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Working Capital Management
Working Capital Management
4.1 Introduction
One of the most important day to day function of finance manager is to manage the
working capital. In first chapter we studied that there are two major functions of a
finance manager, one of them being procurement of funds. The function of procurement
of funds can be bifurcated between Procurement of long term funds to purchase fixed
assets etc. and procurement of funds for short term purposes like funding for working
capital. In this chapter we are going to study the methods of estimating, raising and
controlling the working capital.
Working capital refers to the funds that are invested in current assets net of current
liabilities. Current assets include Cash, inventory (stock), debtors, advances and other
current assets. Current assets are required to use fixed assets profitably, for example If
company is not maintaining stock of raw materials, which is a current asset, then there
can be breakdown in production and result into losses. Similarly granting credit period to
customers (resulting into debtors) is absolutely essential to generate higher sales. It is
obvious that certain amount of funds will always be invested in the debtors, raw
materials, work in progress, finished goods and day to day cash requirements. On the
other hand the business will also receive some credit period from its suppliers resulting
into reduction in the funds requirement. However, generally the requirement of funds in
current assets is more than availability of funds from current liabilities.
The term working capital is defined in two different ways
a. Gross working capital The gross working capital refers to investment in all
current assets taken together
b. Net Working capital The term net working capital refers to excess of current
assets over current liabilities.
a. Permanent working capital It also refers to hard core working capital. It is the
minimum level of investment in working capital required at all times by the
business to carry out minimum level of activities.
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Working Capital Management
Permanent and temporary working capital can be elaborated with the help of
diagrams as follows
A
m
o
u
n
t Permanent
of
WC
Time
Or
A
m
o
u
n
t Permanent
of
WC
Time
Every Business need funds for its day to day operations. Adequacy of funds will ensure
smooth running of such day to day operations. A Finance manager has to ensure the
smooth running of such operations by arranging adequate funds to the business and
simultaneously ensuring that the funds arranged are not excessive and is not resulting
to excessive cost. A very big amount of working capital would mean that the company
has idle funds. Since funds have a cost, the company has to pay large amount as
interest on such funds. Having excess funds, known as over capitalisation, has been a
big reason for sick companies in India
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Working Capital Management
If the firm has inadequate working capital it is termed as under capitalised. Such
firms always have risk of insolvency. This is because shortage of funds may lead to a
situation where the firm may not be able to meet its liabilities. It is interesting to note that
many firms which are otherwise prosperous may fail because of lack of liquidity.
Current ratio (with acid test ratio to support it) has traditionally been considered best
indicator of the working capital situation; current ratio = Current assets / current
liabilities. Academically it is believed that a current ratio of 2 for a manufacturing firm is
ideal ratio i.e current assets = 2 * current liabilities (approx) is considered as ideal.
Another indicator for ideal working capital mix is quick ratio = quick current assets /
current liabilities. Academically it is believed that a quick ratio of 1 for a manufacturing
firm is ideal ratio. The reason to mention it as academic is that practically ideal ratios
vary from industry to industry and should be decided by finance manager for his own
company considering the production process, normal credit terms, location of the
company and customers etc.. An example can be taken of Hero Honda Motors Ltd, a
two wheeler manufacturing company. The company has current ration less than 1 as
company is already utilising its full capacities and due to excessive demand for its
products does not offer any credit period, eliminating debtors and huge turnover of its
products also result into very less finished goods inventory. Here it wont be correct to
say that company is not investing in current assets and hence is losing on profitability,
as the company is able to sell to its full capacity without pilling up stocks and debtors so
for Hero Honda current ratio less than 1 can be considered as ideal. On the other hand
a company who deals in a high credit period industry may have a current ratio of above
3. Here also we cant say that the company is over capitalised and is investing
excessively in its current assets, as the company is just following trend of the industry in
which it is operating. Hence ideal ratio should be determined on basis of facts of each
company and should be compared with the average of the industry in which it operates.
The working capital cycle refers to the length of time between the firms paying cash for
materials, etc., entering into production process and inflow of cash from debtors.
For example Company A buys material worth Rs 5,000 on 1 st January 2004, keeps it
in stock upto 15th January 2004 and then start processing, the material is in process till
31st January 2004. After completing the production it takes one month to sell the product
i.e Finished goods stock is maintained for 1 month and is sold on 2 nd March 2004, it
offers its customer 1 months credit and so recovers the cash only on 31 st March 2004.
Now it is clearly evident here that the investment of Rs 5,000 in materials gets
recovered only after three months and in between it takes various forms of current
assets viz. Cash, Raw materials, work in progress, finished goods, debtors and again
cash. Important point here is that we have only considered material cost and ignored
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Working Capital Management
labour and overheads cost other wise the invested amount will go up. Now consider a
situation where Company A is getting credit period of 1 month, it can be noticed that
though material is purchased on 1 st January 2004, amount of Rs 5,000 is invested only
from 31st of January and now the period of investment is reduced to 2 months.
Cash
Work in progress
Finished goods
The working capital cycle consists of the following events for a manufacturing
company which keeps on repeating
The above formulas are applied to forecast the working capital cycle and can be
compared with other companies in the same industry. The deviation with industry
average shows the efficiencies or inefficiencies of the organisation. For example let
us assume that the average debtors collection period for competitors of company A
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is 15 days and company is offering a credit period of 30 days, then it can be said
that the company A higher risk and is locking excessive funds in current assets.
Problem 4.6.1
From the following information calculate the period of operating cycle of A Ltd. :
Rs.
Solution
= 40,000 / (7,20,000/360)
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= 40,000/2,000
= 20 days
= 25 + 18 + 20 +35 25
= 73 days
Problem 4.6.2
A ltd. has obtained the following data concerning the average working capital cycle
for other companies in the same industry:
Using the following data, calculate the current working capital cycle for A ltd. and
briefly comment on it.
(Rs. In 000)
Sales 500
Cost of production (also cost of goods sold) 210
Average Raw material inventory 8
Average work in progress 9
Average finished goods stock 18
Average debtors 35
Other information -
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Solution
Days (approx.)
1. R = 8 / (60 /360) = 48 days
5. C = 55 days
Operating cycle = R + W + F + D C
Comments
Problem 4.6.3
From the following data, compute the duration of the operating cycle for each of
the two years
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Working Capital Management
Year 1 Year 2
Stock :
Raw Materials 20,000 27,000
Work in progress 14,000 18,000
Finished goods 21,000 24,000
Purchases 96,000 1,35,000
Cost of goods sold 1,40,000 1,80,000
Sales 1,60,000 2,00,000
Debtors 32,000 50,000
Creditors 16,000 18,000
Solution
Year 1 Year 2
Days Days
Debtors [D]:
Year 1 32,000 / (1,60,000 /360) 72
Year 2 50,000 / (2,00,000 /360) 90
Creditors [C]:
Year 1 16,000 / (96,000 /360) 60
Year 2 18,000 / (1,35,000 /360) 48
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In practice working capital cycle is mainly used for comparison with previous periods
and competitors, so that inefficiencies in operations can be pointed out and rectified.
Hence the main purpose of working capital cycle is control. But more essential thing is
perhaps funding for the working capital requirements, which can be done only when
working capital requirements is estimated in terms of money and not days. Banks
providing working capital and short term loans always demand such estimations and
give loan on the basis of such estimations. Such estimations can be done on the basis
of operating cycle. The formulas for estimation of current assets is given below
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Estimated credit sales in units * estimated cost of sales per unit (excluding
depreciation) * average debtors collection period (in months / days)
Estimated production in units * estimated direct labour cost per unit * average
time lag in payment of wages (in months / days)
i. Effect of shift working A company may operate in more than 1 shift in that
case the production is substantially higher. Let us say that for a 2 shift
working production is approx double that of 1 shift working, in such case
current assets like stocks should also get doubled, as daily requirement will
be twice. But in reality it hardly happens and though the stock levels go up it,
it is never in proportion with the production. Though in examination students
should assume the stock levels going up in same proportion as that of
production unless otherwise stated.
Problem 4.8.1
Solution -
Rs.
A Current assets
1. Raw materials = (Cost per unit * production * estimated period
of stock in months) / 12 months
= (50*54,000*1) / 12 2,25,000
Working notes
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Working Capital Management
Rs.
Raw Materials 50
Labour 20
Overheads 30
Total 100
2. Debtors are also valued at same rate as selling expenses are not given.
3. Debtors and finished goods exclude depreciation and profit as they are non-
cash items
Problem 4.8.2
Rs
Raw Material 30
Direct labour 20
Overheads (including depreciation of Rs.10) 20
------
Total Cost 70
Profit 10
------
Selling price 80
------
Solution:
As the annual level of activity is given at 60,000 units, it means that the monthly
turnover would be 60,000 / 12 = 5,000 units
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II Current Liabilities:
Creditors for materials (5000 x 30) 1,50,000
Creditors for Wages (5000 x 20 x 2) 2,00,000
Creditors for Overheads (5000 x 10) 50,000
-------------
Total Current Liabilities 4,00,000
========
Problem 4.8.3
The management of Royal Industries has called for a statement showing the
working capital to finance a level of activity of 1,80,000 units of output for the year.
The cost structure for the companys product for the above mentioned activity level
is detailed below
Rs
Raw Material 20
Direct labour 5
Overheads (including depreciation of Rs.5) 15
------
Total Cost 40
Profit 10
------
Selling price 50
------
Additional information
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Solution -
=======
II Current Liabilities:
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Notes
Problem 4.8.4
H ltd plans to sell 30,000 units next year. The expected cost of goods sold is as
follows
Rs. (per unit)
Raw materials 100
Manufacturing expenses 30
Selling, administration and financial expenses 20
Selling price 200
Assuming monthly sales level of 2,500 units, estimate the gross working capital
requirement if desired cash balance is 5% of the gross working capital
requirement, and work in progress is 25% complete with respect to manufacturing
expenses.
Solution:
Statement of working capital requirements
Work-in-progress :
Raw materials in WIP ( 2500 x 100) 2,50,000
Manufacturing expenses 25% (2,500x30) 18,750
2,68,750
Finished Goods :
Raw materials in WIP ( 2500 x 100 x1/2) 2,50,000
Manufacturing expenses (2,500x30x1/2) 37,500
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1,62,500
13,06,250
=========
Note Selling and distribution expenses never for part of finished goods and
WIP but is always included in Debtors
Problem 4.8.4
Liabilities Rs Assets Rs
Capital 50,500 Building 50,000
General reserve 7,000 Furniture 10,000
Bank loan 40,000 Cash 9,500
Creditors 11,300 Motor car 15,000
Liability for income tax 9,700 Stock in trade 12,000
Debtors 22,000
1,18,500 1,18,50
0
On the basis of following information pertaining to the year ended 31.3.1999, you
are required to prepare a statement of changes in working capital:
a. Sold motor car on 30.9.1998 for Rs 18,000 and on the same date purchased
100 equity shares of Rs 10 each in X ltd.
b. Sales for the year were 20% higher than that in the last year. Purchase of
materials increased by 10%. Customers were allowed 2 months credit and
suppliers allowed 1 month credit. Debtors on 31 st March 1998 represented
sales of February and march ( to be evenly allocated) and creditors also
represented purchases for March (monthly average)
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c. Business expenditure for the year amounted to Rs 1,800 per month (paid in
each month). There were no other receipts and payments during the year.
Gross profit rate was 30% on turnover.
d. Provide for interest on bank loan at 6% p.a and for income tax liability Rs 5,000
( ICWA final, June 1999)
Solution
Statement showing changes in working capital
Working notes
1. As sales are going up by 20%, debtors will also go up by 20%, as debtors are
equal to last 2 months sales (which is going up by 20%). Debtors as on
31.3.1999 = 22,000 + 20%(22,000) = 26,400
4. Amount of purchases for 1999 = creditors *12 = 12,430 *12 = 1,49,160 (As
creditors = 1 months purchases)
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Working Capital Management
2,08,680 2,08,680
1,81,500 1,81,500
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credit policies and efficient debt collection system will have lesser investment
in debtors. Credit policy of the company also depends upon the companys
reputation and demand for its products in the market, a well established
company may not offer any credit to its customers whereas a new company
having same product may offer few months credit.
Estimation of working capital requirements is just par of the finance manager. An equally
important job is management of working capital. We have already discussed that
operating cycle and working capital estimation are control tools as well, i.e. it gives the
management an idea whether the company is having an adequate level working capital
or it is carrying excess / lower working capital. Excess working capital leads to increase
in interest costs whereas lower working capital carries the risk of insolvency. It is
acumen of the finance manager to strike a balance between the risk and profitability. In
current Indian scenario especially after depression in industry since year 2000 the
concept of working capital management has gained significant importance. It will not be
wrong to say that many companies could recover from heavy losses and were able to
turnaround to profits only because of excellent working capital management. In last few
years companies have consistently taken efforts on reduction of unnecessary
inventories by following Just in time purchase techniques, improving delivery systems,
improving communications and co-ordination between marketing, production and
purchase departments. The companies also have taken special efforts to reduce their
debtors collection period and recovery of bad debts. Banking industry has paid a keen
role in cash management of companies by providing facilities like collection centres etc.
Though academically current ratio of 2 is considered to be ideal, currently most of the
companies are eying for a substantially lesser ratio. Well now discuss various aspects
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4.11 Management of cash - Management of cash has always been one of the
important functions of a finance manager, though now a days it appears to be a bit
simpler job as compared to earlier days thanks to technological advancement of
banking industry. The term management of cash includes management of actual cash
and cash equivalents like liquid bank balances and other liquid investments. A major
problem in cash management has always been the geographical diversity of business.
Let us see one example of a Pune based two-wheeler manufacturing company. The
company has its dealers network spread all over India and abroad but has its
production facilities and most of the suppliers in and around Pune. Now let us discuss a
case where the company has a receivable of an amount from a dealer in Assam, say on
1.1.2004 of Rs 10,00,000 and on the same day (or in 2-3 days time) has a payment due
to a Pune based supplier, Say Rs 5,00,000 then though company has a receivablefrom
its dealer in Assam, cannot use the same amount to settle the dues of the Pune based
supplier. Now the company has no option but to borrow from the banks till the time the
cheque gets cleared in the companys account (the payment may take a long time to
reach the company and even longer time to clear cheque from remote place). A similar
problem is faced when one department of the company has excess cash, whereas
another is short of cash. To summarise the requirement of proper cash management
can be highlighted as under
3. Liquidity can always be used for taking profitable opportunities which requires
liquidity. For example a sudden fall in share market may become right time for
investment in share market and company having enough liquid cash / bank
balance can only take shares and take the speculative advantages.
4.11.1 Estimation of cash requirements The first step of cash management is cash
estimation. These estimations are done with the help of cash budgets. Cash
budgets are prepared periodically to identify cash inflows and outflows, as cash
flows determine the requirement of funds and helps identifying investible funds.
Cash budgets are nothing but cash flow statements. One must note that cash flow
is different from profit or loss, to identify cash flow one must adjust all non cash
items to the profit / loss. Other popular way for preparing cash budgets is to
prepare estimated receipts and payments account. The preparation of cash
budgets offers following advantages
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2. It shows the amount of internal accruals; management can assess how much is
needed fro day to day operations and how much is available for purchase of
long term assets.]
3. It shows the need for additional amount of cash required so that loans can be
raised accordingly.
Receipts:
1. Cash sales
2. Collection from
debtors
3. Issue of capital
4.Other income
(Scrap etc.)
5. Loans taken
6.Miscelleneous
receipts
(dividend,
interest etc.)
Total
Payments :
Creditors
Salaries
Wages
Interest
Overheads
- Fixed overheads
- Variable over heads
- selling overheads
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Dividend
Fixed assets
Taxes
Other items
Total
Closing balance
Minimum desired
balance
Surplus / (shortfall)
4.11.2 System of Cash Management The next step of cash management is proper
allocation of funds amongst various departments / locations and maintaining
appropriate balance / liquidity at each place. The collection mechanism can be
made efficient by
a. Speeding up the mailing time of payments from the customers
b. Reducing the time lag between collection of cheques and its deposition with
the banks.
a. The collection process (mailing time of the dealer + clearing time for the
cheque) will be very high as the place is quite far and mailing will take time,
again outstation cheques take long time to get cleared, where as under
concentration banking the time of mailing is completely avoided as the dealer
will deposit the cheque in the collection centre near to his dealership place
and clearing will also take lesser time as the dealer will obviously give cheque
drawn on a local bank.
b. let us assume that total such collections in a year are Rs 3,65,00,000 in a
year (365 days) and the collection process is expected to be reduced by 5
days by using the concentration banking, also the rate of interest on working
capital loan is 10% p.a. Now we can see that the total interest saving will be 5
days collection * 10% = (3,65,00,000 / 365 * 5 * 10%) = Rs 5,00,000 p.a. .
Even if the company incurs Rs 1,00,000 as charges for availing collection
bank facility, it will stand to gain Rs 4,00,000.
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2. Lock box facility The purpose of lock box system is to eliminate the time
between the receipt of remittance by the company and depositing it in the bank.
Under this system the company rents local post office boxes and authorise
banks at each location to collect the remittances in the box. After collecting the
remittances the bank deposits it in the companys account. This also relieves
the company from handling of the cheques.
3. Reducing the floats Float here means the time periods that affect the cash
movements in various stages of collection process. Floats can be bifurcated as
follows
a. Billing float An invoice is the formal document that a seller prepares and
sends to the purchaser as the payment request for goods sold or services
provided. The time between the sale and the mailing of invoice is the billing
float
b. Mail float This is the time when a cheque is being processed by post office
or currior
c. Cheque processing float This is the time required for the seller to sort,
record and deposit the cheque after it has been received by the company
d. Bank processing float This is the time from the deposit of the cheque to
the crediting of funds in the sellers account
Lesser the float faster will be the collection process. To achieve this aim finance
manager must ensure that some basic procedures are followed, like cheques are
deposited on time, timely delivery of invoices, regular analysis of uncleared
cheques etc.
achieve the sales targets without appropriate credit period and perhaps in a competitive
market will substantially lose its market share. Similarly if a finance manager decided to
keep Raw material inventory to the extent of 30 days consumption, which is equal to the
industry average, Production manager may argue against it as reduction in raw material
stock may hamper the production. Selling goods on credit has a cost, the cost includes
2. Discount policy Practically every business offers cash discount for speedy
collection of debts. It helps the seller to improve his liquidity. Cash discount is
generally granted in slabs like say discount of 2% for payment in 0-15 days from
sales, 1% for payment in 16-30 days and so on. Let us take an example to
elaborate the importance of the cash discount Trader A has an annual sale of
Rs 600 lakhs and has average credit period of 3 months. Trader A has decided to
offer 2% discount on cash sales, now suppose 50% of the customers avail this
discount, reducing the debtors from Rs 150 lakhs (3/12 *600) to Rs 75 lakhs.
Now suppose Trader A pays interest @ 18% p.a on working capital loans, then
he is saving Rs 75 lakhs * 18% p.a = Rs 13.5 lakhs against the cost of discount =
Rs 300 lakhs * 2% = Rs 6 lakhs.
4. Credit analysis - Having determined the credit terms, the firm has to evaluate
credit worthiness of individual customers. It is an absolute essential procedure as
it helps the company in substantially reducing its bad debts. This procedure
includes credit rating, in which each and every customer (except for cash
customers) are rated according to their creditworthiness and their credit period
etc are determined according to their ratings. The credit rating depends upon
analysis of various factors like
4.12.1 Factoring
Factoring is the debt collection service provided by the bankers. Bankers provide
like buying the debtors of a company and extending credit upto 70-80% of the
invoice value. It is nothing but financing the sundry debtors and is a type of working
capital finance. Operation of factoring is very simple, clients enter into an
agreement with the factor working out an factoring agreement according to his
requirements. The Factor then takes the responsibility of monitoring, follow up,
collection and risk taking and provision of advance. The factors generally fixes up a
limit customer wise for the seller. Some of the benefits and limitations of factoring
are
a. The company can convert directly its debtors into cash ( after deducting the
factoring commission)
b. Factoring ensures a definite pattern of cash inflows
c. Factoring eliminates the need of a credit and collection department in the
company saving on administration and staff costs. This is particularly very
useful for seasonal businesses where firms cant afford to maintain such
department for whole year, as work for such department is only for a season.
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d. Collection and recovery has been considered as a big problem by almost all
businesses and factoring reduces or nullifies this problem.
a. It is costlier source of finance as the cost includes both factoring fees and
interest on the advance till the amount is recovered from the debtors
b. Bad debts can still be the responsibility of the company and not the factor. If
factor agrees to take the risk as to the bad debts then the factoring fees are
even higher
Thus before availing the services of a Factor the finance manager must consider
the costs and benefits associated with factoring and should appraise its utility to his
company.
Some other popular ways of management of debtors are Debt securitisation, Invoice
discounting etc. Debt securitisation is used by financial concerns like banks NBFCs etc.
A detailed study of these tools will be done in next semester.
4. Inventories are non liquid assets and cant be converted in cash easily.
Therefore inventory control should be done carefully. There are various techniques
developed for inventory control which are discussed in brief
1. Minimum and Maximum levels This is perhaps the simplest form of inventory
management, under his method management simply decides what should be the
minimum and maximum level of various items in inventory. These levels are decided
after considering the availability and importance of various items. It also takes into
consideration cost of purchases and lead time (time period between ordering of
material and actual receiving the material). Cost of procurement is an important point
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especially for imported items as carriage costs are heavy for imports and the cost
can be spread over only bulk quantity.
2. Re order quantity The re-ordering quantity is the level of stock where new
procurement orders are required to be placed without delay.
EOQ = 2AO/ C
A = Total usage in units for a period
O = ordering cost per order
C = Carrying cost per unit
4. Just in time purchase This is a relatively new concept and is far easier to
implement if stock records are maintained on computers. Under this method high
value inventories are procured only when it is required in production, suppliers are
specially developed so that they can arrange these items very promptly
This was just a brief introduction to the tools of inventories, as a detailed study is part of
subject of costing and not financial management.
Indian banks have been traditionally been extending credit to industry and trade solely
on the basis of securities like hypothecation of stocks etc. The organisations ability to
repay these loans and actual usage of these loans were never checked. This resulted
into heavy losses to bankers and defalcation of funds by the promoters. To cure this
problem Reserve Bank of India has set up various committees to study the matter and
provide appropriate guidelines, analysis some of the committees are discussed below
1. The Dahejia committee report In 1969 Dahejia committee pointed out that there
was no relationship between optimum requirements for production and the bank
loans. It was general tendency of the businessmen to take short term loans and use
it for other than production purposes. It was also pointed out that there are multiple
hypothecations on the same stocks. The Dahejia committee suggested that the bank
should make appraisal of credit applications with reference to the total financial
situation of the client. It also suggested that all the Cash credit bank accounts
should be bifurcated between the hard core which would cover the permanent
working capital and a strictly short term component which should be fluctuating part
of the account.
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2. The Tandon committee report The Tandon committee was set up by the RBI in
1974. Along with the suggestions regarding to whom working capital loans should be
granted, how much loan should be granted, the committee gave three different
methods for calculation of working capital. Though earlier these methods were
mandatory for the bankers now it is only recommendatory in nature. The three
methods are as follows
Method I
Bank finance to be granted = 75% (Current Assets Current liabilities [excluding
bank borrowings])
Method II
Bank finance to be granted = 75% (Current Assets) Current liabilities [excluding
bank borrowings]
Method III
Bank finance to be granted = 75% (Current Assets Core current assets) Current
liabilities [excluding bank borrowings]
3. Chore committee In 1979 chore committee was formed by RBI to analyse funding
of working capital the committee gave certain major suggestions regarding
enhancement of borrowers contribution in the working capital, compulsory periodic
review of cash credit accounts by bankers etc.
4.15.1 Problems
1. M/s A ltd. have approached bankers for their working capital requirements. The
bankers agreed to finance but decided to keep some margins as under (i.e agreed
to finance excluding the margins)
Other information Raw material is in stock for 2 months, WIP 15 days and FG 1
month. Debtors get 1 months credit and creditors give 15 days credit. Company
has received an advance of Rs. 15,000
Note - Margin is the amount which is not funded by the bankers e.g. if
bankers decide to fund debtors excluding 30% margin that means if
company estimates debtors to be Rs 100 then bank will fund only Rs 70
2. M/s B ltd. have approached bankers for their working capital requirements. The
bankers agreed to finance but decided to keep some margins as under (i.e agreed
to finance excluding the margins)
Other information Raw material is in stock for 2 months, work in progress (WIP) 1
month and FG 3 month. Debtors get 3 months credit and creditors give 2 months
credit, wages are paid after one month. Calculate WIP considering 100% RM +
50% wages and overheads. Selling price is estimated @ 5 Rs per unit. Cash
requirement is Rs 20,000
3. M/s C ltd. have approached bankers for their working capital requirements. The
bankers agreed to finance but decided to keep 30% margins on all current assets
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excluding Cash balance (i.e agreed to finance excluding the margins) other
information is as follows -
Raw materials 1 month, WIP (Completion - Material 100%, labour & overheads
50%) 1 month,
Debtors 2 month, Creditors 1 month, wages 1/2 month, overheads 30 days,
Finished goods 2 month.
80 % of sales is on credit, Expected cash balance is 75,000
Current assets
Current liabilities
Raw materials 11/2 month, WIP (Completion - Material 50%, labour & overheads
50%) 1 month, Debtors 2 month, Creditors 1 month, wages 1/2 month,
overheads 1/3rd month, Finished goods 1 month.
Expected output is 60,000 units per annum. Calculate the amount of working
capital required.
Liabilities Rs Assets Rs
Capital 1,50,500 Building 1,10,00
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0
General reserve 17,000 Furniture 70,000
Bank loan 34,000 Cash 19,500
Creditors 17,300 Motor car 12,000
Liability for income tax 19,700 Stock in trade 15,000
Debtors 12,000
2,38,500 2,38,50
0
On the basis of following information pertaining to the year ended 31.3.2005, you
are required to prepare a statement of changes in working capital:
a. Furniture on 30.6.2004 for Rs 18,000 and on the same date purchased 100
units of UTI at Rs 100 each.
b. Sales for the year were 30% higher than that in the last year. Purchase of
materials increased by 15%. Customers were allowed 1.5 months credit
and suppliers allowed 1 month credit (Policy was same for 2004)
c. Overheads for the year amounted to Rs 3,500 per month (paid in next
month). There were no other receipts and payments during the year. Gross
profit rate was 40% on turnover.
d. Provide for interest on bank loan at 9% p.a and for income tax liability Rs
7,500
10. Compute the amount of working capital from the following balance sheet
Liabilities Rs Assets Rs
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Working Capital Management
11.You are given below the Profit & loss account for two years for a company
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Working Capital Management
Production during the previous year was 10,00,000 units. The same level of
activity is intended to be maintained during the current year.
Overheads 20%
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Working Capital Management
The raw materials ordinarily remain in stores for 3 months, WIP for 2 months
and finished goods for 3 months. Credit period given by creditors is 4 months and
given to debtors is 2 months. Wages and overheads are overdue for months and
minimum cash balance should be Rs 2,00,000. selling price is 8 per unit you are
required to make a 10% provision for contingencies ( except cash).
e. A company should have large balances of cash in hand so that it can meet
all contingencies
i. Higher the credit period, the greater are the chances of recovery of a debt
2.Company D ltd.
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Working Capital Management
Current assets
Current liabilities
l. Rs. 20 lacs
m. Rs. 75 lacs
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Working Capital Management
b. Rs. 20 lacs
c. Rs. 15 lacs
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Working Capital Management
b. 58,00,000
c. 43,55,000
d. 45,00,000
1. Increasing the sales should be the only criterion before giving credit to the
customers
2. Credit rating refers to ranking the various debtors who seek credit.
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