WORKING CAPITAL

Meaning of Working Capital

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

1) Fixed Capital

2) Working Capital

Every business needs funds for two purposes for its establishment and to carry

out its day- to-day operations. Long terms funds are required to create production

facilities through purchase of fixed assets such as p&m, land, building, furniture,

etc. Investments in these assets represent that part of firm’s capital which is

blocked on permanent or fixed basis and is called fixed capital. Funds are also

needed for short-term purposes for the purchase of raw material, payment of wages

and other day – to- day expenses etc.

These funds are known as working capital. In simple words, working capital refers to

that part of the firm’s capital which is required for financing short- term or current

assets such as cash, marketable securities, debtors & inventories. Funds, thus,

invested in current assts keep revolving fast and are being constantly converted in

to cash and this cash flows out again in exchange for other current assets. Hence, it

is also known as revolving or circulating capital or short term capital.

CONCEPT OF WORKING CAPITAL

There are two concepts of working capital:

1. Gross working capital

2. Net working capital

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

enterprises current assets are those Assets which can convert in to cash within a

short period normally one accounting year.

CONSTITUENTS OF CURRENT ASSETS

1) Cash in hand and cash at bank

2) Bills receivables

3) Sundry debtors

4) Short term loans and advances.

5) Inventories of stock as:

a. Raw material

b. Work in process

c. Stores and spares

d. Finished goods

6. Temporary investment of surplus funds.

7. Prepaid expenses

8. Accrued incomes.

9. Marketable securities.

In a narrow sense, the term working capital refers to the net working. Net working

capital is the excess of current assets over current liability, or, say:

NET WORKING CAPITAL = CURRENT ASSETS – CURRENT LIABILITIES.

Net working capital can be positive or negative. When the current assets exceeds

the current liabilities are more than the current assets. Current liabilities are those

liabilities, which are intended to be paid in the ordinary course of business within a

short period of normally one accounting year out of the current assts or the income

business.
 CONSTITUENTS OF CURRENT LIABILITIES

1. Accrued or outstanding expenses.

2. Short term loans, advances and deposits.

3. Dividends payable.

4. Bank overdraft.

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

6. Bills payable.

7. Sundry creditors.

The gross working capital concept is financial or going concern concept whereas net

working capital is an accounting concept of working capital. Both the concepts have

their own merits.

The gross concept is sometimes preferred to the concept of working capital for the

following reasons:

1. It enables the enterprise to provide correct amount of working capital at

correct time.

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

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

3. It take into consideration of the fact every increase in the funds of the

enterprise would increase its working capital.

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

working capital. The net working capital concept, however, is also important for

following reasons:

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

operating expenses and short-term liabilities.

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

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

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

the permanent sources of funds.

CLASSIFICATION OF WORKING CAPITAL

Working capital may be classified in to ways:

o On the basis of concept.

o On the basis of time.

On the basis of concept working capital can be classified as gross working capital

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

Ø Permanent or fixed working capital.

Ø Temporary or variable working capital

 PERMANENT OR FIXED WORKING CAPITAL

Permanent or fixed working capital is minimum amount which is required to ensure

effective utilization of fixed facilities and for maintaining the circulation of current

assets. Every firm has to maintain a minimum level of raw material, work- in-

process, finished goods and cash balance. This minimum level of current assts is

called permanent or fixed working capital as this part of working is permanently

blocked in current assets. As the business grow the requirements of working capital

also increases due to increase in current assets.

TEMPORARY OR VARIABLE WORKING CAPITAL

Temporary or variable working capital is the amount of working capital which is

required to meet the seasonal demands and some special exigencies. Variable

working capital can further be classified as seasonal working capital and special

working capital. The capital required to meet the seasonal need of the enterprise is

called seasonal working capital. Special working capital is that part of working

capital which is required to meet special exigencies such as launching of extensive

marketing for conducting research, etc.

Temporary working capital differs from permanent working capital in the sense that

is required for short periods and cannot be permanently employed gainfully in the

business.

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

seasonal sets.

IMPORTANCE OR ADVANTAGE OF ADEQUATE WORKING

CAPITAL

Ø SOLVENCY OF THE BUSINESS: Adequate working capital helps in maintaining

the solvency of the business by providing uninterrupted of production.

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

payments and makes and maintain the goodwill.

Ø Easy loans: Adequate working capital leads to high solvency and credit

standing can arrange loans from banks and other on easy and favorable terms.

Ø Cash Discounts: Adequate working capital also enables a concern to avail cash

discounts on the purchases and hence reduces cost.

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

supply of raw material and continuous production.

Ø Regular Payment Of Salaries, Wages And Other Day TO Day Commitments: It

leads to the satisfaction of the employees and raises the morale of its employees,
increases their efficiency, reduces wastage and costs and enhances production and

profits.

Ø Exploitation Of Favorable Market Conditions: If a firm is having adequate

working capital then it can exploit the favorable market conditions such as

purchasing its requirements in bulk when the prices are lower and holdings its

inventories for higher prices.

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

Ø Quick And Regular Return On Investments: Sufficient working capital enables a

concern to pay quick and regular of dividends to its investors and gains confidence

of the investors and can raise more funds in future.

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

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

EXCESS OR INADEQUATE WORKING CAPITAL

Every business concern should have adequate amount of working capital to run its

business operations. It should have neither redundant or excess working capital nor

inadequate nor shortages of working capital. Both excess as well as short working

capital positions are bad for any business. However, it is the inadequate working

capital which is more dangerous from the point of view of the firm.
DISADVANTAGES OF REDUNDANT OR EXCESSIVE WORKING

CAPITAL

1. Excessive working capital means ideal funds which earn no profit for the firm

and business cannot earn the required rate of return on its investments.

2. Redundant working capital leads to unnecessary purchasing and accumulation

of inventories.

3. Excessive working capital implies excessive debtors and defective credit policy

which causes higher incidence of bad debts.

4. It may reduce the overall efficiency of the business.

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

other financial institution may not be maintained.

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

7. The redundant working capital gives rise to speculative transactions.

DISADVANTAGES OF INADEQUATE WORKING CAPITAL

Every business needs some amounts of working capital. The need for working

capital arises due to the time gap between production and realization of cash from

sales. There is an operating cycle involved in sales and realization of cash. There

are time gaps in purchase of raw material and production; production and sales;

and realization of cash.

Thus working capital is needed for the following purposes:

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

· To pay wages and salaries

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

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

· To provide credit facilities to the customer.

· To maintain the inventories of the raw material, work-in-progress, stores and

spares and finished stock.

For studying the need of working capital in a business, one has to study the

business under varying circumstances such as a new concern requires a lot of funds

to meet its initial requirements such as promotion and formation etc. These

expenses are called preliminary expenses and are capitalized. The amount needed

for working capital depends upon the size of the company and ambitions of its

promoters. Greater the size of the business unit, generally larger will be the

requirements of the working capital.

The requirement of the working capital goes on increasing with the growth and

expensing of the business till it gains maturity. At maturity the amount of working

capital required is called normal working capital.

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

FACTORS DETERMINING THE WORKING CAPITAL

REQUIREMENTS
1. NATURE OF BUSINESS: The requirements of working is very limited in public

utility undertakings such as electricity, water supply and railways because

they offer cash sale only and supply services not products, and no funds are

tied up in inventories and receivables. On the other hand the trading and

financial firms requires less investment in fixed assets but have to invest

large amt. of working capital along with fixed investments.

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

requirement of working capital.

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

accumulating inventories it will require higher working capital.

4. LENTH OF PRDUCTION CYCLE: The longer the manufacturing time the raw

material and other supplies have to be carried for a longer in the process with

progressive increment of labor and service costs before the final product is

obtained. So working capital is directly proportional to the length of the

manufacturing process.

5. SEASONALS VARIATIONS: Generally, during the busy season, a firm requires

larger working capital than in slack season.

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

one cycle determines the requirements of working capital. Longer the cycle

larger is the requirement of working capital.

DEBTORS
CASH FINISHED GOODS

RAW MATERIAL WORK IN PROGRESS

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

question of working capital and the velocity or speed with which the sales are

affected. A firm having a high rate of stock turnover wuill needs lower amt. of

working capital as compared to a firm having a low rate of turnover.

8. CREDIT POLICY: A concern that purchases its requirements on credit and

sales its product / services on cash requires lesser amt. of working capital

and vice-versa.

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

is need for larger amt. of working capital due to rise in sales, rise in prices,

optimistic expansion of business, etc. On the contrary in time of depression,

the business contracts, sales decline, difficulties are faced in collection from

debtor and the firm may have a large amt. of working capital.

10. RATE OF GROWTH OF BUSINESS: In faster growing concern, we shall require

large amt. of working capital.

11. EARNING CAPACITY AND DIVIDEND POLICY: Some firms have more earning

capacity than other due to quality of their products, monopoly conditions, etc.

Such firms may generate cash profits from operations and contribute to their
 working capital. The dividend policy also affects the requirement of working

capital. A firm maintaining a steady high rate of cash dividend irrespective of

its profits needs working capital than the firm that retains larger part of its

profits and does not pay so high rate of cash dividend.

12. PRICE LEVEL CHANGES: Changes in the price level also affect the working

capital requirements. Generally rise in prices leads to increase in working

capital.

Others FACTORS: These are:

Operating efficiency.

Management ability.

Irregularities of supply.

Import policy.

Asset structure.

Importance of labor .

Banking facilities, etc.

MANAGEMENT OF WORKING CAPITAL

Management of working capital is concerned with the problem that arises in

attempting to manage the current assets, current liabilities. The basic goal of

working capital management is to manage the current assets and current liabilities
of a firm in such a way that a satisfactory level of working capital is maintained, i.e.

it is neither adequate nor excessive as both the situations are bad for any firm.

There should be no shortage of funds and also no working capital should be ideal.

WORKING CAPITAL MANAGEMENT POLICES of a firm has a great on its probability,

liquidity and structural health of the organization. So working capital management

is three dimensional in nature as

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

liquidity and risk.

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

assets.

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

liabilities.

WORKING CAPITAL ANALYSIS

As we know working capital is the life blood and the centre of a business. Adequate

amount of working capital is very much essential for the smooth running of the

business. And the most important part is the efficient management of working

capital in right time. The liquidity position of the firm is totally effected by the

management of working capital. So, a study of changes in the uses and sources of

working capital is necessary to evaluate the efficiency with which the working

capital is employed in a business. This involves the need of working capital analysis.
The analysis of working capital can be conducted through a number of devices, such

as:

1. Ratio analysis.

2. Fund flow analysis.

3. Budgeting.

1. RATIO ANALYSIS

A ratio is a simple arithmetical expression one number to another. The technique of

ratio analysis can be employed for measuring short-term liquidity or working capital

position of a firm. The following ratios can be calculated for these purposes:

1. Current ratio.

2. Quick ratio

3. Absolute liquid ratio

4. Inventory turnover.

5. Receivables turnover.

6. Payable turnover ratio.

7. Working capital turnover ratio.

8. Working capital leverage

9. Ratio of current liabilities to tangible net worth

2. FUND FLOW ANALYSIS

Fund flow analysis is a technical device designated to the study the source from

which additional funds were derived and the use to which these sources were put.

The fund flow analysis consists of:

a. Preparing schedule of changes of working capital

b. Statement of sources and application of funds.

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

(working capital) business enterprise between beginning and ending of the financial

dates.

3. WORKING CAPITAL BUDGET

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

to be pursued in the future period time. Working capital budget as a part of the total

budge ting process of a business is prepared estimating future long term and short

term working capital needs and sources to finance them, and then comparing the

budgeted figures with actual performance for calculating the variances, if any, so

that corrective actions may be taken in future. He objective working capital budget

is to ensure availability of funds as and needed, and to ensure effective utilization of

these resources. The successful implementation of working capital budget involves

the preparing of separate budget for each element of working capital, such as, cash,

inventories and receivables etc.

ANALYSIS OF SHORT – TERM FINANCIAL POSITION OR TEST OF LIQUIDITY

The short –term creditors of a company such as suppliers of goods of credit and

commercial banks short-term loans are primarily interested to know the ability of a

firm to meet its obligations in time. The short term obligations of a firm can be met

in time only when it is having sufficient liquid assets. So to with the confidence of

investors, creditors, the smooth functioning of the firm and the efficient use of fixed

assets the liquid position of the firm must be strong. But a very high degree of

liquidity of the firm being tied – up in current assets. Therefore, it is important

proper balance in regard to the liquidity of the firm. Two types of ratios can be
calculated for measuring short-term financial position or short-term solvency

position of the firm.

1. Liquidity ratios.

2. Current assets movements ‘ratios.

A) LIQUIDITY RATIOS

Liquidity refers to the ability of a firm to meet its current obligations as and when

these become due. The short-term obligations are met by realizing amounts from

current, floating or circulating assts. The current assets should either be liquid or

near about liquidity. These should be convertible in cash for paying obligations of

short-term nature. The sufficiency or insufficiency of current assets should be

assessed by comparing them with short-term liabilities. If current assets can pay off

the current liabilities then the liquidity position is satisfactory. On the other hand, if

the current liabilities cannot be met out of the current assets then the liquidity

position is bad. To measure the liquidity of a firm, the following ratios can be

calculated:
1. CURRENT RATIO

2. QUICK RATIO

3. ABSOLUTE LIQUID RATIO

1. CURRENT RATIO

Current Ratio, also known as working capital ratio is a measure of general liquidity

and its most widely used to make the analysis of short-term financial position or

liquidity of a firm. It is defined as the relation between current assets and current

liabilities. Thus,

CURRENT RATIO = CURRENT ASSETS

CURRENT LIABILITES
The two components of this ratio are:

1) CURRENT ASSETS

2) CURRENT LIABILITES

Current assets include cash, marketable securities, bill receivables, sundry debtors,

inventories and work-in-progresses. Current liabilities include outstanding expenses,

bill payable, dividend payable etc.

A relatively high current ratio is an indication that the firm is liquid and has the

ability to pay its current obligations in time. On the hand a low current ratio

represents that the liquidity position of the firm is not good and the firm shall not be

able to pay its current liabilities in time. A ratio equal or near to the rule of thumb of

2:1 i.e. current assets double the current liabilities is considered to be satisfactory.

CALCULATION OF CURRENT RATIO

 (Rupees in crore)

e.g.

Year

2006

2007

2008

Current Assets

81.29

83.12

13,6.57

Current Liabilities

27.42

20.58
33.48

Current Ratio

2.96:1

4.03:1

4.08:1

Interpretation:-

As we know that ideal current ratio for any firm is 2:1. If we see the current ratio of

the company for last three years it has increased from 2006 to 2008. The current

ratio of company is more than the ideal ratio. This depicts that company’s liquidity

position is sound. Its current assets are more than its current liabilities.

2. QUICK RATIO

Quick ratio is a more rigorous test of liquidity than current ratio. Quick ratio may be

defined as the relationship between quick/liquid assets and current or liquid

liabilities. An asset is said to be liquid if it can be converted into cash with a short
period without loss of value. It measures the firms’ capacity to pay off current

obligations immediately.

QUICK RATIO = QUICK ASSETS

CURRENT LIABILITES

Where Quick Assets are:

1) Marketable Securities

2) Cash in hand and Cash at bank.

3) Debtors.

A high ratio is an indication that the firm is liquid and has the ability to meet its

current liabilities in time and on the other hand a low quick ratio represents that the

firms’ liquidity position is not good.

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

if quick assets are equal to the current liabilities then the concern may be able to

meet its short-term obligations. However, a firm having high quick ratio may not

have a satisfactory liquidity position if it has slow paying debtors. On the other

hand, a firm having a low liquidity position if it has fast moving inventories.

CALCULATION OF QUICK RATIO

e.g. (Rupees in Crore)

Year

2006

2007

2008

Quick Assets

44.14

47.43

61.55
Current Liabilities

27.42

20.58

33.48

Quick Ratio

1.6 : 1

2.3 : 1

1.8 : 1

Interpretation :

A quick ratio is an indication that the firm is liquid and has the ability to meet

its current liabilities in time. The ideal quick ratio is 1:1. Company’s quick ratio is

more than ideal ratio. This shows company has no liquidity problem.

3. absolute liquid ratio

Although receivables, debtors and bills receivable are generally more liquid than

inventories, yet there may be doubts regarding their realization into cash

immediately or in time. So absolute liquid ratio should be calculated together with

current ratio and acid test ratio so as to exclude even receivables from the current

assets and find out the absolute liquid assets. Absolute Liquid Assets includes :

Absolute liquid ratio = absolute liquid assets

CURRENT LIABILITES

Absolute liquid assets = cash & bank balances.

e.g. (Rupees in Crore)

Year

2006

2007

2008
Absolute Liquid Assets

4.69

1.79

5.06

Current Liabilities

27.42

20.58

33.48

Absolute Liquid Ratio

.17 : 1

.09 : 1

.15 : 1

Interpretation :
 These ratio shows that company carries a small amount of cash. But there is

nothing to be worried about the lack of cash because company has reserve,

borrowing power & long term investment. In India, firms have credit limits

sanctioned from banks and can easily draw cash.

B) current assets movement ratios

Funds are invested in various assets in business to make sales and earn profits. The

efficiency with which assets are managed directly affects the volume of sales. The

better the management of assets, large is the amount of sales and profits. Current

assets movement ratios measure the efficiency with which a firm manages its

resources. These ratios are called turnover ratios because they indicate the speed

with which assets are converted or turned over into sales. Depending upon the

purpose, a number of turnover ratios can be calculated. These are :

1. Inventory Turnover Ratio

2. Debtors Turnover Ratio

3. Creditors Turnover Ratio

4. Working Capital Turnover Ratio

The current ratio and quick ratio give misleading results if current assets include

high amount of debtors due to slow credit collections and moreover if the assets

include high amount of slow moving inventories. As both the ratios ignore the

movement of current assets, it is important to calculate the turnover ratio.

1. Inventory Turnover or Stock Turnover Ratio :

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

meet the requirements of the business. But the level of inventory should neither be

too high nor too low. Because it is harmful to hold more inventory as some amount

of capital is blocked in it and some cost is involved in it. It will therefore be

advisable to dispose the inventory as soon as possible.

inventory turnover ratio = cost of good sold

Average inventory
Inventory turnover ratio measures the speed with which the stock is converted into

sales. Usually a high inventory ratio indicates an efficient management of inventory

because more frequently the stocks are sold ; the lesser amount of money is

required to finance the inventory. Where as low inventory turnover ratio indicates

the inefficient management of inventory. A low inventory turnover implies over

investment in inventories, dull business, poor quality of goods, stock accumulations

and slow moving goods and low profits as compared to total investment.

average stock = opening stock + closing stock

(Rupees in Crore)

Year

2006

2007

2008

Cost of Goods sold

110.6

103.2

96.8

Average Stock

73.59

36.42

55.35

Inventory Turnover Ratio

1.5 times

2.8 times

1.75 times

Interpretation :

These ratio shows how rapidly the inventory is turning into receivable through

sales. In 2007 the company has high inventory turnover ratio but in 2008 it has
reduced to 1.75 times. This shows that the company’s inventory management

technique is less efficient as compare to last year.

2. Inventory conversion period:

Inventory conversion period = 365 (net working days)

inventory turnover ratio

e.g.

Year

2006

2007

2008

Days

365

365
365

Inventory Turnover Ratio

1.5

2.8

1.8

Inventory Conversion Period

243 days

130 days

202 days

Interpretation :

Inventory conversion period shows that how many days inventories takes to

convert from raw material to finished goods. In the company inventory conversion

period is decreasing. This shows the efficiency of management to convert the

inventory into cash.

3. debtors turnover ratio :

A concern may sell its goods on cash as well as on credit to increase its sales and a

liberal credit policy may result in tying up substantial funds of a firm in the form of

trade debtors. Trade debtors are expected to be converted into cash within a short

period and are included in current assets. So liquidity position of a concern also

depends upon the quality of trade debtors. Two types of ratio can be calculated to

evaluate the quality of debtors.

a) Debtors Turnover Ratio

b) Average Collection Period

Debtors Turnover Ratio = Total Sales (Credit)

Average Debtors

Debtor’s velocity indicates the number of times the debtors are turned over during

a year. Generally higher the value of debtor’s turnover ratio the more efficient is the
management of debtors/sales or more liquid are the debtors. Whereas a low debtors

turnover ratio indicates poor management of debtors/sales and less liquid debtors.

This ratio should be compared with ratios of other firms doing the same business

and a trend may be found to make a better interpretation of the ratio.

average debtors= opening debtor+closing debtor

e.g.

Year

2006

2007

2008

Sales
166.0

151.5

169.5

Average Debtors

17.33

18.19

22.50

Debtor Turnover Ratio

9.6 times

8.3 times

7.5 times

Interpretation :

This ratio indicates the speed with which debtors are being converted or

turnover into sales. The higher the values or turnover into sales. The higher the
values of debtors turnover, the more efficient is the management of credit. But in

the company the debtor turnover ratio is decreasing year to year. This shows that

company is not utilizing its debtors efficiency. Now their credit policy become liberal

as compare to previous year.

4. average collection period :

Average Collection Period = No. of Working Days

Debtors Turnover Ratio

The average collection period ratio represents the average number of days for

which a firm has to wait before its receivables are converted into cash. It measures

the quality of debtors. Generally, shorter the average collection period the better is

the quality of debtors as a short collection period implies quick payment by debtors

and vice-versa.

Average Collection Period = 365 (Net Working Days)

Debtors Turnover Ratio

Year

2006

2007

2008

Days

365

365

365

Debtor Turnover Ratio

9.6

8.3

7.5

Average Collection Period

38 days
44 days

49 days

Interpretation :

The average collection period measures the quality of debtors and it helps in

analyzing the efficiency of collection efforts. It also helps to analysis the credit

policy adopted by company. In the firm average collection period increasing year to

year. It shows that the firm has Liberal Credit policy. These changes in policy are

due to competitor’s credit policy.

5. Working capital turnover ratio :

Working capital turnover ratio indicates the velocity of utilization of net working

capital. This ratio indicates the number of times the working capital is turned over in

the course of the year. This ratio measures the efficiency with which the working

capital is used by the firm. A higher ratio indicates efficient utilization of working

capital and a low ratio indicates otherwise. But a very high working capital turnover

is not a good situation for any firm.

Working Capital Turnover Ratio = Cost of Sales

Net Working Capital

Working Capital Turnover = Sales

Networking Capital

e.g.

Year

2006

2007

2008
Sales

166.0

151.5

169.5

Networking Capital

53.87

62.52

103.09

Working Capital Turnover

3.08

2.4

1.64

Interpretation :
 This ratio indicates low much net working capital requires for sales. In 2008,

the reciprocal of this ratio (1/1.64 = .609) shows that for sales of Rs. 1 the company

requires 60 paisa as working capital. Thus this ratio is helpful to forecast the

working capital requirement on the basis of sale.

Inventories

(Rs. in Crores)

Year

2005-2006

2006-2007

2007-2008

Inventories

37.15

35.69

75.01
Interpretation :

Inventories is a major part of current assets. If any company wants to manage

its working capital efficiency, it has to manage its inventories efficiently. The graph

shows that inventory in 2005-2006 is 45%, in 2006-2007 is 43% and in 2007-2008 is

54% of their current assets. The company should try to reduce the inventory upto

10% or 20% of current assets.

Cash bnak balance :

(Rs. in Crores)

Year

2005-2006

2006-2007

2007-2008
Cash Bank Balance

4.69

1.79

5.05

Interpretation :

Cash is basic input or component of working capital. Cash is needed to keep the

business running on a continuous basis. So the organization should have sufficient

cash to meet various requirements. The above graph is indicate that in 2006 the

cash is 4.69 crores but in 2007 it has decrease to 1.79. The result of that it disturb

the firms manufacturing operations. In 2008, it is increased upto approx. 5.1% cash

balance. So in 2008, the company has no problem for meeting its requirement as

compare to 2007.

debtors :

(Rs. in Crores)
Year

2005-2006

2006-2007

2007-2008

Debtors

17.33

19.05

25.94

Interpretation :

Debtors constitute a substantial portion of total current assets. In India it

constitute one third of current assets. The above graph is depict that there is

increase in debtors. It represents an extension of credit to customers. The reason

for increasing credit is competition and company liberal credit policy.

current assets :

(Rs. in Crores)

Year

2005-2006

2006-2007

2007-2008

Current Assets

81.29

83.15

136.57

Interpretation :
 This graph shows that there is 64% increase in current assets in 2008. This

increase is arise because there is approx. 50% increase in inventories. Increase in

current assets shows the liquidity soundness of company.

current liability :

(Rs. in Crores)

Year

2005-2006

2006-2007

2007-2008

Current Liability

27.42

20.58

33.48
Interpretation :

Current liabilities shows company short term debts pay to outsiders. In 2008

the current liabilities of the company increased. But still increase in current assets

are more than its current liabilities.

net wokring capital :

(Rs. in Crores)

Year

2005-2006

2006-2007

2007-2008
Net Working Capital

53.87

62.53

103.09

Interpretation :

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

should be an optimum level of working capital. It should not be too less or not too

excess. In the company there is increase in working capital. The increase in working

capital arises because the company has expanded its business.

RESEARCH METHODOLOGY

The methodology, I have adopted for my study is the various tools, which basically

analyze critically financial position of to the organization:

 I. COMMON-SIZE P/L A/C

II. COMMON-SIZE BALANCE SHEET

III. COMPARTIVE P/L A/C

IV. COMPARTIVE BALANCE SHEET

V. TREND ANALYSIS

VI. RATIO ANALYSIS

The above parameters are used for critical analysis of financial position. With the

evaluation of each component, the financial position from different angles is tried to

be presented in well and systematic manner. By critical analysis with the help of

different tools, it becomes clear how the financial manager handles the finance
matters in profitable manner in the critical challenging atmosphere, the

recommendation are made which would suggest the organization in formulation of a

healthy and strong position financially with proper management system.

I sincerely hope, through the evaluation of various percentage, ratios and

comparative analysis, the organization would be able to conquer its in efficiencies

and makes the desired changes.

ANALYSIS OF FINANCIAL STATEMENTS

FINANCIAL STATEMENTS:

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

consistent accounting procedure to convey an under-standing of some financial

aspects of a business firm. It may show position at a moment in time, as in the case

of balance sheet or may reveal a series of activities over a given period of time, as
in the case of an income statement. Thus, the term ‘financial statements’ generally

refers to the two statements

(1) The position statement or Balance sheet.

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

OBJECTIVES OF FINANCIAL STATEMENTS:

According to accounting Principal Board of America (APB) states

The following objectives of financial statements: -

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

of a business firm.

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

and obligation.
3. To provide reliable information about change in net resources (recourses less

obligations) missing out of business activities.

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

the business.

LIMITATIONS OF FINANCIAL STATEMENTS:

Though financial statements are relevant and useful for a concern, still they do not

present a final picture a final picture of a concern. The utility of these statements is

dependent upon a number of factors. The analysis and interpretation of these

statements must be done carefully otherwise misleading conclusion may be drawn.

Financial statements suffer from the following limitations: -

1. Financial statements do not given a final picture of the concern. The data given in

these statements is only approximate. The actual value can only be determined

when the business is sold or liquidated.

2. Financial statements have been prepared for different accounting periods,

generally one year, during the life of a concern. The costs and incomes are
apportioned to different periods with a view to determine profits etc. The allocation

of expenses and income depends upon the personal judgment of the accountant.

The existence of contingent assets and liabilities also make the statements

imprecise. So financial statement are at the most interim reports rather than the

final picture of the firm.

3. The financial statements are expressed in monetary value, so they appear to give

final and accurate position. The value of fixed assets in the balance sheet neither

represent the value for which fixed assets can be sold nor the amount which will be

required to replace these assets. The balance sheet is prepared on the presumption

of a going concern. The concern is expected to continue in future. So fixed assets

are shown at cost less accumulated deprecation. Moreover, there are certain assets

in the balance sheet which will realize nothing at the time of liquidation but they are

shown in the balance sheets.

4. The financial statements are prepared on the basis of historical costs Or original

costs. The value of assets decreases with the passage of time current price changes

are not taken into account. The statement are not prepared with the keeping in

view the economic conditions. the balance sheet loses the significance of being an

index of current economics realities. Similarly, the profitability shown by the income

statements may be represent the earning capacity of the concern.

5. There are certain factors which have a bearing on the financial position and

operating result of the business but they do not become a part of these statements

because they cannot be measured in monetary terms. The basic limitation of the

traditional financial statements comprising the balance sheet, profit & loss A/c is

that they do not give all the information regarding the financial operation of the

firm. Nevertheless, they provide some extremely useful information to the extent

the balance sheet mirrors the financial position on a particular data in lines of the

structure of assets, liabilities etc. and the profit & loss A/c shows the result of

operation during a certain period in terms revenue obtained and cost incurred

during the year. Thus, the financial position and operation of the firm.

FINANCIAL STATEMENT ANALYSIS

It is the process of identifying the financial strength and weakness of a firm from

the available accounting data and financial statements. The analysis is done

CALCULATIONS OF RATIOS

Ratios are relationship expressed in mathematical terms between figures, which are

connected with each other in some manner.

CLASSIFICATION OF RATIOS

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

classification

The traditional classification has been on the basis of the financial statement to

which the determination of ratios belongs.

These are:-

· Profit & Loss account ratios

· Balance Sheet ratios

· Composite ratios
Project Description :

Title : Working Capital Management of ____________

Pages : 73

Category : Project Report for MBA

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