CHAPTER 7 WORKING CAPITAL MANAGEMENT

WORKING CAPITAL MANAGEMENT

Introduction

The life blood of business, as is evident, signified funds required for day-to-day operations of the firm. The management of working capital assumes great importance because shortage of working capital funds is perhaps the biggest possible cause of failure of many business units in recent times. There it is of great importance on the part of management to pay particular attention to the planning and control for working capital. An attempt has been made to make critical study of the various dimensions of the working capital management of GROUP. KAPLAN

Meaning of Working Capital

Working capital refers to that part of firms capital, which is required for financing short term or current assets such as cash, marketable securities, debtors and inventories.

Every business needs investment to procure fixed assets, which remain in use for a longer period. Money invested in these assets is called Long term Funds or Fixed Capital. Business also needs funds for short-term purposes to finance current operations. Investment in short term assets like cash, inventories, debtors etc., is called Short-term Funds or Working Capital. The Working Capital can be categorized, as funds needed for carrying out day-to-day operations of the business smoothly. The management of the working capital is equally important as the management of long-term financial investment.

Every running business needs working capital. Even a business which is fully equipped with all types of fixed assets required is bound to collapse without o adequate supply of raw materials for processing; o cash to pay for wages, power and other costs; o creating a stock of finished goods to feed the market demand regularly; and, o The ability to grant credit to its customers.

All these require working capital. Working capital is thus like the lifeblood of a business. The business will not be able to carry on day-today activities without the availability of adequate working capital.

Working capital cycle involves conversions and rotation of various constituents. Components of the working capital initially cash are converted into raw materials. Subsequently, with the usage of fixed assets resulting in value additions, the raw materials get converted into work in process and then into finished goods. When sold on credit, the finished goods assume the form of debtors who give the business cash on due date. Thus cash assumes its original form again at the end of one such working capital cycle but in the course it passes through various other forms of current assets too. This is how various components of current assets keep on changing their forms due to value addition. As a result, they rotate and business operations continue. Thus, the working capital cycle involves rotation of various constituents of the working capital.

While managing the working capital, two characteristics of current assets should be kept in mind viz. (I) short life span, and (ii) swift transformation into other form of current asset.

Each constituent of current asset has comparatively very short life span. Investment remains in a particular form of current asset for a short period. The life span of current assets depends upon the time required in the activities of procurement; production, sales and collection and degree of synchronization among them. A very short life span of current assets results into swift transformation into other form of current assets for a running business.

CLASIFICATION OF WORKING CAPITAL

KINDS OF WORKING CAPITAL

ON THE BASIS OF CONCEPT

ON THE BASIS OF TIME

GROSS WORKING CAPITAL

NET WORKING CAPITAL

PERMANENT OR FIXED WORKING CAPITAL (MINIMUM AMOUNT ALWAYS REQUIRED)

TEMPORARY OR VARIABLE WORKING CAPITAL

SPECIAL W.C. SEASONAL W.C. (SEASONAL DEMAND) (SPECIAL DEMANDS LIKE RESEARCH)

RESEARCH)

ON THE BASIS OF CONCEPT

On the basis of concept working capital may be divided into two parts i.e.

A) Gross working capital: Gross working capital is the capital invested in

total current assets of the enterprise.

B) Net working capital: Net working capital is the excess of current

assets over current liabilities, so,
Net working capital = current assets current liabilities

Gross working capital is the total of all current assets. Net working capital is the difference between current assets and current liabilities. Though the later concept of working capital is commonly used it is an accounting concept with little sense to say that a firm manages its net working capital. What a firm really does is to take decisions with respect to various current assets and current liabilities.

ON THE BASIS OF TIME

It may be classified as:

A) Permanent or fixed working capital: It is the minimum amount,
which is required to ensure effective utilization of fixed facilities and for maintaining the circulation of current assets. There is always a minimum level of current assets, which is continuously required by the enterprise to carry out its normal business operations. For Example: every firm has to maintain a minimum level of raw materials, work in process, finished goods and cash balance. This minimum level of current assets is called permanent or fixed working capital as this part of capital is permanently blocked in current assets. As a business grows, the requirements of permanent working capital also increase due to the increase in current assets. It can be further divided into two parts:

Regular working capital: It is that part of the working capital which is

required to ensure the circulation of current assets from cash to inventories, from inventories to receivables and from receivables to cash and so on.

Reserve working capital: It is the excess amount over the requirement

for regular working capital, which may be provided for contingencies that may arise at unstated periods such as strikes, rise in prices, depression.

B) Temporary or variable working capital: It is the amount of

working capital, which is required to meet the seasonal demands and some special exigencies. Variable working capital can be further divided into two:

Seasonal working capital: It is that part of the working capital, which is

required to meet the seasonal needs of the enterprise.

Special working capital: It is that part of the working capital which is

required to meet special exigencies such as launching of extensive marketing campaigns for conducting research,

Importance or advantages adequate of working capital

Solvency of business: Adequate working capital helps in maintaining

the solvency of the business by providing uninterrupted of production.

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

prompt payments and makes and maintains the goodwill.

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

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

 Cash discounts: Adequate working capital also enables a concern to

avail cash discounts on the purchases and hence reduces cost.

Regular supply of raw material: Sufficient working capital ensures

regular supply of raw material and continuous production.

Regular

payment of salaries, wages and other day-to-day

commitments: 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.
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.
Ability to face crisis: A concern can face the situation during the

depression.
Quick and regular return on investment: Sufficient working capital

enables a concern to pay quick and regular of dividends to its investors and gains confidence of the investor and can raise more funds in future.
High morale: Adequate working capital brings an environment of

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

DISADVANTAGES OF REDUNDANT OR EXCESSIVE WORKING CAPITAL

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. Redundant working capital leads to unnecessary purchasing and accumulation of inventories.
Excessive working capital implies excessive debtors and defective credit

policy which causes higher incidence of bad debts. It may reduce the overall efficiency of the business. If a firm is having excessive working capital then the relations with banks and other financial institution may not be maintained. Due to lower rate of return on investments, the values of shares may also fall. 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 are time gaps in purchase of raw material and production; production and sales; and realization of cash. Thus at the end our production process will stop due to inadequate of working capital.

FACTORS AFFECTING THE REQUIREMENT OF WORKING CAPITAL

Size of business: This is very clear that if there is any big concern
means it need maximum of working capital to run the business smoothly but the requirement of working capital will be reduced if we will reduced the size of business as we do not have the sufficient long operating cycle to invest the higher rate of working capital.

Seasonal operation: The seasonal operation also effect on the

requirement of working capital because the sale can be increased or decreased if they is any concern which is manufacturing the seasonal goods.

Example: If any manufacturing unit which is producing garments

requires less amount of working capital during the summer season but on the other hand in the winters they require more working capital to produce the woolen clothes.

Credit policy:

This policy normally takes an important place to impact on

the requirement of working capital means any company having a good credit policy for a shorter period may required the less working capital on the other hand the lenient credit policy may generate the risk of doubtful debts. In this case the company requires more working capital during this period this takes place to convert the credit into cash.

Marketable competition:

As per the present synergic of the market

we can find the toughest competition between every two company which are dealing with the same time of product to reduce the competitiveness and to win the gain the company gives or provides the some special offers to the buyer and to the seller and these offers are not related with the operating cycle of the company so the company needs exist amount of working capital to manage the amount of these offers.

Growth and expansion:

As for as the growth and expansion is

concerned it is very clear it will increase the size of business we require some extra money for this purpose. In the same condition if any company going to launch a new product they again r4equired exist amount of working capital to complete the operating cycle of that particular product. The increment in the size is known as growth and the establishment in the new sector or segment is called expansion.

Shortage of raw material:

The requirement of working capital is

also depends on the availability of the raw material in the market. At the time of shortage of raw material the price may also be high due to higher demand and less availability in this case the firm has to purchase the raw material on higher price and required some extra amount for the increment of cost. It means the company has to invest more money for purchasing.

Dividend policy:

This factor is important because it is directly impact on

the financial position of the firm because the higher dividend rate makes the company enable to get a strong position in the market. So to fulfill the requirement of the dividend the company may use the retained earnings or profit or they have to generate the funds for dividend from other sources. So this will impact on the operating cycle as well as these will degrees the cash balance of the company, which the company is used to fulfill requirement of temporary working capital.

Depreciation policy:

Depreciation policy also is treated as a source of

working capital because we can use the depreciation funds for the timing of fulfills the requirement of temporary working capital. If the company is not maintaining the depreciation policy in this case the company has to generate the funds from the long term sources or any other source which can be increase the liability of the firm.

Business Cycle: Business Cycle refers to alternate expansion and

contraction in general business activities. In a period of born i.e. when the business is prosperous there is a need for larger amount of working capital due to increase in sales, rise in prices, optimistic expansion of business etc. On the country at the time of depression i.e. when there is a down swing of the cycle, business contracts, sales decline, difficulties are faced in collections from debtors and firms may have a large amount of working capital lying ideal.

Earning Capacity and Dividend policy: Some firms have

more earning capacity than others due to the quality of their products, monopoly conditions etc. Such firms with high earning capacity may generate cash profits from operations and contribute to their capital. The dividend policy of a concern also influences the requirements of the working capital. A firm that maintains steady high rate of cash dividend irrespective of its generation of profits needs more capital than the firm retains larger part of its profits and does not pay high rate of cash dividend.

Price level Changes: Changes in the price level also affect the
working capital requirements. Generally rise in prices leads to increase in working capital.

Other Factors

Operating efficiency. Irregularities a supply.

o Management ability.
o

o Import policy, asset structure. o Importance of labor.

o

Banking facilities, etc. also influences the requirement of working capital.

Important Terms

Working Capital Cycle

Cash flows in a cycle into, around and out of a business. It is the business's life blood and every manager's primary task is to help keep it flowing and to use the cash flow to generate profits. If a business is operating profitably, then it should, in theory, generate cash surpluses. If it doesn't generate surpluses, the business will eventually run out of cash and expire. The faster a business expands the more cash it will need for working capital and investment. The cheapest and best sources of cash exist as working capital right within business. Good management of working capital will generate cash will help improve profits and reduce risks. Bear in mind that the cost of providing credit to customers and

holding stocks can represent a substantial proportion of a firm's total profits. There are two elements in the business cycle that absorb cash Inventory (stocks and work-in-progress) and Receivables (debtors owing you money). The main sources of cash are Payables (your creditors) and Equity and Loans.

Each component of working capital (namely inventory, receivables and payables) has two dimensions TIME and MONEY. If you can get money to move faster around the cycle (e.g. collect monies due from debtors more quickly) or reduce the amount of money tied up (e.g. reduce inventory levels relative to sales), the business will generate more cash or it will need to borrow less money to fund working capital. As a consequence, you could reduce the cost of bank interest or you'll have additional free money available to support additional sales growth or investment. Similarly, if you can negotiate improved terms with suppliers e.g. get longer credit or an increased credit limit; you effectively create free finance to help fund future sales.

 If you....... Collect receivables (debtors) faster Collect receivables (debtors) slower Get better credit (in terms of duration or amount) from suppliers Shift inventory (stocks) faster Move inventory (stocks) slower

Then...... You release cash from the cycle Your receivables soak up cash You increase your cash resources You free up cash You consume more cash

It can be tempting to pay cash, if available, for fixed assets e.g. computers, plant, vehicles etc. If you do pay cash, remember that this is now longer available for working capital. Therefore, if cash is tight, consider other ways of financing capital investment - loans, equity, leasing etc. Similarly, if you pay dividends or increase drawings, these are cash outflows and, like water flowing downs a plug hole, they remove liquidity from the business. More businesses fail for lack of cash than for want of profit.

The following Debtors:

measures

will

help

manage

your

o Have the right mental attitude to the control of credit and make sure that it gets the priority it deserves. o Establish clear credit practices as a matter of company policy. o Make sure that these practices are clearly understood by staff, suppliers and customers. o Be professional when accepting new accounts, and especially larger ones. o Check out each customer thoroughly before you offer credit. Use credit agencies, bank references, industry sources etc. o Establish credit limits for each customer... and stick to them.

o Continuously review these limits when you suspect tough times are coming or if operating in a volatile sector. o Keep very close to your larger customers. o Invoice promptly and clearly. o Consider charging penalties on overdue accounts. o Consider accepting credit /debit cards as a payment option. o Monitor your debtor balances and ageing schedules, and don't let any debts get too large or too old.

Profits only come from paid sales.

Managing Payables (Creditors)

Creditors are a vital part of effective cash management and should be managed carefully to enhance the cash position. Purchasing initiates cash outflows and an over-zealous purchasing function can create liquidity problems. Consider the following: o Who authorizes purchasing in your company - is it tightly managed or spread among a number of (junior) people? o Are purchase quantities geared to demand forecasts?

o Do you use order quantities which take account of stock-holding and purchasing costs? o Do you know the cost to the company of carrying stock? o Do you have alternative sources of supply? If not, get quotes from major suppliers and shop around for the best discounts, credit terms, and reduce dependence on a single supplier. o How many of your suppliers have a returns policy? o Are you in a position to pass on cost increases quickly through price increases to your customers? o If a supplier of goods or services lets you down can you charge back the cost of the delay? o Can you arrange (with confidence!) to have delivery of supplies staggered or on a just-in-time basis?

There is an old adage in business that if you can buy well then you can sell well. Management of your creditors and suppliers is just as important as the management of your debtors. It is important to look after your creditors - slow payment by you may create ill-feeling and can signal that your company is inefficient (or in trouble!).

[Remember, a good supplier is someone who will work with you to enhance the future viability and profitability of your company]

CHAPTER 8 ANALYSIS OF WORKING CAPITAL

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.

A) LIQUIDITY RATIOS.
B)

CURRENT ASSETS MOVEMEMT RATIOS.

A)
I.

LIQUIDITY RATIO:Liquidity ratio means the firms ability to meet current obligations. These ratios indicating the position of liquidity. They are computed to ascertain whether the company is capable of meeting its short term obligation from its short term resources. For example: Current ratio shows the capacity of a firm to meet it current liabilities, they nature the important liquidity ratio are, Current ratio, Quick ratio and Absolute Liquid ratio.

II. III. IV.

Current ratio. Quick ratio. Absolute Liquid ratio.

1) CURRENT RATIO:This ratio shows the proposition of current assets to current liabilities it is a measures of known as working capital s it is a measure of working capital available at a particular time. The ratio is obtained by dividing current assets by current liabilities. CURRENT RATIO = CURRENT ASSETS

CURRENT LIABLITES o Current assets include cash balance, bank balance, debtors, bills receivable of can be area reality converted into cash with short time. o Current liabilities include creditors, bills payable, bank overdraft outstanding expenses, provision for tax etc.

CURRENT RATIO OF KAPLAN GROUP.

e.g. (Rupees in crore) Year Current Assets Current Liabilities Current Ratio 2009 81.29 27.42 2.96 : 1 2010 83.12 20.58 4.03 : 1 2011 13,6.57 33.48 4.08 : 1

Interpretation:As we know that ideal current ratio for any firm is 2 : 1. If we see the current ratio of company for last three years it has increased from 2009 to 2011. The current ratio of company is more than the ideal ratio. This depicts that companys liquidity position is sound. Its current assets are more than its current liabilities.

2)

QUICK RATIO:Quick asset are the one which are relatively liquid and includes receivable market securities cash is one of the most important quick assets inventories are to be reduced from current assets. Generally a

quick ratio is in general a norm is 01:01 it considers to be better. Quick ratio is found out by dividing quick assets and current liabilities. QUICK TATIO= QUICK ASSETS CURRENT LIABLITES Where Quick Assets are: 1. Marketable Securities. 2. Cash in hand and Cash at bank. 3. Debtors.

QUICK RATIO OF KAPLAN GROUP.

e.g.

(Rupees in crore) Year Current Assets Current Liabilities Current Ratio 2009 44.14 27.42 1.6 : 1 2010 47.43 20.58 2.3 : 1 2011 61.55 33.48 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 liquidity problem.

3)

ABSOLUTE LIQUID RATIO:Although receivables, debtors and bills receivables are generally

more liquid than inventories, yet there may be doubts regarding their realization in to 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 RATIO CURRENT LIABLITES ABSOLUTE LIQUID RATIO = CASH & BANK BALANCES.

ABSOLUTE LIQUID RATIO OF KAPLAN GROUP.

e.g.

(Rupees in crore) Year Absolute Liquid assets Current liabilities Absolute Liquid ratio 2009 4.69 27.42 17 : 1 2010 1.79 20.58 09 : 1 2011 5.06 33.48 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.

CURRENT ASSESTS 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 other 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 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 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 RATIO:

TURNOVER

OR

STOCK

TURNOVER

Every 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 = INVENTORY

COST OF GOOD SOLD AVERAGE

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 frequency the stocks are sold; the lesser amount of money is required to finance the inventory. Whereas 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.

CALCULATION OF INVENTORY TURNOVER RATIO e.g.

(Rupees in crore) Year Cost of Good sold Average Stock Inventory Turnover Ratio 2009 110.6 73.59 1.5 times 2010 103.2 36.42 2.8 times 2011 96.8 55.35 1.75 times

Interpretation:
This Ratio shows how rapidly the inventory is turning into receivable through sales. In 2010 the company has high inventory turnover ratio but in 2011 it has reduced to 1.75 times. This shows that the companys inventory management technique is less efficient as compare to last year.

2) 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 the 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

Debtors velocity indicates the number of times the debtors are turned over during a year. Generally higher the value of debtors turnovers 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 DEBTORS + CLOSING DEBTORS 2

CALCULATION OF DEBTORS TURNOVER RATIO e.g.

(Rupees in crore) Year Sales Average Debtors Debtors Turnover Ratio 2009 166.0 17.33 9.6 times 2010 151.5 18.19 8.3 times 2011 22.50 22.50 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 becomes liberal as compared to previous years.

CHAPTER 9

SWOT ANALYSIS

 SWOT Analysis:STRENGTH:

WEAKENESS:

OPPORTUNITY:

THREATS:

SUGGESTION

SUGGESTION
After undergone training for a limited period in KAPLAN GROUP, I found during my training some suggestions but these suggestions merely my own opinion. I hope these suggestions will help at least to some extent if implemented. Following are the suggestions that are based on my observations of the different departments of the company:

1. Company is having huge loans which results in the financial expenses, so proper strategies and techniques of budgeting should be used which results in the proper utilization of borrowed money. 2. Company should use Management Information System (MIS) as it provides very effective information, which ultimately helps in decision-making. This results in the proper future projections effectively.
3. To increase in their net profit. Effective efforts should be taken for this the

company must reduce indirect expenses and to control unnecessary costs. 4. Company should install modernized equipments and machines in the production plants and new techniques should also be used to produce. 5. Improve co-operation and co-ordination among the departments. 6. Proper market survey should be conducted to know consumers/dealers buying behavior.
7. KAPLAN GROUP needs to improve a lot in advertisements. Advertisements

are the best way to enhance the sales and ultimately the revenues. But the company is not able to advertise its products properly, due to which the customer is unaware of any brand that comes from KAPLAN GROUP. It is a common saying that out of sight is out of mind. Therefore the company must make attempts to use proper advertising media so as to set their brands in the minds of the consumers. It should be more consumers oriented rather than being customer oriented.

CONCLUSION

CONCLUSION
After studying the components of working capital management of KAPLAN GROUP. It is found that the company has a sound and effective policy and its performance is very good even in this bad recession situation company has managed to post good profit. Company is competing well at the domestic as well as the international level because of its proper management of finance, specially the short term finance known as the working capital. The company is a matured one and it has contributed well in the countries growth and development and will also continue to perform and contribute to the whole nation. In conclusion, we can say that the Companies management is an effective one and knows well the management of finance, its working capital management system is very good because of which only the company has got the status.

BIBLIOGRAPHY

BIBLIOGRAPHY
Records of company.

Prasanna Chandra, Financial Management. I M Pandey, Financial Management.

Company

site.