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Working Capital
Working Capital
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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.
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Assets which can convert in to cash within a short period normally one accounting
year.
2) Bills receivables
3) Sundry debtors
a. Raw material
b. Work in process
d. Finished goods
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 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.
3. Dividends payable.
4. Bank overdraft.
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.
3. It take into consideration of the fact every increase in the funds of the
enterprise would increase its working capital.
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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 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.
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$ % Adequate working capital helps in
maintaining the solvency of the business by providing uninterrupted of
production.
ü () (% Adequate working capital leads to high solvency and credit
standing can arrange loans from banks and other on easy and favorable terms.
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+ ((% A concern can face the situation during the
depression.
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.
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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.
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.
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% 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.
43 5
$%Greater the size of the business,
greater is the requirement of working capital.
±3
!% If the policy is to keep production
steady by accumulating inventories it will require higher working capital.
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!% The longer the
manufacturing time the raw material and other supplies have to be carried for
a longer in the process with progressive increment of labor and service costs
before the final product is obtained. So working capital is directly proportional
to the length of the manufacturing process.
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% Generally, during the busy
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!% The speed with which the
working cycle completes one cycle determines the requirements of working
capital. Longer the cycle larger is the requirement of working capital.
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7.
"% There is an inverse co-relationship
between the question of working capital and the velocity or speed with which
the sales are affected. A firm having a high rate of stock turnover wuill needs
lower amt. of working capital as compared to a firm having a low rate of
turnover.
8.
!% A concern that purchases its requirements on credit
and sales its product / services on cash requires lesser amt. of working capital
and vice-versa.
10.
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$ % In faster growing concern, we
shall require large amt. of working capital.
12. " $% Changes in the price level also affect the
working capital requirements. Generally rise in prices leads to increase in
working capital.
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% These are:
â Operating efficiency.
â Management ability.
â Irregularities of supply.
â Import policy.
â Asset structure.
â Importance of labor.
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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.
1. Ratio analysis.
3. Budgeting.
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1. Current ratio.
2. Quick ratio
4. Inventory turnover.
5. Receivables turnover.
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:
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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.
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
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CURRENT LIABILITES
The two components of this ratio are:
1) CURRENT ASSETS
2) CURRENT LIABILITES
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.
(Rupees in crore)
e.g.
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.
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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.
CURRENT LIABILITES
1) Marketable Securities
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.
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.
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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 :
CURRENT LIABILITES
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.
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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 :
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.
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.
(Rupees in Crore)
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.
e.g.
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.
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.
e.g.
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.
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.
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.
Networking Capital
e.g.
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)
Interpretation :
(Rs in Crores)
Interpretation :
DEBTORS :
(Rs in Crores)
Interpretation :
CURRENT ASSETS :
(Rs in Crores)
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 LIABILITA :
(Rs in Crores)
Interpretation :
(Rs in Crores)
Interpretation :
RESEARCH METHODOLOGA
The methodology, I have adopted for my study is the various tools, which basically analyze
critically financial position of to the organization:
V TREND ANALASIS
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
FINANCIAL STATEMENTS:
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.
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.
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.
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:-
h Composite ratios
Project Description :
Title : Working Capital Management of ____________
Pages : 73
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