately. accurately. Cash outflows, outflows, on the other  hand, are relatively certain. The firm is therefore, required to invest in current assets for a smooth, uninterrupted functioning. The firm’s requirem requirement ent for workin working g capital capital,, is thus, thus, depend depends s on its operating cycle. For that purpose it needs to forecast the length of its operating cycle.

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How to determine the length of the operating cycle? The length of the operating cycle can be determined by addition of the inventory conversion period and debtor’s conversion period. The inventory conversion period is the total time needed for producing and selling the product. The debtor’s conversion period is the time required to collect the outstanding amount from the customers. The total of inventory conversion period and debtor’s conversion period is cycle. referred to as gross operating cycle. There are certain expenses, the payment of which can be temporarily postponed. Such types of expenses are the spontaneous sources of  working capital  for a firm to finance its investment in current assets. The period during which the firm can temporarily defer the payment of  period and the difference such expenses is called as payables as  payables deferral period and between the gross operating cycle and the payables deferral period is referred to as net operating cycle. Based on the forecast of the operating cycle of a firm, its requirement for  working capital can be estimated.

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Working Capital Management – An Analysis

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TYPES OF WORKING CAPITAL : Basically two types of working capital are needed in the business: 1. Perman Permanent ent Worki Working ng Capita Capitall 2. Variab Variable le Worki Working ng Capita Capitall These two types of working capital can also be classified as under :

Working Capital

Permanent

Initial Working Capital

Variable

Regular  Working Capital

Seasonal Working Capital

Special Working Capital

Let’s discuss each of the types in brief:

Permanent Capital : Capital : ♦

Working

This This is the minim minimum um level level of curren currentt assets assets,, which which is contin continuou uously sly required by the firm to carry on its business operations. It is permanent in the same way as the firm’s fixed assets are. Depending upon the changes in the production and sales, the need for working capital, over  and above the permanent working capital, will fluctuate.

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Initial Working Capital :

In the initial period of its operation, a firm must need enough money to pay certain expenses before the business yields cash receipt. In the initial years the banks may not grant loans or overdrafts, sales may have to be made on credit and it may be necessary to pay the 9

Working Capital Management – An Analysis

credit creditors ors immedi immediate ately. ly. Theref Therefor or the owners owners thems themselv elves es have have to provide necessary funds in the initial period, which may be known as initial working capital.

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Regular Working Capital

: The firm is always required to keep certain funds with it to continue the regular business operations, which is called as Regular Working Capital. It is required to maintain regular stock of raw materials and work-in-progress and also of the finishes goods, which must be maintained permanently at a definite level. Regular working capital is the excess of current assets over current liabilities. It ensures smooth operation of business.

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Variable Working Capital :

This is the working capital which, keeps on changing with the change in the production production and sales activities. activities. It is the extra working working capital, capital, over  and above the permanent working capital, that is needed to support the changing production and sales activities. This type of working capital is also called as fluctuating or variable working capital.

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Seasonal Capital :

Working

Some business operations require additional working capital during a particular season. For example, the groundnut oil producers may have to purchase groundnut in a particular season and have to empl employ oy addi additi tion onal al labo labour ur for for that that purp purpos ose. e. Thes These e may may requ require ire additional funds for a temporary period, which may be called as seasonal working capital.

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Special Capital :

Working

In all enterprises, some unforeseen events do occur like sudden incr increa ease se in dem demand, and, down downwa ward rd move moveme ment nt of pric prices es of raw raw materials, strike or natural calamities, when extra funds are needed to tide over such situation. Such type of extra funds is called as Special working capital.

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Working Capital Management – An Analysis

Both the kinds of working capital – permanent and temporary – are necessary to facilitate the production and sales through the operating cycle. However, the temporary temporary working capital capital is created by the firm to meet the liquidity requirements that will last only temporarily. The difference between the permanent and variable working capital may be represented in the following two diagrams: .) s R( l

at i p a c g ni kr o w f o t n u o m A

Figure 2

Temporary or fluctuating Permanent

Time

Permanent and temporary working capital 

.) s R( l

at i p a c g ni kr o w f o t n u o m A

Figure 3

Temporary or fluctuating

Permanent

Time

Permanent and temporary working capital 

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Working Capital Management – An Analysis

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DETERMINANTS OF WORKING CAPITAL : There There are no set rules or formu formulat late e to determ determine ine the working working capita capitall requirements of a firm. There are ‘n’ numbers of factors influencing the working capital requirements of a firm, which can be briefed as under:

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Nature of business :

Working capital requirement of a firm is basically influenced by the nature of its business. Trading and financial firms require large amount of working capital. In contrast, the manufacturing firms require less amount of working capital and large amount of fixed assets.

Sales and Conditions : ♦

Demand

The sales and demand conditions of a firm also affect its working capita capitall positio position. n. It is diffic difficult ult to precis precisely ely determ determine ine the relati relations onship hip between volume of sales and working capital needs. Sales depend on the demand conditions. Most of the firms experience seasonal and cyclic cyclical al fluctua fluctuatio tions ns in the demand demand of their their produc products ts and servic services. es. These These busine business ss variat variation ions s affect affect the workin working g capita capitall requir requireme ement, nt, particularly the temporary working capital requirement of the firm. When there is an upward swing in the economy, the sales will increase and untimely the firm’s investment in inventories and debtors will also increase. On the other hand, when there is a decline in the economy, the sales will fall and ultimately, the level of inventories and debtors will also fall. Under recessionary conditions firms try to reduce their shortterm borrowings.

Technology Manufacturing Policy : ♦

and

The manufacturing cycle of the firm also affects the requirement of the working capital. The manufacturing cycle comprises the purchase and use of raw material material and producti production on of finish finished ed goods. goods. Longer Longer the manu manufa fact ctur urin ing g cyc cycle, le, larg larger er will will be the the firm firm’s ’s work workin ing g capi capita tall requirements and vice versa. An extended manufacturing time span mean means s a larg larger er tie-u tie-up p of fund funds s in inve invent ntor orie ies. s. Thus Thus,, if ther there e are are alternative technologies for manufacturing a product, the technological process with the shortest manufacturing cycle may be chosen.

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Working Capital Management – An Analysis

Further, the requirement of working capital also depends on whether  the firm has adopted steady production policy or variable production policy.

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Credit Policy :

In the present day cir circumstances, cumstances, almost all units have to sell goods on credit credit.. The nature nature of credit credit policy policy is an import important ant consid considera eratio tion n in deciding the amount of working capital requirement. The larger the volume of credit sales, the greater will be the requirement of working capital. Also the longer the period of collection of payment, the greater  will be the requirement of working capital. Generally, the credit policy of  an individual firm depends on the norms of the industry to which the firm belongs.

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Availability of Credit :

The availa availabil bility ity of credit credit from from banks banks and financi financial al institu institution tions s also also influences the working capital requirement of a firm. The availability of  credit to a firm depends upon the creditworthiness of the firm in the money market. If a firm has good credit standing in the market, it can get credit credit easily easily on favora favorable ble terms and hence hence it will will requir require e less less working capital.

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Operating Efficiency :

The operating efficiency of the firm relates to the optimum utilisation of  resources at minimum costs. If the firm is efficient in controlling its operating costs and utilizing its current assets, than it helps in keeping the working capital at a lower level. The use of working capital is impr improv oved ed and and pace pace of cash cash conv conver ersi sion on cycl cycle e is acce acceler lerat ated ed with with operating efficiency.

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Price Level Changes :

The The pric price e leve levell chan change ges s also also affe affect ct the the leve levell of work workin ing g capi capita tal. l. Genera Generally, lly, rising rising price price levels levels will will requir require e a firm to mainta maintain in higher  higher  amount of working capital. However, the effect of rising prices may be differe different nt for differ different ent compan companies ies,, as thoug though h the genera generall price price level level increases, the individual prices may move differently. Therefor some firms may require more working capital, while other may require less working capital in case of price rise.

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Working Capital Management – An Analysis

Growth Plans : ♦

and

Expansion

The growth and expansion plans to be undertaken by a firm also affect its requirements of working capital. capital. Hence the planning of the working capital requirements and its procurements must go hand in hand with the the plan planni ning ng of the the grow growth th and and expa expans nsio ion n of the the firm firm.. Even Even the the expansion of the sales also increases the requirements of working capital.

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Working Capital Management – An Analysis

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OPTIMUM WORKING CAPITAL : A firm has to maintain an adequate level of working capital to run its operations smoothly and effectively. It should be adequate in the sense that it shall not be more than the requirements nor it shall be less than the requirements. Both the excessive as well as inadequate working capital positions are dangerous from the firm’s point view. We know that the current liabilities are met out of the current assets. So the level of current assets shall be sufficient enough to meet the current liabilities. Excessive working capital refers to the position where when the level level of curren currentt assets assets is much much higher higher to meet meet curren currentt liabil liabilitie ities. s. The excess excessive ive capital capital has opportu opportunity nity cost cost for the firm, firm, as this exces excessiv sive e capital remains idle in the firm, which earns no profit for the firm. If these funds shall be invested in some profitable project, it adds the profitability of  the Company. On the other hand, inadequate working capital refers to the position where the current assets are not sufficient enough to meet the current liabilities. Such type of position may be harmful to the firm as it may interrupt the prod produc ucti tion on and and sale sales s of the the Comp Compan any, y, whic which h ulti ultima mate tely ly affe affect cts s the the profitability of the Company. Company. Moreover if the liquidity liquidity position of the firm is not not adeq adequa uate te enou enough gh to meet meet its curre current nt liab liabil ilit ities ies,, it may may affe affect ct its credibility in the market. Therefore an enlightened management should maintain the right amount of working capital on a continuos basis. Only then the proper functioning of  business operations can be ensured. The amount of the working capital shal shalll be main mainta tain ined ed at such such leve level, l, whic which h is adeq adequa uate te for for it to run run its its busine business ss operat operation ions, s, neithe neitherr excess excessive ive nor inadeq inadequat uate. e. This This level level of  working capital is called as the “Optimum Working Capital”.

Risk – Return Trade-of -off : Liquidity v/s Profitability: ♦

The level of working capital affects the degree of risk and profitability both. Hence the level of working capital should be so fixed that, on the one hand, its financial soundness is maintained and on the other hand, its profitability is optimised. At this point it is necessary to be clear about the meaning of solvency or insolvency of the firm. Solvency means a situation in which a firm can easily repay its debts as and when they mature. On the other  hand, insolvency is a situation in which a firm is not able to repay its debts as and when they become due for payment.

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Working Capital Management – An Analysis

The term risk implies the profitability that a firm will become technically insolvent, so that it will not be able to meet its obligations as and when they become due for payment.

Nature of trade-off: If profitability is to be increased, the firm must increase its risk. If the firm wants to decrease risk, its profitability will also decrease. If a firm wants to maintain insolvency, it must maintain a higher level of li quidity. That is, it must hold a larger amount of current assets such as cash, receivables, stock of goods etc., so that there would be no problem in repaying the debts as and when they due for payment. However, if a firm firm hold holds s more more amou amount nt of curr curren entt asse assets ts,, the the pros prospe pect cts s of prof profit it decline due to the fact that most of its funds are locked up in idle current assets, which earn no profit. On the other hand, if a firm wants s to increase its profitability, it must be prepared to increase its risk of insolvency, as it would have to reduce its investment in current assets. However a smaller amount of  liquidity increases risk of insolvency and, at the same time, it increases profitability also. The firm should maintain the its current assets at such level that on the one hand its profitability increases and on the other hand its risk of  insolvency decreases. There should be a balance between profitability and risk. The level, at which there is a trade-off between the risk and return, is the optimum level of working capital for a fir m. The following following figure will clear the idea about the Risk – Return TradeTradeoff of a firm:

Optimum Working Capital tiy di u iq L /

k is R

Return / Profitability

Figure 4

Risk – Return Trade-off 

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Working Capital Management – An Analysis

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Working Capital Management – An Analysis

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MANAGEMENT OF WORKING CAPITAL : Working Capital management refers to the administration of all aspects of  curren currentt assets assets namely namely cash, cash, marke marketab table le securi securities ties,, debtor debtors s and stock stock (inve (invent ntor orie ies) s) and and curr curren entt liab liabili iliti ties es.. The The finan financi cial al mana manage gerr shou should ld determine levels and composition of current assets. He must see that right sources are tapped to finance current assets and that current liabilities are paid in time. Working capital management is critical for all firms, but particularly for  small firms. A small firm may not have much investment in fixed assets, but it has to invest in current assets. Further, the role of current liabilities in financing the current assets is far more significant in case of small firms, as, unlike large firms they, face difficulties in raising long-term finances. The main problems of the management of working capital are as stated below: a. to deter determi mine ne a prop proper er amoun amountt of worki working ng capit capital al to be held held in the business i.e. estimating the working capital needs b. to take decisi decision on on the sourc sources es of working working capital capital i.e. procur procureme ement nt of  working capital c. to ensure ensure that the working working capita capitall is efficien efficiently tly utilise utilised d i.e. optimum optimum of  utilisation of working capital Before Before we consi consider der these these proble problems ms lets lets first first under understa stand nd some some of the principles of working capital management: 

Principles of Working Capital Management :

The financial manager must keep in mind the following principles of  working capital management:

Principle of Optimisation :

→

The level of working capital must be so kept that the rate of return on invest investmen mentt is optimi optimised sed.. In other other words, words, the workin working g capita capitall should be maintained at an optimum level. This is the point at which the increase in cost due to decline in working capital is equal to the increase in the gain associated with it. According to the principle of optimisation, the magnitude of working capital should be such that each rupee invested adds to its net value. In other words Capital should be invested in each component of working capital as long as the equity position of firm increases.”

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Working Capital Management – An Analysis

Principle of Risk Variation :

→

This principle is based on the assumption that the rate of return on investment is linked with degree of risk in the business. The greater  on investment is linked with the degree of risk in the business assumes, the greater is the opportunity for gain or loss.

Principle Capital : →

of

Cost

of  

Each source of working capital has different cost of capital. The degree of risk also differs from one source to another. The type of  capital used to finance working capital directly affects the amount of  risk that a firm assumes as well as the opportunity for gain or loss and cost of capital. A firm should raise capital in such a manner that a balance is maintained between risk and profit. profi t.

Principle Payment : →

of

Maturity

of 

This principle states that the working capital should be so raised from different sources that the firm is able to repay them on maturity out of its inflows of funds. funds. Otherwise the firm would would fail to repay on maturity and ultimately, it would find itself into liquidation though it is earning huge profits. This implies that the firm’s ability to repay its short-term debts depends not on its earnings but on the flow of  cash into it. These are some of the principles of working capital, which a financial manager should keep in mind while managing working capital. Now let’s discuss how to manage working capital. ⇒

Estimating Working Capital needs :

The first step in managing working capital is to estimate about the working capital needs. The most appropriate method for calculating working capital needs of a firm is the concept of operating cycle. In estimating working capital needs, different people adopt different approaches. Some authors suggest that the working capital should be grea greate terr than than the the mini minim mum requ requir irem emen ents ts of the the firm firm.. The The mana manage geme ment nt shou should ld feel feel safe safety ty.. It woul would d be able able to meet meet its obligations even in adverse circumstances. However, the excessive capital may lead to waste and inefficiency.

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Working Capital Management – An Analysis

On the other hand, many authors suggest that the working capital should be lower than the requirement so that no idle funds shall be invested in the current assets and it ultimately leads to increase in profitability of the Company. However, in such case the firm always have risk of technical insolvency as it may not meet its obligations as and when they falls due for payment. So the question is what the proper amount of working capital is. It is not not an abso absolu lute te amount ount.. It depe epends nds upon the the need eeds and circumstances available in the firm. There are various approaches which have been applied in practice for estimating the working capital needs of a firm. Let’s discuss some of them in brief.

•

Conservative Approach:

The conser conservat vative ive approa approach ch states states that that the propor proportio tion n of  current assets to current liabilities should be kept at 2:1. Is this proportion is to be kept the firm would be able to meet its obligations on time and hence its financial solvency would not be in trouble. trouble. However, the limitation limitation of this approach approach is that that it sugg sugges ests ts only only quan quanti tita tativ tive e meas measur ure. e. It does does not not suggest as to what type of assets are to be included in current assets. If the current assets contain stock, which is outdated or receivable which are not collectable, than the amount of current assets has no meaning. Further, in the pres presen entt scen scenar ario io no firm firm main mainta tains ins this this rati ratio, o, as it’s it’s too too difficult for them to maintain such a high level of current assets.

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Objective Test:

Some objective tests are suggested for determining the level of working capital of a firm. On the basis of answer to the following questions, it can be determined whether the l evel of  working capital is adequate or not: 1. Whethe Whetherr the Company Company is able able to make make cash purcha purchases ses and can avail of cash discounts. 2. Whethe Whetherr the Company Company has enoug enough h credit credit worthine worthiness ss to get finance from Banks easily as and when needed? 3. Whether Whether the creditors creditors allow allow enough enough credit credit on purchase purchases? s? 4. Whet Whethe herr the the Com Company pany expe experi rien ence ces s any any diff diffic icul ulty ty in paying dividend?

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Working Capital Management – An Analysis

•

Modern Approach :

Apart from the conventional methods for estimating the need for working capital, the following foll owing two methods are used in the modern enterprises for the purpose: 1. Ratio Ratio of Curre Current nt Assets Assets to Fixe Fixed d Assets Assets 2. Curren Currentt Asset Asset holdin holding g perio period d Let’s have a brief idea about each of them.

1. Ratio of Current Current Assets Assets to to Fixed Assets Assets The financ financial ial manage managerr shoul should d determ determine ine the optimu optimum m level of current assets so that the wealth of shareholders is maximised. In a business enterprise both fixed and current assets are needed to support a particular level of  output. However, to support the same level of output, the firm can have different levels of working capital. The level of current assets can be measuring the current assets to fixed assets i.e. by measuring the ratio of current assets to fixed assets. Dividing current assets by fixed assets gives the ratio of  Current Assets to Fixed Assets. From the viewpoint of this ratio, there are three types of  approaches: A. Conse Conserva rvativ tive e appro approach ach Many firms maintain a high ratio of current assets to fixed assets so that they may not have any difficulty even in crisis. It suggests greater liquidity and lower  risk. Risk adverse firms mainly adopt this approach. B. Aggres Aggressiv sive e approa approach ch Many Many firms firms mainta maintain in low ratio ratio of curren currentt asset assets s to fixed assets, so that their funds may not block idle and they they can can be used used for for some some prof profit itab able le purp purpos ose. e. It involves higher risks and smaller liquidity. C. Averag Average e Capita Capitall approac approach h

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Working Capital Management – An Analysis

Most of the firms maintain their current level between these two extreme levels. This is an average capital appr approa oach ch.. This This invo involv lves es mode modera rate te liqu liquid idit ity y and and moderate risk.

st e s s A t n re

A. Cons Conser erva vati tive ve Appr Approa oach ch

AAAAAA

B. Aver Averag age e Appr Approa oach ch C. Aggr Aggres essi sive ve App Appro roac ach h

r

u C f o l e v e L

Output

Figure 5

Alternative Current Asset Approaches

2. Current Current Assets Assets holding holding period period In this method the working capital requirements are to be estim estimat ated ed on the the basi basis s of aver averag age e hold holdin ing g peri period od of  current assets and relating them to costs based on the firm’s experience in the previous years. This method is essentially based on the operating cycle concept. A modified version of this method is also used by various firms, firms, in which the current current assets assets are carefully estimated estimated and at the same time the current liabilities are also to be estima estimated ted.. The differ differenc ence e betwee between n two gives gives a rough rough idea about the net working capital requirements of the firm. Let’s have a brief idea about how various components of  current assets and current liabilities are to be estimated for estimating the working capital requirements: 1. Stoc Stock k of Raw Raw Mat Mater eria ials ls = No. No. of Unit Units s Prod Produc uced ed * Per Per Unit Unit Cost Cost of raw raw materia rials * Average holding period iod of raw materials 2. Work ork in Prog Progre ress ss = i. Material ials : No No. of Un Units Produced * Per Un Unit Cost of raw materials * Average period of raw materials in process

22

Working Capital Management – An Analysis

ii .

iii. iii.

Labour :

No. of Produced * Per Unit Cost of Labour * Average of period of  labour in process Overh verhe ead: No. No. of of Pro Prod duce uced * Per Uni Unitt Cos Costt of Overheads* Average of period of Overheads in process

Generally, the WIP is to be taken as half a month’s raw raw mate materi rial al cost cost and and one one mont month’s h’s labo labour ur and and variable cost. 3. Fini Finish shed ed Good Goods s= No. of Units Produced * Per Unit Total Cost 4. Sund Sundry ry Debt Debtor ors s= No. of Units Sold * Period of credit given to debtors * Total Cost of Production Prof Profit it is not to be cons onside idered red for for calc calcul ulat atin ing g the the outstanding debtors. On the same way only the sales which are made on credit are to be considered. Thus the cash cash sales sales are are to be dedu deduct cted ed befo before re estim estimat atin ing g the the debtors. 5. Sund Sundry ry Cred Credito itors rs = No. No. of Unit Units s Prod Produc uced ed * Per Per unit unit cost cost of raw raw materials * Credit period allowed by the suppliers 6. Outsta Outstandi nding ng Wage Wages s and Overhe Overheads ads = No. of Units Produced * Per unit cost of Wages and Overheads * Time leg in payment of Wages and Overheads After estimating the components of current assets and curre current nt liab liabili iliti ties es a Stat Statem emen entt Show Showing ing the the Work Workin ing g Capital Requirement is to be prepared as under:

23

Working Capital Management – An Analysis

Statement Showing Requirement of Working Capital Particulars Current Assets : 1. Stoc Stock k of Raw Raw Mate Materi rial als s 2. Stock Stock of Work Work in in prog progres ress s: Material Cost ---------Wages ---------Overheads ---------3. Stock Stock of of Finis Finished hed Goods Goods (at (at cost cost of  of  production) 4. Debtors 5. Mini Minimu mum m Cash Cash req requi uire red d 6. Adva Advanc nce e Paym Paymen ents ts

Rs. ----------

----------------------------------------------

Total Current Assets (A) Current Liabilities : 1. Cred Credito itors rs for for purch purchas ases es 2. Outsta Outstandi nding ng wages wages and and overh overhead eads s 3. Advanc Advance e receiv received ed from from custom customers ers

Rs.

-------------

--------------------------

Total Current Liabilities (B)

-----------

Total Working Capital Requirement (A – B)

-----------

These are some of the methods that are used in estimating the working capital requirements. After estimating the working capital requir requireme ements nts,, the second second step step for financ financial ial manage managerr is to think think about the procurement of working capital. Let’s see how a financial financial manager manager decides decides about the procurement procurement of working capital. ⇒

Procurement (financing) of Working Capital:

The second step in managing the Working Capital is to take into consideration the various sources from which a working capital can be proc procur ured ed and and to deci decide de abou aboutt the the best best suita suitabl ble e sour source ce for  for  procurement of Working Capital. Generally, it is believed that funds for acquiring the Fixed Assets should be raised from long term sources and short-term sources should should be utilise utilised d for raisin raising g workin working g capita capital. l. But in the recent recent mode modern rn ente enterp rpris rises es,, both both the the type types s of sourc sources es are are util utilis ised ed for  for  financing both fixed and current assets.

24

Working Capital Management – An Analysis

There are different approaches for determining the proportion in which the short term and long term sources shall be used to finance fixed assets and current assets. There are three approaches: 1. Hedging Approach:

Under this approach, the funds for acquiring fixed assets and permanent current should be acquired with long term funds and for temporary working capital short term funds should be used. 2. Conservative Approach:

This This approa approach ch sugges suggests ts that that in additi addition on to fixed fixed assets assets and permanent current assets, even a part of variable current assets should should be financ financed ed from from long-t long-term erm source sources. s. The short short-te -term rm sources are used only to meet the peak seasonal requirements. Duri During ng the the off off seas season on,, the the surp surplu lus s fund fund is kept kept inve invest sted ed in marketable securities. This approach depends upon the longterm sources to a great extent. 3. Aggressive Approach:

This approach depends more on short-term funds. More shortterm funds are used particularly for variable current assets and a part of even permanent current assets, the funds are raised from short term sources. The main sources from which the working capital can procured are as under: 1. 2. 3. 4. 5. 6. 7.

Shares and Debentures Retained Profits Comm Commer erci cial al Bank Banks s by way way of loan loan,, cas cash h cred credit it etc. etc. Trade Creditors Public Deposits Indigenous Ba Bankers and Mo Money-len lenders Urban Co-operative Banks

The financial manager should decide about the best suitable source for procuring the working capital, as each source has its own pros and cons.

25

Working Capital Management – An Analysis

MANAGEMENT OF COMPENENTS OF WORKING CAPITAL : The fin financi ancia al manag anager er of a firm firm sha shall, ll, whil while e thin thinki kin ng about bout the the management of working capital, consider the management of the following components of working capital individually: 1. Cash Cash Man Manag agem emen entt 2. Inve Invent ntor ory y Manag Managem emen entt 3. Rece Receiv ivab able le Manag Managem emen entt The exercise of management of each component of Working Capital leads to effective management of Working Capital of a firm. Let’s have a brief idea about the management of each component of  working capital.

1. Cash Cash Manag Manageme ement nt : Cash is the medium of exchange which allows management to carry on the various activities of the business on day to day basis. It includes coins, currency, cheques held by the firm and the balance in its bank accounts. In a broader sense, it also includes “Near Cash Assets” such as marketable securities and time deposits with the bank. A firm should have a sufficient balance of cash neither more nor less than the requirements. A firm holds cash for the following motives : a) b) c) d)

Tran Transa sact ctio ion n Motiv Motive, e, Precau Precautio tionar nary y Motive Motive,, Spec Specul ulat ativ ive e Moti Motive ve and and Compen Compensat sating ing Motive Motive..

The cash cash manag managem ement ent of a firm involves involves the consid considera eratio tion n of the following four factors : Ascertainment of the minimum cash balance and controlling the levels of cash → Controlling cash inflows → Controlling cash outflows → Optimum investment of surplus cash →

•

Controlling cash :

the

levels

of 

The financial manager of a firm shall have the following tools available with him for controlling the levels of cash.

26

Working Capital Management – An Analysis



Preparing Cash Budget:

Cash Cash budget budget is a statem statement ent showin showing g the estima estimated ted cash cash inflows and cash outflows over the next planning period. The surplus or shortfall of cash is highlighted by the cash budget. 

Providing for contingencies:

In addi additi tion on to the the leve levell of cash cash dete determ rmin ined ed by the the cash cash budget, a suitable minimum amount of cash must be kept for  meet meetin ing g the the unfo unfore rese seen en cont contin inge genc ncies ies such such as strik strikes es,, floods, fire etc. 

Consideration of cost of shortage of cash:

The The cost cost aris arises es in term terms s of loss loss of firm’ firm’s s repu reputa tati tion on or  additional cost of borrowing at higher rate of interest shall be considered. 

Availability of other sources of funds:

In case of shortage of cash, which are the sources that can be trapped for meeting the urgent cash requirements.

•

Controlling inflows:

of

cash

After having prepared the cash budget, a finance manager  must ensure that there is no significant deviation between the projected cash inflows and the actual cash inflows. Effe Effect ctiv ive e cash cash coll collec ectio tion n shal shalll be made made by adop adopti ting ng the the following techniques. 

Concentration Banking :

The Concen Concentra tratio tion n Bankin Banking g is a system system of decent decentral ralise ised d coll collec ectio tion n of acco accoun unts ts rece receiv ivab able le in case case of larg large e firm firms s having their business spread over a large area, by opening a number of collection centers at selected strategically located areas areas and and making making collec collectio tions ns from from that that center centers s from from the customers residing in that area. 

Local Box System :

In this system, the firm hires a post-office box and asks its customers to send the cheques to the box. The firm’s local bank bank is give given n auth author orit ity y to open open the the box box and and cred credit it the the payment in the firm’s bank account. 27

Working Capital Management – An Analysis

•

Controlling outflows:

of

cash

The opera perati tin ng cash ash requi equire rem ment ent can can be redu reduce ced d by controlling the cash outflows. The financial manager can use the following techniques for the purpose. 

Centralised Disbursements :

All the payment can be made from only one account at the Head Head Offi Office ce.. This This will will resu result lt in dela delay y in pres presen enta tatio tion n of  cheques for payment by parties who are working from distant places. 

Playing ‘Float’ :

‘Float’ means the amount tied up in cheques that have been drawn but have not yet been presented for payment. There is always a time lag between the issue of a cheque by the firm and its actual presentment for payment. As a result the firm’s actual balance at bank may be more than the balance as show shown n by its its book books. s. This This diff differ eren entt is calle called d “Pay “Payme ment nt in Float”.

•

Optimum Investment Surplus Cash :

of 

The financial manager shall use it’s the cash efficiently and for that purpose, the following points shall be kept in mind. 

Determining Surplus Cash :

Surplus cash is the cash in excess of the firm’s normal cash requir requireme ements nts.. This This requir requirem ement ent can be compu computed ted by the multi multiplic plicati ation on of desire desired d days days of cash cash and averag average e daily daily outf outflo lows ws.. If the the cash cash bala balanc nce e is more more than than this this norm normal al requ requir irem emen ent, t, then then the the surp surplu lus s cash cash can can be inve invest sted ed somewhere to earn returns. 

Determining Channels of Investment :

Surplus funds can be invested in marketable securities or  somewhere else. While exercising such discretion, a finance mana manage gerr must must take take care care of secu securit rity, y, liqu liquid idit ity, y, yiel yield d and and maturity associated with marketable securities.

28

Working Capital Management – An Analysis

29

Working Capital Management – An Analysis

2. Invent Inventory ory Manag Manageme ement nt : Inventory is composed off the assets that will be sold in future in the normal course of business operations. To the finance manager, the inventory connotes the value of raw materials, consumables, spares, work-in-progress, finished goods and scrap in which the firm’s funds have been invested. A firm holds inventory mainly for the following motives: a. b. c.

Transaction Motive Precautionary Mo Motive Speculative Motive

As the inventory involves the investment of the funds, it should be managed properly or rather controlled properly. Inventory management is a planned method to determine which items is to be purchased and how much to be kept in stock, so that the costs of purchase and stor storag age e both both are are mini minimi mise sed d with withou outt adve advers rsel ely y affe affect ctin ing g eith either  er  production or sales. It involves the decision of the firm as to the extent to which inventories can be economically stored. The inventory hold by the firm involves the following cost to the firm: a.

Ordering Costs: Every time an order is placed for stock replenishment; certain costs are incurred called as ordering cost. It includes paper work costs, follow up costs, staff costs etc.

b.

Carrying Costs: Carrying costs are the costs of holding inventory for a given period of time. It includes storage cost, handling cost, insurance cost, obsolesce cost etc.



Objectives of Inventory Management: A fund fundam amen enta tall obje object ctiv ive e of a good good syst system em of inve invent ntor ory y management is to be able to place an order at the right time from the right source to acquire the right quantity at a right price and of right quantity. Main Mainly ly ther there e are are the the follo followi wing ng objec objectiv tives es of the the Inve Invent ntor ory y Management: 1. 2. 3. 4.

to ensure adequate stock to mi minimise in inventories on ha hand to ma maint intain co continuity ity in in pr production ion to minim inimis ise e th the cos costt of of pu purcha rchas sing ing an and sto storrage age

30

Working Capital Management – An Analysis

5. 6. 7. 8. 9. 10. 10. 11. 11. 12. 12. 

to mi minimise th the wa wastage an and lo loss to reduce the risk isk of deterior ioration to use the the avail vaila able ble capi capita tall effe effec ctiv tively ely to be be he helpful in in ef efficient pu purchasing ing to give ive maxim aximum um satis atisfa fact ctio ion n to to cus custo tom mers ers to minim inimis ise e los loss s due due to to pric price e dec decli line ne maxim aximu um us use of of sto stora rag ge cap capa acity city prop proper er stor torage age of mater ateria ials ls

Techniques for Inventory Management: Usually the following techniques are being used by the financial manager for inventory control.

a.

Determining Quantity(EOQ):

the

Economic

Order

Economic Order Quantity is that quantity at which the total ordering costs and inventory carrying costs will be the minimum. A firm is required to consider a number of  factors before fixing an economic ordering quantity. Of  these factors, important ones are inventory carrying costs and ordering costs. When the inventory carrying cost and ordering cost are in balance, the total cost of ordered quantity is lowest and therefore it is called as economic order quantity. The firm should maintain its inventory at such a level so that its inventory carrying cost and ordering cost are at balance. There are three methods for determining the EOQ: 1. Graphic Method 2. Formula Method 3. Trial and Error Method The results of all three methods are more and less same.

b.

Det Determ erminin ining g ot other her inv inve ento tor ry lev leve els: ls: In orde orderr that that the the inve invent ntor ory y cost costs s are are redu reduce ced d to the the minimum and yet the process of production and sales goes on uninterrupted, it is necessary to determine the following inventory levels: 1.

Re-order Po Point or or Or Ordering Le Level It represents the quantity level at which an order  for fresh supplies must be placed with the supplier  to replenish the present stock.

31

Working Capital Management – An Analysis

Generally the following formula is to be used for  the purpose: Order rderin ing g Lev Level = Max Maximum imum Maximum Delivery Time 2.

Cons onsumpt umptio ion n

*

Minimum Level The minim minimum um level level indica indicates tes the lower level level of  stocks of inventory. Min. Level = Re-ordering ing level – Averag rage Consumption of Average Delivery Period

3.

Maximum Level The The maxi maximu mum m leve levell of inve invent ntor ory y indic indicat ates es the the uppe upperr limi limitt of leve levell of stoc stocks ks.. It repr repres esen ents ts the the largest quantity of material to be kept in stock. Max. Max. Lev Level = Re-or e-orde derring ing lev level – Mini Minim mum Consum Consumpti ption on of Minimu Minimum m Period Period + Re-ord Re-orderi ering ng Quantity

c.

ABC System of Inv Inventory Control : A modern system of inventory control, which is economical, too is ABC System of inventory control. It is Always Better Control (ABC). Some items included in the inventory are of very low valu value e and and its its deta detail iled ed acco accoun unti ting ng is not not econ econom omic ical al.. Hence, such items must be stored in sufficient quantity and its use is not restricted. On the other hand, there are cert certa ain ite items of inv invento entory ry tha that repre epres sent a larg large e proportion of the total value of inventory. In ABC ABC Analy nalys sis all item items s are divid ivided ed into nto thre three e categories A, B and C. In category A, are included those items which are very impo import rtan antt and and of high high valu value e but but form forms s only only a smal smalll proportion of total quantity of inventory. Strict control over  receip receipts, ts, storag storage e and issue issue shoul should d be exerc exercise ised d over  over  such such item items. s. Its Its requ requir irem emen ents ts must must be esti estima mate ted d in advance and its purchases must be planned, so that it is available as and when needed. In category B, those items are included, which are not as impo import rtan antt as thos those e are are in A grou group, p, but but are are impo import rtan antt

32

Working Capital Management – An Analysis

enough for its proper records to be maintained. Maximum and Minimum levels must be fixed for such items and they must be issued against proper material requisition only. The remaining items must be places in Category C. They are are not not impo import rtan antt from from the the view view point point of main mainta tain inin ing g control over their receipts and consumption. Little control is to be put on such items. The ABC System of inventory control is very useful for  the modern management as it helps in saving their time from from the the unne unnece cess ssar ary y work work and and lead leads s to effi effici cien entt inventory control.

d.

Perpetual Inven ventory System : For effici efficient ent invent inventory ory contro control, l, it is necess necessary ary that that the various items of inventory must be continuously checked and compared with records maintained. This is done by Perpetual Inventory System. Perpe Perpetu tual al Inve Invent ntor ory y mean means s a syst system em of main mainta tain ining ing continuous stock records through bin cards and stores ledger. This implies continuous stock taking in which a certa certain in numb number er of inve invent ntor ory y items items are are chec checke ked d and and verified everyday or at frequent intervals.

3. Receivables Receivables Managemen Managementt : When the goods are sold on credit in business, the price of the goods becomes receivable. In the present economic system, credit sales are essent essential ials, s, unless unless the goods goods sold sold are in short short supply supply.. The money involved in inventories are blocked till future and therefore there is an opportunity cost of receivables. However, the credit sales are also ess essenti ential al in ord order to meet the the seve ever comp ompetit etitio ion. n. Thus, us, the the management of receivable requires great care. It must be so managed that the benefit available from additional sales and the cost of funds raised to finance the additional credit coincide. The management of receivables is important in the sense that in India it form forms s abou aboutt oneone-th thir ird d of curre current nt asse assets ts.. The The mana manage geme ment nt of  rece receiv ivab able le is need needed ed as; as; a firm firm has has to incu incurr the the foll follow owin ing g cost cost associated with receivables. 1. 2. 3. 4.

Colle Collect ctio ion n Cos Costt i.e i.e.. the the cost costs s inc incur urre red d in in col colle lect cting ing the the pay payme ment nts s Defa Defaul ultt Cost Cost i.e i.e.. the the bad bad debt debt los losse ses s ari arise se whe when n a fir firm m is unab unable le to collect some receivable Opportunity Cost Administrative Cost

33

Working Capital Management – An Analysis



Optimum Credit Policy :

If a firm sells goods on credit, it has to decide the optimum credit policy. It has neither to be too rigid nor too liberal. The sales must go on rising and yet the bad debts and collection costs are kept to the minimum. Thus two types of credit policies are to be considered: 1. Libera Liberall or Len Lenien ientt Credit Credit Polic Policy y 2. Strict Strict or or string stringent ent cred credit it polic policy y In Liberal Credit Policy, the customers are allowed liberal terms for  credit sales and credit is granted for a longer period even to those custom customers ers whose whose financ financial ial positio position n is doubt doubtful ful.. A libera liberall policy policy results results into increase increase of sales and increase of profits. profits. However, the risk of bad debts and the opportunity cost of receivables are also increased. The collection costs are also increased. On the other hand, a strict or stringent policy implies that the firm sell sells s in cred credit it on a high highly ly sele select ctiv ive e basi basis s and and only only to thos those e customers whose financial position is sound. It results into reduction in sales and reduction in profit also. However, the cost involved with the the high high volu volume me of rece receiv ivab able les s and and risk risk of bad bad debt debts s are are also also reduced. The firm should determine its credit policy in such a manner that on one hand its profitability is to be increased and on the other hand its liquidity position is not hampered. That means the point at which the profitability and liquidity is balanced is the optimum credit policy for  the firm. 

Credit Policy Variables :

While framing optimum credit policy, the financial manager shall consider carefully the following variables of the credit policy: a. Cred Credit it Stan Standa dard rds s Credit Standards means the criteria on the basis of which, credit is gran grante ted d to a part partic icul ular ar cust custom omer er or part partic icul ular ar grou group p of  customers. If the standards are very strict in would reduce the volume of receivables and vice versa. Credit Standards of most of the firms include the creditworthiness of the customer. That means the credit should be granted to a customer after accessing his credit worthiness.

34

Working Capital Management – An Analysis

For accessing the creditworthiness of a customer two factors are important : i. ii.

aver avera age colle ollect ctio ion n per perio iod d of of a parti articu cula larr cus custo tom mer  his default rate

While determining the creditworthiness of a customer five C’s are taken into account: i. ii. iii. iv. v.

Character   Capacity Collateral Condition and Capital

b. Cred Credit it Term Terms s Credit terms means both the credit period and the cash discount offered, the credit period is the length of time for which credit is extended to customers. It is stated by such terms as “3/15 Net 45” meaning that if payment is made within 15 days, 3% cash discount will be given. Even without discount, payment will be made within 45 days. Generally, the customers of the industry determine the credit terms. c. Coll Collec ecti tion on Poli Policy cy The collection policy must be such as would help in collecting book-debts in time and reduce the bad debts. A collection policy should ensure prompt and regular collection. This would reduce the need for for more working working capital capital and and loss of bad debts. debts. The firm must frame frame a proced procedure ure to exped expedite ite colle collecti ction on from from the customers. e.g. First, a letter must be written to the customer to pay his dues. If he does not respond, then a strong letter must be writt written en.. As a last last step step,, a lett letter er must must be sent sent info inform rmin ing g the the customer that legal action would be taken is dues are not paid within certain days. Thus, a financial manager of a firm shall, while managing its working capita capital, l, consi consider der carefu carefully lly the manag manageme ement nt of the compon component ents s of the working capital, in the manner as stated above.

35

Working Capital Management – An Analysis



CONCLUSION: Working Capital occupies a peculiar position in the Capital Structure of a firm. firm. It is the life-bl life-bloo ood d of all types types of enterp enterpris rises, es, manufa manufactu cturin ring g and trading both. If the business has enough Working Capital, it can maintain its its oper operat atin ing g effic efficie ienc ncy. y. Not Not only only that that,, but but adeq adequa uate te work workin ing g capi capita tall provides psychological satisfaction and relief to the management. Only those enterprises, which have adequate working capital, can survive in time times s of depr depres essi sion on.. It has has been been obse observ rved ed that that numb number er of busi busine ness ss enterprises have failed due to inefficient i nefficient management of working capital. That is the reason why the management of working capital becomes a tedious exercise for a financial manager of a firm. For any enterprise the question of adequacy of working capital and its efficient management is a test of efficiency of a financial manager. The experience shows that much of the financial manager’s time is used in the management of working capital. Working Capital constitutes a large portion of total investment in assets. It is estimated that about 60% of the total net assets of the public sector  companies in India is in the form of current assets. This underlines the importance of the working capital management. Workin Working g Capita Capitall manag manageme ement nt is more more impor importan tantt for small small firms firms also. also. Generally, in the small units, investment in such current assets as cash, receivables and inventories tends to be larger than investment in fixed assets. Also it is more difficult for small units to raise enough long term capital for the current assets. Therefore, the exercise of the management of working capital must be take taken n with with grea greatt care care and and atte attent ntio ion. n. The The finan financi cial al mana manage gerr must must be constantly alert to ensure that there is no over investment in working capital. On the other hand, he also has to ensure that the firm does not face the problem of shortage of working capital. The financial manager has to constantly make efforts to ensure that whatever working capital the firm possess, is managed properly so as to increase the operating efficiency of  the firm.

36

Working Capital Management – An Analysis

37

Working Capital Management – An Analysis

CALCULATION OF WORKING CAPITAL FOR BHILAI STEEL PLANT (In crores)

YEAR

2004-05

2005-06

2006-07

2007-08

1041.68

1505.76

1556.66

1712.9

SUNDRY DEBTORS

19.48

20.53

18.82

13.7

CASH & BANK

22.35

36.8

39.86

INTEREST RECEVIABLE

18.89

33.81 16.55

13.86

12.6

LOANS & ADVANCES

194.82

218.44

325.12

480.72

TOTAL CURRENT ASSETS

1297.22

1795.09

1951.26

2259.78

CURRENT ASSETS:

INVENTORIES

38

Working Capital Management – An Analysis

CURRENT LIABILITIES:

CURRENT LIABILITIES

894.57

850.16

910.08

1190.59

PROVISIONS

93.98

103.46

79.37

82.42

TOTAL CURRENT LIABILITIES

988.55

953.62

989.45

1273.01

NET WORKING CAPITAL

308.67

841.47

961.81

986.77

CHART SHOWING WC OF BSP: 1000

961.81

986.77

2006-07

2007-08

841.47 800 600 400

308.67

200 0 2004-05

2005-06

NET WORKING CAPIT ITAL OF BHILAI AI STEEL PLANT

CALCULATION OF WORKING WORKING CAPITAL FOR ROURKELA ROURKELA STEEL PLANT (In crores)

YEAR

2004-05

2005-06

2006-07

2007-08

500.44

718.11

877.56

870.13

SUNDRY DEBTORS

12.44

14.6

12.96

11.66

CASH & BANK

15.75

18.79

20.66

2.54

17.22 2.47

1.83

1.58

195.93

212.72

230.94

243.15

727.1

965.12

1142.08

1147.18

CURRENT ASSETS:

INVENTORIES

INTEREST RECEVIABLE LOANS & ADVANCES TOTAL CURRENT ASSETS

39

Working Capital Management – An Analysis

CURRENT LIABILITIES:

CURRENT LIABILITIES

400.82

422.96

486.09

539.79

50.52

49.57

50.78

48.35

TOTAL CURRENT LIABILITIES

451.34

472.53

536.87

588.14

NET WORKING CAPITAL

275.76

492.59

605.21

559.04

PROVISIONS

CHART SHOWING WC OF RSP: 700 605.21

600

559.04

492.59

500 400 300

275.76

200 100 0 2004-05

2005-06

2006-07

2007-08

NET WORKIN NG G CAPIT ITAL OF ROURKELA STEELPLANT

CALCULATION OF WORKING CAPITAL FOR BOKARO STEEL (In crores) YEAR

2004-05

2005-06

2006-07

2007-08

953.87

1365.56

1407.49

1185.74

SUNDRY DEBTORS

11.13

12.51

8.95

7.74

CASH & BANK

35.77

41.08

44

INTEREST RECEVIABLE

23.14

37.9 18.96

14.02

10.95

255.87

391.18

390.9

587.45

1279.78

1826.11

1862.44

1835.88

CURRENT ASSETS:

INVENTORIES

LOANS & ADVANCES

TOTAL CURRENT ASSETS CURRENT LIABILITIES:

40

Working Capital Management – An Analysis

CURRENT LIABILITIES

656.07

761.14

800.47

917.47

99.22

94.82

53.99

48.27

TOTAL CURRENT LIABILITIES

755.29

855.96

854.46

965.74

NET WORKING CAPITAL

524.49

970.15

1007.98

870.14

PROVISIONS

CHART SHOWING WC OF BSL: 1200 970.15

1000

1007.98 870.14

800 600

524.49

400 200 0 2004-05

2005-06

2006-07

2007-08

NETWORKINGCAPIT ITALOFBOKARO STEELPLANT

41

Working Capital Management – An Analysis

42