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WORKING CAPITAL - Meaning of Working Capital
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 firms
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 firms 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.
2.
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)
2)
Bills receivables
3)
Sundry debtors
4)
5)
Raw material
b.
Work in process
c.
d.
Finished goods
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:
2.
3.
Dividends payable.
4.
Bank overdraft.
5.
6.
Bills payable.
7.
Sundry creditors.
2.
3.
It take into consideration of the fact every increase in the funds of the
enterprise would increase its working capital.
4.
out
of
the
permanent
sources
of
funds.
it is the inadequate working capital which is more dangerous from the point
of view of the firm.
DISADVANTAGES OF
WORKING CAPITAL
REDUNDANT
OR
EXCESSIVE
1.
2.
3.
4.
5.
6.
7.
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
REQUIREMENTS
THE
WORKING
CAPITAL
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
RAW MATERIAL
FINISHED GOODS
WORK IN PROGRESS
7.
RATE OF STOCK TURNOVER: There is an inverse corelationship 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.
9.
Operating efficiency.
Management ability.
Irregularities of supply.
Import policy.
Asset structure.
Importance of labor.
2.
3.
Ratio analysis.
2.
3.
Budgeting.
1.
RATIO ANALYSIS
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.
a.
b.
3.
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.
Liquidity ratios.
2.
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
CURRENT RATIO
2.
QUICK RATIO
3.
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 shortterm 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
Year
2011
2012
2013
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
2011 to 2013. The current ratio of company is more than the ideal ratio.
Marketable Securities
2)
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
2011
2012
2013
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. Companys 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 =
e.g.
(Rupees in Crore)
Year
2011
2012
2013
4.69
1.79
5.06
Current Liabilities
27.42
20.58
33.48
.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.
2.
3.
4.
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.
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
2
(Rupees in Crore)
Year
2011
2012
2013
110.6
103.2
96.8
Average Stock
73.59
36.42
55.35
1.5 times
2.8 times
1.75 times
Interpretation :
These ratio shows how rapidly the inventory is turning into
receivable through sales. In 2012 the company has high inventory
turnover ratio but in 2013 it has reduced to 1.75 times. This shows that
the companys inventory management technique is less efficient as
compare to last year.
2.
Year
2011
2012
2013
Days
365
365
365
1.5
2.8
1.8
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.
b)
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
2
e.g.
Year
2011
2012
2013
Sales
166.0
151.5
169.5
Average Debtors
17.33
18.19
22.50
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.
Year
2011
2012
2013
Days
365
365
365
9.6
8.3
7.5
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
competitors credit policy.
5.
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
Sales
Networking Capital
e.g.
Year
2011
2012
2013
Sales
166.0
151.5
169.5
Networking Capital
53.87
62.52
103.09
3.08
2.4
1.64
Interpretation :
This ratio indicates low much net working capital requires
for sales. In 2013, the reciprocal of this ratio (1/1.64 = .609) shows that
for sales of Rs. 1 the company requires 60 paisa as working capital.
Year
Inventories
2010-2011
2011-2012
2012-2013
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 2010-2011 is 45%, in
2011-2012 is 43% and in 2012-2013 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
2010-2011
2011-2012
2012-2013
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
Year
Debtors
2010-2011
2011-2012
2012-2013
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
Current Assets
2010-2011
2011-2012
2012-2013
81.29
83.15
136.57
Interpretation :
This graph shows that there is 64% increase in current assets in
2013. 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
Current Liability
2010-2011
2011-2012
2012-2013
27.42
20.58
33.48
Interpretation :
Current liabilities shows company short term debts pay to outsiders.
In 2013 the current liabilities of the company increased. But still
increase in current assets are more than its current liabilities.
Year
2010-2011
2011-2012
2012-2013
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.
II.
III.
IV.
V.
VI.
TREND ANALYSIS
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
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.
CLASSIFICATION OF RATIOS
These are:
Composite ratios
Project Description :
Title : Project Report on Working Capital Management
Pages : 73