A

Project Report
On
“WORKING CAPITAL MANAGEMENT”

OF
BIRLA SUNLIFE INSURANCE

submitted in partial fulfillment of the requirement for the award of

degree of

MASTER OF BUSINESS ADMINISTRATION

UPTU, LUCKNOW

To

VANKATSHVARA INSTITUTE TECHNOLOGY

2014-2015
SUBMITTED TO: SUBMITTED BY:

SHALU RANA UMAKANT

MBA 3RD SEM

ROLL NO.: 1308750058

ACKNOWLEDGEMENT

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We are heartly grateful to SHALU RANA . They have always been an
invaluable source of inspiration , hard work , sincerity and dedication .
It gives me immense pleasure in submitting this project on
“WORKING CAPITAL MANAGEMENT’’ . I have developed this
project in partial fulfilment of M B A 3 rd sem from Vankatshvar
Institute Technology . I would like to express my sincere ineptness to his
constant guidance and valuable support during the project work.
Encouragement and excellent guidance in the successful completion of
the project work . And of course nothing could have come true without
the support of my family , friends and all the classmates for their
constant encouragement and useful tips through out my project . I will
always grateful to them .

DECLARATION

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I Umakant student of Vankatshvara Institute Technology M B A 3 rd SEM
hereby declare that summer training project report entitled “
BIRLA SUN LIFE INSURANCE COMPANY” is the outcome of my own
strong effort .This project so far has neither been published nor
submitted to any university / college / institute for award of any degree
/ diploma course . the information presented in this project report is
correct to the best of my knowledge

Umakant

MBA 3rd sem

SNO. TITLE

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 1 Profile of the Company
1.1Profile of Birla Sun Life Insurance
1.2Nature of the organization
1.3company mission and vision
1.4product range
1.5size of organization
1.6organisational structure
1.7Industry analysis
1.8landmark in the history
2 Theoretical Background
2.1Conceptual framework of the study
2.2Applicability of the concept in the organization
3 Problem statement & objectives of the study
3.1significance of the study
3.2 objective of the study
3.3scope of the study
4 Research methodology
4.1Research Design
4.2sources of data collection
4.3sampling procedure
4.4limitations of the study
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Analysis & Interpretation

6 Findings, Conclusion &Recommendation

6.1Findings
6.2Recommendation 6.3conclusion

RESEARCH METHODOLOGY

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 The information is collected through secondary sources during the project. That
information was utilized for calculating performance evaluation and based on that,
interpretations were made.

Sources of secondary data:

Most of the calculations are made on the financial statements of the company provided
statements. Referring standard texts and referred books collected some of the information
regarding theoretical aspects. Method- to assess the performance of he company method of
observation of the work in finance department in followed.

STATEMENT OF PROJECT

 Evaluation, analysis & interpretation of working capital management of United

Engineering Services.

 Suggesting ways to improve its working capital utilization.

OBJECTIVE OF RESEARCH

 Estimation of working capital requirement

 Evaluation of working capital management

 Evaluation of Liquidity position & working capital utilization

 Analysis of relationship between working capital and profitability

 Analysis & sources of working capital

 Analyzing the level of current assets with relation to current liabilities

METHODS OF QUANTATIVE ANALYSIS

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  Calculation of net working capital requirements.

 Ratio analysis

 Operating cycle & cash cycle

 Cash flow analysis

 Determining the Financing mix

 Statistical tools like graphical presentation

ASSUMPTIONS

 Year is taken of 365 days

 All purchases have been taken as credit purchases and all sales have been taken as credit

sales.

 In the absence of relevant data the data from internet site is taken as the relevant

information.

COMPANY PROFILE

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 1.1BIRLA SUN LIFE = ADITYA BIRLA GROUP (INDIA) + SUN LIFE
FINANCIAL’S (CANADA)

Main branch address: 1St Floor, Building No. 11, Corporate Park,
SionTrombay Road, Chembur, Mumbai - 400071
022 2527 6201

The Aditya Birla Group is India’s first truly multinational corporation, Global in vision, rooted in
values, the group is driven by performance ethic pegged on value creation for its multiple
stakeholders. A US$ 24 billion conglomerate, with a market capitalization of US$ 24 billion and
in the league of Fortune 500, it is anchored by an extraordinary belonging to over 25 different
nationalities. Over 50 percent of its revenues flow from its operations across the world. The
Aditya Birla group is US$ 30 billion conglomerate which gets 60% of its revenues from outside
India. The group is a major player in all the industry sectors it operates in. The Aditya Birla
Group has been adjudged the best employer in India and among the top 20 in Asia by the Hewitt-
Economic Times and Wall Street Journal Study 2007. The origins of the group lie in the
conglomerate once held by one of India's foremost industrialists Mr. Ghanshyam Das Birla.

The Group’s products and services offer distinctive solutions worldwide .Its 85 state-of-the-art
manufacturing units and sect oral services span 20 countries – India, Thailand, Laos, Indonesia,
Philippines, Egypt, Canada, Australia, China, USA, UK, Germany, Hungary, brajil, Italy,
France, Luxembourg, Switzerland, Malaysia and Korea.

The group has been adjudged the best employer in India and among the top 20 in Asia

by the Hewitt-Economic Times and Wall street journal Study 2007.

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 In India the group holds a frontrunner position as

 India’s leading copper producer

 A premier branded garments player
 The second largest player in viscose filament yarm.
 The second largest player in the chlor alkali sector.
 Among the top five mobile technology players
 A leading player in Life insurance and asset management.

1.2 Nature of Organisation

Sun Life Financial is a leading international financial services organization providing a diverse
range of protection and wealth accumulation products and services to individuals and corporate
customers. Chartered in 1865, Sun Life Financial and its partners today have operations in key
markets worldwide, including Canada, the United States, the United Kingdom, Ireland, Hong
Kong, the Philippines, Japan, Indonesia, India, China and Bermuda. As of March 31, 2007, the
Sun Life Financial group of companies had total assets under management of CDN$446 billion.

Type of industry: service industry

Type of business: Life insurance

Area of Training: HR

1.3 Company’s Vision and Mission

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 Vision-

To be a world class provider of financial security to individuals and corporate and to be amongst
the top three private sectors life insurance companies in India.

Mission-

To be the first preference of our customers by providing innovative, need based life insurance and
retirement solutions to individuals as well as corporate. These solutions will be made available
well trained professionals through a multi-channel distribution network and superior technology.

It will provide constant value addition to customers throughout their relationship with us, within
the regulatory framework.

Values-

Ø Integrity

Ø Commitment

Ø Passion

Ø Seamlessness

ØSpeed

Product range of the company

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• Insurance Plans

Life is unpredictable. But in face of adversity, our responsibilities towards our parents, children
and loved ones need not be compromised. Insurance planning equips you to smooth out the
uncertainties and adversities that life might send your way, so that the best that life has to offer,
secure in the knowledge that your beloved ones are well provided for.
BSLI offers a complete range of insurance products
1. Protection Plan
2. Savings Plan
3. Investment Plan
4. Child   Plan
5. Retirement Plan
6. Group Plan

7. Rural Plan
8. Plans for NRIs

• Protection Plan

• Choose a specified level of protection (available only with Lifetime).

• Two levels of Sum Assured to choose from (available only with Lifetime II).
• Flexibility to increase or decrease your sum assured.
• Add-on riders to protect you against any eventuality.

• Savings Plan
Flexibility to increase or decrease your contribution.Facilityof Premium Holiday, wherein the
policy continues even if there is a temporary break in the payment of annual contribution
(available only with Life Time).

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Facility of Automatic Cover Continuance, wherein the policy continues even if there is a
temporary break in the payment of annual contributionFacility to top-up your investment any
time you have surplus funds. Additional allocation of units on a periodic basis.
Loans against the policy.

• Investment Plan
Choose from among four funds, based on your investment objective and risk appetite.
Choice to switch between investments options (4 free switches every policy year).
You can also enhance your policy by adding Critical Illness Rider, Major Surgical Assistance
Rider, Accident & Disability Benefit Rider, Accident Benefit Rider (available only with Life
Time) and Waiver of Premium Ride

Child Plan
As a responsible parent, you will always strive to ensure a hassle-free, successful life for your
child. However, life is full of Uncertainties and even the best-laid plans can go wrong. Here’s
how you can give your child a 100% safe and assured tomorrow, whatever the uncertainties.
Smart Kid is especially designed to provide flexibility and safeguard your child’s future
education and lifestyle, taking all possibilities into account. Choose from amongst a basket of

4 plans:

• Smart Kid regular premium

• Smart Kid unit-linked regular premium
• Smart Kid unit-linked regular premium II
• Smart Kid unit-linked single premium II

All these plans offer you:

Financial Benefits:  Regular payments at critical stages in your child’s life, like Board
examinations, Graduation and Post-graduation.
Total peace of mind, even if you are not around

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Sum Assured is paid immediately:  Ensures that your loved ones stay financially secure,
even in your absence.
All future premiums are waived:  Ensuring that your family is not financially burdened in
your absence.
Policy benefits continue:  The educational benefits of the policy continue, ensuring that your
child can realize his or her dreams without any hassles.

Development Allowance:  Smart Kid guarantees regular income to secure your child’s
educational career and also ensures his or her all-round development, for a nominal additional
amount. The Income Benefit Rider takes care of this through an annual payment of 10% of the
sum assured, to your child, till the maturity of the policy, in the unfortunate event of the death of
the parent.

 All SmartKid plans can be enhanced with the Accident & Disability Benefit
Rider  andIncome Benefit Rider . You can also an Accident Benefit Rider  to a Smart
Kid Regular Premium policy, and a Waiver of Premium Rider (WOP)  to Smart Kid unit-
linked regular premium policy.

 Death Benefit:  The Sum Assured under the product has 2 options, either 500% of the initial
premium or 105% of the initial premium. In the event of an unfortunate death, the beneficiary
will receive higher of the value of units or the initial death benefit, less any withdrawals.

Withdrawal Benefit:  One can make partial withdrawals from the accumulated value of the
policy after completion of one policy year.

Flexibility:  Choose from four fund options, based on your investment objective and risk
appetite. If at a later stage your financial priorities change, you can switch between the various
fund options, absolutely free, 4 times a year.

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• Retirement plan
 Life Expectancy has been rising rapidly and today you can expect to live longer than your
earlier generations. For you, this increase will mean a longer retirement life, stretching into a
couple of decades.  BSLI Retirement Solutions that combine the best of insurance and
investment. These solutions are developed to ensure your peace of mind for the years to come.
BSLI Group Solutions Advantage:

An integrated basket of employee benefits solutions that offer incomparable flexible benefits.
Sound investment management that focuses on safety, stability and profitability of the portfolio.
Personalized financial planning for your employee that takes care of his/her changing financial
needs at every stage of life.
Quality service initiatives and transparency across all operations, promising superlative
operational efficiency.

• Group Gratuity Plan

 BSLI group gratuity plan helps employers fund their gratuity obligation in a scientific manner.
Employers can avail of the tax benefits as applicable to approved gratuity funds. The plan can
also be customized to structure schemes that can provide benefits beyond the statutory
obligations.

Highlights include:

Wider choice of investments with Market Linked Plans  - to meet the diverse financial
goals. We offer 4 investment options (short-term debt, debt and balanced and capital guarantee
plan) where investments will be made in accordance with the fund objectives.

Transparency  through Daily disclosure of Unit Value and regular disclosure of the portfolio of
each of the investment option

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Flexibility  through switching and contribution redirection option to enable reshuffling of
portfolioBundled Life Cover  greater values to the employee by packaging life insurance
cover with the gratuity, with minimal amount of underwriting.

Actuarial services  to provide a scientific estimation of the gratuity liability.

Low explicit charge structure  with the conditions for exit specified upfront.

Enhanced service levels  through faster claim settlement, easier access to information and
regular statements.

Complete end to end solutions in the legal and regulatory approval process for
scheme set up or transfer
 
Employee Benefits:

The contribution made by the employer is not included in the value of taxable perquisites in the
hands of the employee.
Gratuity received up to Rs 350000 is exempt from Income tax under Sec 10(10)

Employer Benefits:

Annual contribution up to 8.33% of salary bill in a financial year is allowed a deduction for the
purpose of computation of profits and gains of business.
Contribution towards past service liability is allowed as deduction as per the Income Tax rules.

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• Rural Plans
 BSLI Rural Products are designed to meet the needs of the rural consumers. These products
offer the following features:
1. Low and Affordable Premiums
2. Life Cover
3. Savings Option
4. Hassle free procedure
 

• NRI Plans:
Being away from India doesn't mean you have to compromise the safety and security of your
loved ones. In fact, your savings from your time overseas can be easily canalized to meet your
family's needs - now and in the future. So, whether its your dream to retire in your hometown; to
secure funds for your children's education; or to build assets, BSLI has a range of solutions that
can be customized to meet your needs.

1.5 Size of organization

Birla Sun Life Insurance hopes to be double its turnover to Rs 300crore in the current fiscal
against Rs 151 crore in the previous fiscal.
“Policy disbursement increase towards the year end on tax considerations, thus this year end on
tax consideration, thus this target is achievable,” said Peter Akers Birla Sun Life chief operating
officer at a press conference in Mumbai.
“Centralised client servicing backed by state –of-the art technology and processing achievement
have enabled strong operational cost efficiency which will contribute towards achieving a faster
break-even, “he added.
As on March 31, 2003, the company has invested Rs 18 crore in information technology.
The company is offering its retirement plan and the single premium plan through the internetThe
account for less than one percent of the current sales”, said Mario Braganza, head, client services
and underwriting birla Sun life.

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1.6Organizational Structure of the Company

HEAD OFFICE

BRANCH OFFICE

BRANCH MANAGER

SALES MANAGER KEY ACCOUNTS ANNUAL MAINTAINANCE

CHANNEL MANAGER CONTRACT MANAGER

SALES EXECUTIVE-1 SALES EXECUTIVE-2 SERVICE ENGINEER

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1.7 -Industry Analysis

Major insurance company share in market

LIC 82.3
ICICI PRUDENTIAL 5.63
BIRLA SUN LIFE 2.56
BAJA ALLIANZ 2.03
SBI LIFE 1.80
HDFC STANDARD 1.36
TATA AIG 1.29
MAX NEW YORK 0.90
AVIVA 0.79
OM KOTAK MAHINDRA 0.51
ING VYASA .37
AMP SANMAR 0.26
METLIFE 0.21

Birla Sun Life Asset Management Company Ltd. (BSLAMC), the investment managers of Birla
Sun Life Mutual Fund, is a joint venture between the Aditya Birla Group and the Sun Life
Financial Services Inc. of Canada. The joint venture brings together the Aditya Birla Group's
experience in the Indian market and Sun Life's global experience.

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Established in 1994, Birla Sun Life Mutual fund has emerged as one of India's leading flagships
of Mutual Funds business managing assets of a large investor base. Our solutions offer a range of
investment options, including diversified and sector specific equity schemes, fund of fund
schemes, hybrid and monthly income funds, a wide range of debt and treasury products and
offshore funds.

Birla Sun Life Asset Management Company has one of the largest team of research analysts in
the industry, dedicated to tracking down the best companies to invest in. BSLAMC strives to
provide transparent, ethical and research-based investments and wealth management services

The Aditya Birla Group

The Aditya Birla Group is one of India's largest business houses. Global in vision, rooted in
Indian values, the Group is driven by a performance ethic pegged on value creation for its
multiple stakeholders.

The Group operates in 26 countries – India, UK, Germany, Hungary, Brazil, Italy, France,
Luxembourg, Switzerland, Australia, USA, Canada, Egypt, China, Thailand, Laos, Indonesia,
Philippines, UAE, Singapore, Myanmar, Bangladesh, Vietnam, Malaysia, Bahrain and Korea.

A US $29 billion corporation in the League of Fortune 500, the Aditya Birla Group is anchored
by an extraordinary work force of 130,000 employees, belonging to 40 different nationalities.
Over 60 per cent of its revenues flow from its operations across the world.

The Aditya Birla Group is a dominant player in all its areas of operations viz; Aluminium,
Copper, Cement, Viscose Staple Fibre, Carbon Black, Viscose Filament Yarn, Fertilisers,
Insulators, Sponge Iron, Chemicals, Branded Apparels, Insurance, Mutual Funds, Software and
Telecom. The Group has strategic joint ventures with global majors such as Sun Life (Canada),
AT&T (USA), the Tata Group and NGK Insulators (Japan), and has ventured into the BPO
sector with the acquisition of TransWorks, a leading ITES/BPO company.

Sun Life Financial

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Sun Life Financial Inc is a leading international financial services organization providing a
diverse range of wealth accumulation and protection products and services to individuals and
corporate customers. Chartered in 1865, Sun Life Financial Inc and its partners today have
operations in key markets worldwide, including Canada, the United States, the United Kingdom,
Hong Kong, the Philippines, Japan, Indonesia, India, China and Bermuda.

OBJECTIVES OF THE STUDY

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Objective of the study includes the following:
• To analyse the working capital management of the
company.

The sub objective of the project include

• To know about:

• The working capital

• Debtors management
• Cash management of the company
• Creditors management

INTRODUCTION OF WORKING CAPITAL

The net working capital of business is its current assets less its current liabilities.

Current Assets include:

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 • Stock of Raw Material

• Work in Progress

• Finished Goods

• Trade Debtors

• Prepayments

• Cash Balances

Current Liabilities include:

• Trade Creditors

• Accruals

• Taxation Payable

• Dividends Payable

• Short term Loans

Every business needs adequate liquid resources in order to maintain day to day cash flows. It

needs enough cash to by wages and salaries as they fall due and to pay creditors if it is to keep

its workforce and ensure its supplies. Maintaining adequate working capital; is not just

important in the short term.

Sufficient liquidity must be maintained in order to ensure the survival of business in the

long term as well. Even a profitable business may fail if it does not have adequate cash flows to

meet its liabilities as tyhey fall a due. Therefore when business make investment decisions they

must not only consider the financial outlay involved with acquiring the new machine or the

new building etc, but must also take account of the additional current assets that are usually

involved with any expansion of activity .

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Increase production tends to engender a need to hold additional stocks of raw material & work

in progress.

Increased sales usually mean that the level of debtor will increase. A general increase in the

firm’s scales of operation tends to imply a need for greater level of cash.

THEORY OF WORKING CAPITAL

MEANING OF WORKING CAPITAL:

Capital required for a business can be classifies under two main categories:

• Fixed Capital

• Working Capital

Every business needs funds for two purposes for its establishments and to carry out day to day

operations. Long term funds are required to create production facilities through purchase of fixed

assets such as plant and machinery, land and building, furniture etc. Investments in these assets

are representing that part of firm’s capital which is blocked on a permanent or fixed basis and is

called fixed capital. Funds are also needed for short term purposes for the purchasing of raw

materials, payments 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

and inventories.

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CONCEPTS OF WORKING CAPITAL:

There are two concepts of working capital:

• Balance Sheet concepts

• Operating Cycle or circular flow concept

BALANCE SHEET CONCEPT:

There are two interpretation of working capital under the balance sheet concept:

• Gross Working Capital

• Net Working Capital

The term working capital refers to the Gross working capital and represents the amount of funds

invested in current assets . Thus, the gross working capital is the capital invested in total current

assets of the enterprises. Current assets are those assets which are converted into cash within

short periods of normally one accounting year. Example of current assets is:

Constituents of Current Assets:

• Cash in hand and Bank balance

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 • Bills Receivable

• Sundry Debtors

• Short term Loans and Advances

• Inventories of Stock as:

• Raw Materials

• Work in Process

• Stores and Spaces

• Finished Goods

 Temporary Investments of Surplus Funds

 Prepaid Expenses

 Accrued Incomes

The term working capital refers to the net working capital. Net working capital is the excess of

current assets over current liabilities or say:

Net Working Capital = Current Assets – Current Liabilities.

NET WORKING CAPITAL MAY BE NEGATIVE OR POSITIVE:

When the current assets exceed the current liabilities, the working capital is positive and the

negative working capital results when 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 of the current assets or the

income of the business. Examples of current liabilities are:

CONSTITUENTS OF CURRENT LIBILITIES:

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 • Bills Payable

• Sundry Creditors or Account Payable

• Accrued or Outstanding Expenses

• Short term Loans, Advances and Deposits

• Dividends Payable

• Bank Overdraft

Provision for Taxation, If does not amount to appropriation of profits

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

capital is an accounting concept of working capital.

OPERATING CYCLE OR CIRCULATING CASH FORMAT:

Working Capital refers to that part of firm’s capital which is required for financing short term or

current assets such as cash, marketable securities, debtors and inventories. Funds thus invested in

current assets keep revolving fast and being constantly converted into cash and these cash flows

out again in exchange for other current assets. Hence it is also known as revolving or circulating

capital. The circular flow concept of working capital is based upon this operating or working

capital cycle of a firm. The cycle starts with the purchase of raw material and other resources

And ends with the realization of cash from the sales of finished goods. It involves purchase of

raw material and stores, its conversion into stocks of finished goods through work in progress

with progressive increment of labor and service cost, conversion of finished stocks into sales,

debtors and receivables and ultimately realization of cash and this cycle continuous again from

cash to purchase of raw materials and so on. The speed/ time of duration required to complete

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 one cycle determines the requirements of working capital longer the period of cycle, larger is the

requirement of working capital.

CLASSIFICATION OR KIND OF WORKING CAPITAL:

Working capital may be classified in two ways:

• On the basis of concept

• On the basis of time

Om the basis of concept, working capital is classified as gross working capital and net working capital.

The classification is important from the point of view of the financial manager.

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

• Permanent or Fixed working capital

• Temporary or Variable working capital

1.PERMANENT OR FIXED WORKING CAPITAL:

Permanent or fixed working capital 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 enterprises to carry out

its normal business operations.

2. TEMPRORAY OR VARIABLE WORKING CAPITAL:

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

meet the seasonal demands and some special exigencies.Varibles working capital can be further

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classified as second working capital and special working capital. The capital required to meet the

seasonal needs of the enterprises is called the seasonal working capital.

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

IMPORATNCE OR ADVANTAGE OF ADEQUATE WORKING CAPITAL:

Working capital is the life blood and nerve centre of a business . just a circulation of a blood is

essential in the human body for maintaining life, working capital is very essential to maintain the

smooth running of a business. No business can run successfully without an adequate amount of

working capital. The main advantages of maintaining adequate amount of working capital are as

follows:

• Solvency of the Business

• Goodwill

• Easy Loans

• Cash discounts

• Regular supply of Raw Materials

• Regular payments of salaries, wages & other day to day commitments.

• Exploitation of favorable market conditions

• Ability of crisis

• Quick and regular return on investments

• High morals

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THE NEED OR OBJECTS OF WORKING CAPITAL:

The need for working capital cannot be emphasized. Every business needs some amount of

working capital. The need of working capital arises due to the time gap between production and

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

cash. There are time gaps in purchase of raw materials and production, production and sales,

And sales, and realization of cash, thus , working capital is needed for the following purposes:

• For the purchase of raw materials , components and spaces

• To pay wages and salaries

• To incur day to day expenses and overhead costs such as fuel, power and office expenses

etc.

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

• To provide credit facilities to the customers.

• To maintain the inventories of raw materials, work –in- progress, stores and spares and

finished stock.

FACTORS DETERMING THE WORKING CAPITAL REQUIRMENT:

The working capital requirements of a concern depend upon a large number of factors such as

nature and size of the business, the characteristics of their operations, the length of production

cycle , the rate of stock turnover and the state of economic situation. However the following are

the important factors generally influencing the working capital requirements.

• NATURE OR CHARACTERSTICS OF A BUSINESS : The nature and the working

capital requirement of enterprises are interlinked. While a manufacturing industry has a

long cycle of operation of the working capital, the same would be short in an enterprises

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 involve in providing services. The amount required also varies as per the nature, an

enterprises involved in production would required more working capital then a service

sector enterprise.

• MANAFACTURE PRODUCTION POLICY: Each enterprises in the manufacturing

sector has its own production policy, some follow the policy of uniform production even

if the demand varies from time to time and other may follow the principles of demand

based production in which production is based on the demand during the particular phase

of time. Accordingly the working capital requirements vary for both of them.

• OPERATIONS: The requirement of working capital fluctuates for seasonal business.

The working capital needs of such business may increase considerably during the busy

season and decrease during the

• MARKET CONDITION: If there is a high competition in the chosen project category

then one shall need to offer sops like credit, immediate delivery of goods etc for which

the working capital requirement will be high. Otherwise if there is no competition or less

competition in the market then the working capital requirements will be low.

• AVABILITY OF RAW MATERIAL: If raw material is readily available then one

need not maintain a large stock of the same thereby reducing the working capital

investment in the raw material stock . On other hand if raw material is not readily

available then a large inventory stocks need to be maintained, there by calling for

substantial investment in the same.

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 • GROWTH AND EXAPNSION: Growth and Expansions in the volume of business

result in enhancement of the working capital requirements. As business growth and

expands it needs a larger amount of the working capital. Normally the needs for increased

working capital funds processed growth in business activities.

• PRICE LEVEL CHANGES : Generally raising price level require a higher investment

in the working capital. With increasing prices, the same levels of current assets needs

enhanced investments.

• MANAFACTURING CYCLE: The manufacturing cycle starts with the purchase of raw

material and is completed with the production of finished goods. If the manufacturing

cycle involves a longer period the need for working capital would be more. At time

business needs to estimate the requirement of working capital in advance for proper

control and management. The factors discussed above influence the quantum of working

capital in the business. The assessment of the working capital requirement is made

keeping this factor in view. Each constituents of the working capital retains it form for a

certain period and that holding period is determined by the factors discussed above. So

for correct assessment of the working capital requirement the duration at various stages

of the working capital cycle is estimated. Thereafter proper value is assigned to the

respective current assets, depending on its level of completion. The basis for assigning

value to each component is given below:

COMPONENTS OF WORKING CAPITAL BASIS OF VALUATION

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 Stock of Raw Material Purchase of Raw Material

Stock of Work -in- Process At cost of Market value which is lower

Stock of finished Goods Cost of Production

Debtors Cost of Sales or Sales Value

Cah Working Expenses

Each constituent of the working capital is valued on the basis of valuation Enumerated above for

the holding period estimated.

WORKING CAPITAL ANALYSIS

As we know working capital is the life blood and the centre of a business. Adequate amount of
working capital is very much essential for the smooth running of the business. And the most
important part is the efficient management of working capital in right time. The liquidity position
of the firm is totally effected by the management of working capital. So, a study of changes in
the uses and sources of working capital is necessary to evaluate the efficiency with which the
working capital is employed in a business. This involves the need of working capital analysis.

The analysis of working capital can be conducted through a number of devices, such as:

1.     Ratio analysis.

2.     Fund flow analysis.

3.     Budgeting.

1. RATIO ANALYSIS : A ratio is a simple arithmetical expression one number to another. The
technique of ratio analysis can be employed for measuring short-term liquidity or working
capital position of a firm. The following ratios can be calculated for these purposes:

1. Current ratio.

2. Quick ratio

3.  Absolute liquid ratio

4.  Inventory turnover.

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 5.  Receivables turnover.

6.  Payable turnover ratio.

7.  Working capital turnover ratio.

8.  Working capital leverage

9.  Ratio of current liabilities to tangible net worth.

2.    FUND FLOW ANALYSIS

Fund flow analysis is a technical device designated to the study the source from which additional
funds were derived and the use to which these sources were put. The fund flow analysis consists
of:

a.      Preparing schedule of changes of working capital

b.     Statement of sources and application of funds.

It is an effective management tool to study the changes in financial position (working capital)
business enterprise between beginning and ending of the financial dates.

3.    WORKING CAPITAL BUDGET

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

pursued in the future period time. Working capital budget as a part of the total budge ting process
of a business is prepared estimating future long term and short term working capital needs and
sources to finance them, and then comparing the budgeted figures with actual performance for
calculating the variances, if any, so that corrective actions may be taken in future. He objective
working capital budget is to ensure availability of funds as and needed, and to ensure effective
utilization of these resources. The successful implementation of working capital budget involves
the preparing of separate budget for each element of working capital, such as, cash, inventories
and receivables etc.  

ANALYSIS OF FINANCIAL STATEMENTS

FINANCIAL STATEMENTS: Financial statement is a collection of data organized according
to logical and consistent accounting procedure to convey an under-standing of some financial
aspects of a business firm. It may show position at a moment in time, as in the case of balance

32
sheet or may reveal a series of activities over a given period of time, as in the case of an income
statement. Thus, the term ‘financial statements’ generally refers to the two statements

(1) The position statement or Balance sheet.

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

OBJECTIVES OF FINANCIAL STATEMENTS:

According to accounting Principal Board of America (APB) states

The following objectives of financial statements: -

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

business firm.

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

3. To provide reliable information about change in net resources (recourses less obligations)
missing out of business activities.

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

LIMITATIONS OF FINANCIAL STATEMENTS:

Though financial statements are relevant and useful for a concern, still they do not present a final
picture a final picture of a concern. The utility of these statements is dependent upon a number of
factors. The analysis and interpretation of these statements must be done carefully otherwise
misleading conclusion may be drawn.

Financial statements suffer from the following limitations: -

1. Financial statements do not given a final picture of the concern. The data given in these
statements is only approximate. The actual value can only be determined when the business is
sold or liquidated.

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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.

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RATIO ANALYSIS
Meaning of Ratio:- A ratio is simple arithmetical expression of the relationship of one number
to another. It may be defined as the indicated quotient of two mathematical expressions.

According to Accountant’s Handbook by Wixon, Kell and Bedford, “a ratio is an expression of

the quantitative relationship between two numbers”.

  Ratio Analysis:- Ratio analysis is the process of determining and presenting the relationship of
items and group of items in the statements. According to Batty J. Management Accounting
“Ratio can assist management in its basic functions of forecasting, planning coordination, control
and communication”.

Ratio analysis is defined as the systematic use of the ratio to interpret the financial
statements. So that the strengths and weaknesses of a firm, as well as its historical performance
and current financial condition can be determined. Ratio reflects a quantitative relationship helps
to form a quantitative judgm

 It is helpful to know about the liquidity, solvency, capital structure and
profitability of an organization. It is helpful tool to aid in applying judgement, otherwise
complex situations.

Ratio analysis can represent following three methods.

Ratio may be expressed in the following three ways :

1.     Pure Ratio or Simple Ratio :- It is expressed by the simple division of one number by
another. For example , if the current assets of a business are Rs. 200000 and its current
liabilities are Rs. 100000, the ratio of ‘Current assets to current liabilities’ will be 2:1.

2.     ‘Rate’ or ‘So Many Times :- In this type , it is calculated how many times a figure is, in
comparison to another figure. For example , if a firm’s credit sales during the year are Rs.
200000 and its debtors at the end of the year are Rs. 40000 , its Debtors Turnover Ratio is
200000/40000 = 5 times. It shows that the credit sales are 5 times in comparison to
debtors.

35
 3.     Percentage :- In this type, the relation between two figures is expressed in hundredth.
For example, if a firm’s capital is Rs.1000000 and its profit is Rs.200000 the ratio of
profit capital, in term of percentage, is 200000/1000000*100 = 20%

ADVANTAGE OF RATIO ANALYSIS 

1. Helpful in analysis of Financial Statements.

2. Helpful in comparative Study.

3. Helpful in locating the weak spots of the business.

4. Helpful in Forecasting.

5. Estimate about the trend of the business.

6. Fixation of ideal Standards.

7. Effective Control.

8. Study of Financial Soundness.

LIMITATIONS OF RATIO ANALYSIS

1.     Comparison not possible if different firms adopt different accounting policies.

2.     Ratio analysis becomes less effective due to price level changes.

3.     Ratio may be misleading in the absence of absolute data.

4.     Limited use of a single data.

5.     Lack of proper standards.

6.     False accounting data gives false ratio.

7.     Ratios alone are not adequate for proper conclusions.

8.     Effect of personal ability and bias of the analyst. 

CLASSIFICATION OF RATIO 

Ratio may be classified into the four categories as follows:

A.     Liquidity Ratio

a.      Current Ratio

b.     Quick Ratio or Acid Test Ratio

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 B.     Leverage or Capital Structure Ratio

a.      Debt Equity Ratio

b.     Debt to Total Fund Ratio

c.     Proprietary Ratio

d.     Fixed Assets to Proprietor’s Fund Ratio

e.      Capital Gearing Ratio

f.       Interest Coverage Ratio

C.     Activity Ratio or Turnover Ratio

a.      Stock Turnover Ratio

b.     Debtors or Receivables Turnover Ratio

c.     Average Collection Period

d.     Creditors or Payables Turnover Ratio

e.      Average Payment Period

f.       Fixed Assets Turnover Ratio

g.     Working Capital Turnover Ratio

D.    Profitability Ratio or Income Ratio

  (A) Profitability Ratio based on Sales :

 a. Gross Profit Ratio

 b. Net Profit Ratio

 c. Operating Ratio

 d. Expenses Ratio

 (B) Profitability Ratio Based on Investment :

             I.        Return on Capital Employed

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       II.        Return on Shareholder’s Funds :

a.      Return on Total Shareholder’s Funds

b.     Return on Equity Shareholder’s Funds

c.     Earning Per Share

d.     Dividend Per Share

e.      Dividend Payout Ratio

f.       Earning and Dividend Yield

g.     Price Earning Ratio

LIQUIDITY RATIO
• Liquidity Ratio:- It refers to the ability of the firm to meet  its current liabilities. The
liquidity ratio, therefore, are also called ‘Short-term Solvency Ratio’. These ratio are used
to assess the short-term financial position of the concern. They indicate the firm’s ability to
meet its current obligation out of current resources.

• Concept And Types Of Liquidity Ratios

Liquidity represents one's ability to pay its current obligations or short-term debts within a
period less than one year. Liquidity ratios, therefore, measures a company's liquidity
position. The ratios are important from the viewpoint of its creditors as well as
management. The liquidity position of the company can be measured mainly by using two
liquidity ratios such as follows.

a. Current Ratio

b. Quick Ratio

• Current Ratio

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 This ratio explains the relationship between current assets and current liabilities of a
business.

Current Assets:-‘Current assets’ includes those assets which can be converted into cash
with in a year’s time.

Current Assets = Cash in Hand + Cash at Bank + B/R + Short Term Investment +
Debtors(Debtors – Provision) + Stock(Stock of Finished Goods + Stock of Raw Material
+ Work in Progress) + Prepaid Expenses.

• Current Liabilities :- ‘Current liabilities’ include those liabilities which are repayable in
a year’s time.

• Current Liabilities = Bank Overdraft + B/P + Creditors + Provision for Taxation +

Proposed Dividend + Unclaimed Dividends + Outstanding Expenses + Loans Payable
with in a Year.

• Significance :- According to accounting principles, a current ratio of 2:1 is supposed to

be an ideal ratio.

It means that current assets of a business should, at least , be twice of its current liabilities.
The higher ratio indicates the better liquidity position, the firm will be able to pay its current
liabilities more easily. If the ratio is less than 2:1, it indicate lack of liquidity and shortage of
working capital.

• The biggest drawback of the current ratio is that it is susceptible to “window dressing”.
This ratio can be improved by an equal decrease in both current assets and current
liabilities.

Current ratio is also known as short-term solvency ratio or working capital ratio. Current ratio is
used to assess the short-term financial position of the business. In other words, it is an indicator
of the firm's ability to meet its short-term obligations.

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Current ratio is calculated by using following formula:

Current ratio = Current assets/Current liabilities

Current assets are cash and those cash equivalent of a business which can be converted into cash
within a short period of time not exceeding a year. Cash in hand, cash at bank, bills receivables,
sundry debtors, accrued incomes, prepaid expenses, inventory, short term loans provided ,
advance given etc are the examples of current assets.

Current liabilities are those obligations of a business, which are to be paid within in a short
period of time not exceeding a year. Bills payable ,sundry creditors, short term loan taken,
income tax payable, dividend payable, advance incomes, accrued expenses are the examples of
current liabilities.

b. Quick Ratio

Quick ratio is another measure of a company's liquidity. Quick ratio is also known as liquid ratio
or acid test ratio. However, although it is used to test the short-term solvency or liquidity position
of the firm, it is a more stringent measure of liquidity than the current ratio. This ratio is
calculated by dividing liquid assets by current liabilities. Liquid assets are cash and other assets
which are either equivalent to cash or convertible into cash within a very short period of time.

The following formula is used to calculate quick ratio:

Quick Ratio = Liquid assets/Current Liabilities

Liquid assets = Total current assets - stock- prepaid expenses

b. Quick Ratio:- Quick ratio indicates whether the firm is in a position to pay its current
liabilities with in a month or immediately.

‘Liquid Assets’ means those assets, which will yield cash very shortly.

 Liquid Assets = Current Assets – Stock – Prepaid Expenses

Significance :- An ideal quick ratio is said to be 1:1. If it is more, it is considered to be better.

This ratio is a better test of short-term financial position of the company.

LEVERAGE OR CAPITAL STRUCTURE RATIO

Solvency ratios, also called leverage ratios, measure a company's ability to sustain operations
indefinitely by comparing debt levels with equity, assets, and earnings. In other words, solvency

40
ratios identify going concern issues and a firm's ability to pay its bills in the long term. Many
people confuse solvency ratios with liquidity ratios. Although they both measure the ability of a
company to pay off its obligations, solvency ratios focus more on the long-term sustainability of
a company instead of the current liability payments.

Solvency ratios show a company's ability to make payments and pay off its long-term obligations
to creditors, bondholders, and banks. Better solvency ratios indicate a more creditworthy and
financially sound company in the long-term.

The most common solvency ratios include:

• Debt to Equity Ratio

• Equity Ratio

• Debt Ratio

(B) Leverage or Capital Structure Ratio :- This ratio disclose the firm’s ability to meet the
interest costs regularly and Long term indebtedness at maturity.

These ratio include the following ratios :

a.      Debt Equity Ratio:- This ratio can be expressed in two ways:

First Approach : According to this approach, this ratio expresses the relationship between long
term debts and shareholder’s fund. The debt to equity ratio is a financial, liquidity ratio that
compares a company's total debt to total equity. The debt to equity ratio shows the percentage of
company financing that comes from creditors and investors. A higher debt to equity ratio
indicates that more creditor financing (bank loans) is used than investor financing (shareholders).

The debt to equity ratio is calculated by dividing total liabilities by total equity. The debt to
equity ratio is considered a balance sheet ratio because all of the elements are reported on the
balance sheet.

Long Term Loans:- These refer to long term liabilities which mature after one year. These
include Debentures, Mortgage Loan, Bank Loan, Loan from Financial institutions and Public
Deposits etc.

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Shareholder’s Funds :- These include Equity Share Capital, Preference Share Capital, Share
Premium, General Reserve, Capital Reserve, Other Reserve and Credit Balance of Profit & Loss
Account.

Second Approach : According to this approach the ratio is calculated as follows:-

 Formula:

Debt Equity Ratio=External Equities/internal Equities

 Debt equity ratio is calculated for using second approach.

Significance :- This Ratio is calculated to assess the ability of the firm to meet its long term
liabilities. Generally, debt equity ratio of is considered safe.

If the debt equity ratio is more than that, it shows a rather risky financial position from the long-
term point of view, as it indicates that more and more funds invested in the business are provided
by long-term lenders.The lower this ratio, the better it is for long-term lenders because they are
more secure in that case. Lower than 2:1 debt equity ratio provides sufficient protection to long-
term lenders.

b. Debt to Total Funds Ratio : This Ratio is a variation of the debt equity ratio and gives the
same indication as the debt equity ratio. In the ratio, debt is expressed in relation to total funds,
i.e., both equity and debt.

Formula:

Debt to Total Funds Ratio = Long-term Loans/Shareholder’s funds + Long-term Loans

 Significance :- Generally, debt to total funds ratio of 0.67:1 (or

67%) is considered satisfactory. In other words, the proportion of long term loans should not be
more than 67% of total funds.

A higher ratio indicates a burden of payment of large amount of interest charges periodically and
the repayment of large amount of loans at maturity. Payment of interest may become difficult if
profit is reduced. Hence, good concerns keep the debt to total funds ratio below 67%. The lower
ratio is better from the long-term solvency point of view.

c. Proprietary Ratio:- This ratio indicates the proportion of total funds provide by owners or
shareholders.

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 Formula:

Proprietary Ratio = Shareholder’s Funds/Shareholder’s Funds + Long term loans

 Significance :- This ratio should be 33% or more than that. In other words, the proportion of
shareholders funds to total funds should be 33% or more.

A higher proprietary ratio is generally treated an indicator of sound financial position from long-
term point of view, because it means that the firm is less dependent on external sources of
finance.

If the ratio is low it indicates that long-term loans are less secured and they face the risk of losing
their money.

d. Fixed Assets to Proprietor’s Fund Ratio :- This ratio is also know as fixed assets to net worth
ratio.

 Formula:

Fixed Asset to Proprietor’s Fund Ratio = Fixed Assets/Proprietor’s Funds (i.e., Net Worth)

Significance :- The ratio indicates the extent to which proprietor’s (Shareholder’s) funds are
sunk into fixed assets. Normally , the purchase of fixed assets should be financed by proprietor’s
funds. If this ratio is less than 100%, it would mean that proprietor’s fund are more than fixed
assets and a part of working capital is provided by the proprietors. This will indicate the long-
term financial soundness of business.

• Capital Gearing Ratio:- This ratio establishes a relationship between equity capital
(including all reserves and undistributed profits) and fixed cost bearing capital.

• Formula:

Capital Gearing Ratio = Equity Share Capital+ Reserves + P&L Balance/ Fixed cost Bearing
Capital

Whereas, Fixed Cost Bearing Capital = Preference Share Capital  + Debentures + Long Term
Loan

Significance:- If the amount of fixed cost bearing capital is more than the equity share capital
including reserves an undistributed profits), it will be called high capital gearing and if it is less,
it will be called low capital gearing.

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The high gearing will be beneficial to equity shareholders when the rate of interest/dividend
payable on fixed cost bearing capital is lower than the rate of return on investment in business.

Thus, the main objective of using fixed cost bearing capital is to maximize the profits available
to equity shareholders.

f. Interest Coverage Ratio:- This ratio is also termed as ‘Debt Service Ratio’. This ratio is
calculated as follows:

 Formula:

Interest Coverage Ratio = Net Profit before charging interest and tax / Fixed Interest
Charges

Significance :- This ratio indicates how many times the interest charges are covered by the
profits available to pay interest charges.

This ratio measures the margin of safety for long-term lenders.

 This higher the ratio, more secure the lenders is in respect of payment of interest regularly. If
profit just equals interest, it is an unsafe position for the lender as well as for the company also ,
as nothing will be left for shareholders.

 An interest coverage ratio of 6 or 7 times is considered appropriate.

ACTIVITY RATIO OR TURNOVER RATIO

  (C) Activity Ratio or Turnover Ratio :- These ratio are calculated on the bases of ‘cost of sales’
or sales, therefore, these ratio are also called as ‘Turnover Ratio’.  Turnover indicates the speed
or number of times the  capital employed has been rotated in the process of doing business.
Higher turnover ratio indicates the better use of capital or resources and in turn lead to higher
profitability.

 It includes the following :

A.      Stock Turnover Ratio:- This ratio indicates the relationship between the cost of goods
during the year and average stock kept during that year.

Formula:

Stock Turnover Ratio = Cost of Goods Sold / Average Stock

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 Here, Cost of goods sold = Net Sales – Gross Profit

 Average Stock = Opening Stock + Closing Stock/2

Significance:- This ratio indicates whether stock has been used or not. It shows the speed with
which the stock is rotated into sales or the number of times the stock is turned into sales during
the year.

The higher the ratio, the better it is, since it indicates that stock is selling quickly. In a business
where stock turnover ratio is high, goods can be sold at a low margin of profit and even than
the profitability may be quit high.

b.      Debtors Turnover Ratio :- This ratio indicates the relationship between credit sales and
average debtors during the year :

Formula:

Debtor Turnover Ratio = Net Credit Sales / Average Debtors + Average B/R

While calculating this ratio, provision for bad and doubtful debts is not deducted from the
debtors, so that it may not give a false impression that debtors are collected quickly.

Significance :- This ratio indicates the speed with which the amount is collected from debtors.
The higher the ratio, the better it is, since it indicates that amount from debtors is being collected
more quickly. The more quickly the debtors pay, the less the risk from bad- debts, and so the
lower the expenses of collection and increase in the liquidity of the firm.

By comparing the debtors turnover ratio of the current year with the previous year, it may be
assessed whether the sales policy of the management is efficient or not.

c.       Average Collection Period :- This ratio indicates the time with in which the amount is
collected from debtors and bills receivables.

 Formula:

Average Collection Period = Debtors + Bills Receivable / Credit Sales per day

Here, Credit Sales per day = Net Credit Sales of the year / 365

Second Formula :-

Average Collection Period = Average Debtors *365 / Net Credit Sales

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Average collection period can also be calculated on the bases of ‘Debtors Turnover Ratio’. The
formula will be:

Average Collection Period = 12 months or 365 days / Debtors Turnover Ratio

Significance :- This ratio shows the time in which the customers are paying for credit sales. A
higher debt collection period is thus, an indicates of the inefficiency and negligency on the part
of management. On the other hand, if there is decrease in debt collection period, it indicates
prompt payment by debtors which reduces the chance of bad debts.

d. Creditors Turnover Ratio :- This ratio indicates the relationship between credit purchases and
average creditors during the year .

Formula:-

Creditors Turnover Ratio = Net credit Purchases / Average Creditors + Average B/P

Note :- If the amount of credit purchase is not given in the question, the ratio may be calculated
on the bases of total purchase.

Significance :- This ratio indicates the speed with which the amount is being paid to creditors.
The higher the ratio, the better it is, since it will indicate that the creditors are being paid more
quickly which increases the credit worthiness of the firm.

d. Average Payment Period :- This ratio indicates the period which is normally taken by the firm
to make payment to its creditors.

 Formula:-

Average Payment Period = Creditors + B/P/ Credit Purchase per day

This ratio may also be calculated as follows :

Average Payment Period = 12 months or 365 days / Creditors Turnover Ratio

Significance :- The lower the ratio, the better it is, because a shorter payment period implies that
the creditors are being paid rapidly.

d.      Fixed Assets Turnover Ratio :- This ratio reveals how efficiently the fixed assets are
being utilized.

Formula:-

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 Fixed Assets Turnover Ratio = Cost of Goods Sold/ Net Fixed Assets

Here, Net Fixed Assets = Fixed Assets – Depreciation

Significance:- This ratio is particular importance in manufacturing concerns where the

investment in fixed asset is quit high. Compared with the previous year, if there is increase in
this ratio, it will indicate that there is better utilization of fixed assets. If there is a fall in this
ratio, it will show that fixed assets have not been used as efficiently, as they had been used in the
previous year.

e.       Working Capital Turnover Ratio :- This ratio reveals how efficiently working capital
has been utilized in making sales.

Formula :-

Working Capital Turnover Ratio = Cost of Goods Sold / Working Capital

Here, Cost of Goods Sold = Opening Stock + Purchases +  Carriage + Wages + Other Direct
Expenses - Closing Stock

Working Capital = Current Assets – Current Liabilities

Significance :- This ratio is of particular importance in non-manufacturing concerns where

current assets play a major role in generating sales. It shows the number of times working capital
has been rotated in producing sales.

A high working capital turnover ratio shows efficient use of working capital and quick turnover
of current assets like stock and debtors.

A low working capital turnover ratio indicates under-utilisation of working capital.

Profitability Ratios or Income Ratios

(D) Profitability Ratios or Income Ratios:- The main object of every business concern is to earn
profits. A business must be able to earn adequate profits in relation to the risk and capital
invested in it. The efficiency and the success of a business can be measured with the help of
profitability ratio.

 Profitability ratios are calculated to provide answers to the following questions:

          i.            Is the firm earning adequate profits?

        ii.            What is the rate of gross profit and net profit on sales?
47
      iii.            What is the rate of return on capital employed in the firm?

      iv.            What is the rate of return on proprietor’s (shareholder’s) funds?

        v.            What is the earning per share?

 Profitability ratio can be determined on the basis of either sales or investment into business.

(A)       Profitability Ratio Based on Sales :

  a) Gross Profit Ratio : This ratio shows the relationship between gross profit and sales.

 Formula :

Gross Profit Ratio = Gross Profit / Net Sales *100

 Here, Net Sales = Sales – Sales Return

Significance:- This ratio measures the margin of profit available on sales. The higher the gross
profit ratio, the better it is. No ideal standard is fixed for this ratio, but the gross profit ratio
should be adequate enough not only to cover the operating expenses but also to provide for
deprecation, interest on loans, dividends and creation of reserves.

b) Net Profit Ratio:- This ratio shows the relationship between net profit and sales. It may be
calculated by two methods:

 Formula:

Net Profit Ratio = Net Profit / Net sales *100

Operating Net Profit = Operating Net Profit / Net Sales *100

Here, Operating Net Profit = Gross Profit – Operating Expenses such as Office and
Administrative Expenses, Selling and Distribution Expenses, Discount, Bad Debts, Interest on
short-term debts etc.

Significance :- This ratio measures the rate of net profit earned on sales. It helps in determining
the overall efficiency of the business operations. An increase in the ratio over the previous year
shows improvement in the overall efficiency and profitability of the business.

(c) Operating Ratio:- This ratio measures the proportion of an enterprise cost of sales and
operating expenses in comparison to its sales.

 Formula:

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Operating Ratio = Cost of Goods Sold + Operating Expenses/ Net Sales *100

Where, Cost of Goods Sold = Opening Stock + Purchases + Carriage + Wages + Other Direct
Expenses - Closing Stock

Operating Expenses = Office and Administration Exp. + Selling and Distribution Exp. +
Discount + Bad Debts + Interest on Short- term loans.

‘Operating Ratio’ and ‘Operating Net Profit Ratio’ are inter-related. Total of both these ratios
will be 100.

Significance:- Operating Ratio is a measurement of the efficiency and profitability of the

business enterprise. The ratio indicates the extent of sales that is absorbed by the cost of goods
sold and operating expenses. Lower the operating ratio is better, because it will leave higher
margin of profit on sales.

(d) Expenses Ratio:- These ratio indicate the relationship between expenses and sales. Although
the operating ratio reveals the ratio of total operating expenses in relation to sales but some of the
expenses include in operating ratio may be increasing while some may be decreasing. Hence,
specific expenses ratio are computed by dividing each type of expense with the net sales to
analyse the causes of variation in each type of expense.

The ratio may be calculated as :

(a) Material Consumed Ratio = Material Consumed/Net Sales*100

(b) Direct Labour cost Ratio = Direct labour cost / Net sales*100

(c) Factory Expenses Ratio = Factory Expenses / Net Sales *100

 (a), (b) and (c) mentioned above will be jointly called cost of goods sold ratio.

 It may be calculated as:

 Cost of Goods Sold Ratio = Cost of Goods Sold / Net Sales*100

(d) Office and Administrative Expenses Ratio = Office and Administrative Exp./

                                                                            Net Sales*100

(e) Selling Expenses Ratio = Selling Expenses / Net Sales *100

(f) Non- Operating Expenses Ratio = Non-Operating Exp./Net sales*100

49
  

Significance:- Various expenses ratio when compared with the same ratios of the previous year
give a very important indication whether these expenses in relation to sales are increasing,
decreasing or remain stationary. If the expenses ratio is lower, the profitability will be greater
and if the expenses ratio is higher, the profitability will be lower.

(B) Profitability Ratio Based on Investment in the Business:-

These ratio reflect the true capacity of the resources employed in the enterprise. Sometimes the
profitability ratio based on sales are high whereas profitability ratio based on investment are low.
Since the capital is employed to earn profit, these ratios are the real measure of the success of the
business and managerial efficiency.

These ratio may be calculated into two categories:

I. Return on Capital Employed

II. Return on Shareholder’s funds

I.      Return on Capital Employed :- This ratio reflects the overall profitability of the business. It
is calculated by comparing the profit earned and the capital employed to earn it. This ratio is
usually in percentage and is also known as ‘Rate of Return’ or ‘Yield on Capital’. 

Formula:

Return on Capital Employed = Profit before interest, tax and dividends/

Capital Employed *100

Where, Capital Employed = Equity Share Capital + Preference Share Capital + All Reserves +
P&L Balance +Long-Term Loans- Fictitious Assets (Such as Preliminary Expenses OR etc.) –
Non-Operating Assets like Investment made outside the business.

Capital Employed = Fixed Assets + Working Capital  

Advantages of ‘Return on Capital Employed’:-

     Since profit is the overall objective of a business enterprise, this ratio is a barometer of the
overall performance of the enterprise. It measures how efficiently the capital employed in the
business is being used.

     Even the performance of two dissimilar firms may be compared with the help of this ratio.
50
     The ratio can be used to judge the borrowing policy of the enterprise.

     This ratio helps in taking decisions regarding capital investment in new projects. The new
projects will be commenced only if the rate of return on capital employed in such projects is
expected to be more than the rate of borrowing.

     This ratio helps in affecting the necessary changes in the financial policies of the firm.

     Lenders like bankers and financial institution will be determine whether the enterprise is
viable for giving credit or extending loans or not.

     With the help of this ratio, shareholders can also find out whether they will receive regular
and higher dividend or not.

II. Return on Shareholder’s Funds :-

Return on Capital Employed Shows the overall profitability of the funds supplied by long term
lenders and shareholders taken together. Whereas, Return on shareholders funds measures only
the profitability of the funds invested by shareholders.

These are several measures to calculate the return on shareholder’s funds:

(a) Return on total Shareholder’s Funds :-

For calculating this ratio ‘Net Profit after Interest and Tax’ is divided by total shareholder’s
funds.

 Formula:

Return on Total Shareholder’s Funds = Net Profit after Interest and Tax / Total Shareholder’s
Funds

Where, Total Shareholder’s Funds = Equity Share Capital + Preference Share Capital + All
Reserves + P&L A/c Balance –Fictitious Assets

Significance:- This ratio reveals how profitably the proprietor’s funds have been utilized by the
firm. A comparison of this ratio with that of similar firms will throw light on the relative
profitability and strength of the firm.

(b) Return on Equity Shareholder’s Funds:-

51
 Equity Shareholders of a company are more interested in knowing the earning capacity of their
funds in the business. As such, this ratio measures the profitability of the funds belonging to the
equity shareholder’s.

Formula:

Return on Equity Shareholder’s Funds = Net Profit (after int., tax & preference dividend) /
Equity Shareholder’s Funds *100

 Where, Equity Shareholder’s Funds = Equity Share Capital + All Reserves + P&L A/c

 Balance – Fictitious Assets

 Significance:- This ratio measures how efficiently the equity shareholder’s funds are being used
in the business. It is a true measure of the efficiency of the management since it shows what the
earning capacity of the equity shareholders funds. If the ratio is high, it is better, because in such
a case equity shareholders may be given a higher dividend.

(c) Earning Per Share (E.P.S.) :- This ratio measure the profit available to the equity
shareholders on a per share basis. All profit left after payment of tax and preference dividend are
available to equity shareholders.

 Formula:

Earning Per Share = Net Profit – Dividend on Preference Shares / No. of Equity Shares

Significance:- This ratio helpful in the determining of the market price of the equity share of the
company. The ratio is also helpful in estimating the capacity of the company to declare dividends
on equity shares.

(d) Dividend Per Share (D.P.S.):- Profits remaining after payment of tax and preference
dividend are available to equity shareholders.

But of these are not distributed among them as dividend . Out of these profits is retained in the
business and the remaining is distributed among equity shareholders as dividend. D.P.S. is the
dividend distributed to equity shareholders divided by the number of equity shares.

 Formula:

D.P.S. = Dividend paid to Equity Shareholder’s / No. of Equity Shares *100

52
(e) Dividend Payout Ratio or D.P. :- It measures the relationship between the earning available
to equity shareholders and the dividend distributed among them.

 Formula:

 D.P. = Dividend paid to Equity Shareholders/ Total

Net Profit belonging to Equity Shareholders*100

OR

D.P. = D.P.S. / E.P.S. *100

 (f) Earning and Dividend Yield :- This ratio is closely related to E.P.S. and D.P.S. While the
E.P.S. and D.P.S. are calculated on the basis of the book value of shares, this ratio is calculated
on the basis of the market value of share

 (g) Price Earning (P.E.) Ratio:- Price earning ratio is the ratio between market price per equity
share & earnings per share. The ratio is calculated to make an estimate of appreciation in the
value of a share of a company & is widely used by investors to decide whether or not to buy
shares in a particular company.

Significance :- This ratio shows how much is to be invested in the market in this company’s
shares to get each rupee of earning on its shares. This ratio is used to measure whether the
market price of a share is high or low.

PRINCIPLES OF WORKING CAPITAL MANAGEMENT POLICY:

The following are the general principles of a sound working capital management policy:

1. PRINCIPLE OF RISK VARIATION (CURRENT ASSETS POLICY):

Risk here refers to the inability of a firm to meet its obligations as and when they become due for
payment. Larger investment in current Assets with less dependence on short term borrowings,
increase liquidity, reduces risk and thereby decreases the opportunity for gain or loss. On the
other hand less investments in current assets with greater dependence on short term borrowings,

53
reduces liquidity and increase profitability. In other words there is a definite inverse relationship
between the degree of risk and profitability. In other words, there is a definite inverse
relationship between the risk and profitability. A conservative management prefers to minimize
risk by maintaining a higher level of current assets or working capital while a liberal
management assumes greater risk by reducing working capital. However, the goal of
management should be to establish a suitable trade off between profitability and risk.

2. PRINCIPLES OF COST OF CAPITAL: The various source of raising working capital

finance have different cost of capital and the degree of risk involved. Generally, higher and risk
however the risk lower is the cost and lower the risk higher is the cost. A sound working capital
management should always try to achieve a proper balance between these two.

3.PRINCIPLE OF EQUITY POSITION: The principle is concerned with planning the total
investments in current assets. According to this principle, the amount of working capital invested
in each component should be adequately justified by a firm’s equity position. Every rupee
invested in current assets should contribute to the net worth of the firm. The level of current
assets may be measured with the help of two ratios:

1. Current assets as a percentage of total assets and

2. Current assets as a percentage of total sales

While deciding about the composition of current assets, the financial manager may consider the
relevant industrial averages.

4. PRINCIPLES OF MATURITY OF PAYMENT: The principle is concerned with planning

the source of finance for working capital. According to the principles, a firm should make every
effort to relate maturities of payment to its flow of internally generated funds. Maturity pattern of
various current obligations is an important factor in risk assumptions and risk assessments.
Generally shorter the maturity schedule of current liabilities in relation to expected cash inflows,
the greater the inability to meet its obligations in time.

54
INVENTORY MANAGEMNT: Inventory includes all type of stocks. For effective working

capital management, inventory needs to be managed effectively. The level of inventory should

be such that the total cost of ordering and holding inventory is the least. Simultaneously stock

out costs should be minimized. Business therefore should fix the minimum safety stock level

reorder level of ordering quantity so that the inventory costs is reduced and outs management

become efficient.

55
The management of stock/ inventory is a key aspect of working capital management.

Inventory-A physical resource that a firm holds in stock with the intent of selling it or
transforming it into a more valuable state.— Inventory System- A set of policies and controls
that monitors levels of inventory and determines what levels should be maintained, when stock
should be replenished, and how large orders should be placed.

Items carried in inventory can be Raw materials Purchased parts Components Subassemblies
Work-in-process Finished goods

Reasons for keeping Inventories To stabilise production To take advantage of price discounts
To meet the demand during the replenishment period To prevent loss of orders(sales) To keep
pace with changing market conditions.

Inventory is a major investment for many companies. Manufacturing companies can easily be
carrying inventory equivalent to between 50% and100% of the revenue of the business. It is
therefore essential to reduce the levels of inventory held to the necessary minimum.

56
Importance of inventory management

The challenge of good inventory management is to determine:

• the optimum re-order level (how many items are left in inventory when the next order is
placed), and

• the optimum re-order quantity (how many items should be ordered when the order is
placed)

In practice, this means striking a balance between holding costs on the one hand and stock out
and re-order costs on the other.

Costs of high inventory levels

Keeping inventory levels high is expensive due to:

• purchase costs

• holding cost (storage, stores administration

• risk of theft/damage/obsolescence)

Carrying inventory involves a major working capital investment and therefore levels need to be
very tightly controlled. The cost is not just that of purchasing the goods, but also storing,
insuring, and managing them once they are in inventory.

Costs of low inventory levels

If inventory levels are kept too low, the business faces alternative problems:

• Stock outs (lost contribution, production stoppages, emergency orders)

• high re-order/setup costs

• lost quantity discounts.

Objectives and Benefits

57
 Inventory control aims at keeping track of inventories. In other words, inventories of good
quality and right quantities should be made available to different departments as and when they
needed.

COSTS ASSOCIATED WITH INVENTORY

• Purchase (or Production) cost

• Capital cost Ordering cost

• Inventory carrying costs (holding costs)

• Shortage cost

Inventory Planning and Control For maintaining the right balance between high and low
inventory to minimize cost

Inventory Control Decision

• How much to order?

• When to order?

ECONOMIC ORDER QUANTITY

Annual Cost ($) ,Higher ,Minimum, Total Annual Stocking Costs, Total Annual Stocking Costs
Annual Carrying Costs, Lower Annual Ordering Costs, Order Quantity Smaller EOQ Larger

TYPES OF INVENTORY MODELS

• Simple EOQ model

• EOQ model with stock outs allowed

• Inventory model under risk

58
 SELECTIVE CONTROL OF INVENTORY - Selective control refers to the variation in
method of control from item to item on some selective basis. Many criteria used for this purpose
are Based on the cost of product Lead time Usage rate Procurement difficulties, criticality,
frequency of usage

SELECTIVE CONTROL OF INVENTORY –

• ABC analysis,

• VED Analysis

• Material requirements planning (MRP)

RECEIVABLE MANAGEMENT: Given a choice, every business would prefer selling its

produce on cash basis. However, due to factors like trade policies , prevailing market conditions

etc. Business are compelled to sells their goods on credit. In certain circumstances a business

may deliberately extend credit as a strategy of increasing sales. Extending credit means creating

current assets in the form of debtors or account receivables. Investment in the type of current

assets needs proper and effective management as, it gives rise to costs such as :

• Cost of carrying receivables

• Cost of bad debts losses

Thus the objective of any management policy pertaining to accounts receivables would be to

ensure the benefits arising due to the receivables are more then the costs incurred for the

receivables and the gap between benefit and costs increased resulting in increase profits. An

effective control of receivables

59
Help a great deal in properly managing it. Each business should therefore try to find out

coverage credit extends to its clients using the below given formula:

Average Credit = Total amount of receivable

(Extend in days) Average credit sale per day

Each business should project expected sales and expected investments in receivable based on

various factor, which influence the working capital requirement. From this it would be

possible to find out the average credit days using the above given formula. A business should

continuously try to monitor the credit days and see that the average. Credit offer to clients is

not crossing the budgeted period otherwise the requirement of investment in the working

capital would increase and as a result, activities may get squeezed. This may lead to cash

crisis.

CASH MANAGEMENT

Cash is a key part of working capital management.

Cash management refers to a broad area of finance involving the collection, handling, and usage
of cash. It involves assessing market liquidity, cash flow, and investments.

Cash management services can be costly but usually the cost to a company is outweighed by the
benefits: cost savings, accuracy, efficiencies, etc.

CASH BUDGET: Cash budget basically incorporates estimates of future inflow and outflows

of cash cover a projected short period of time which may usually be a year, a half or a quarter

60
year . effective cash management is facilated if the cash budget is further broken down into

months, weeks or even a daily basis.

There are two components of cash budget are:

1. Cash inflows

2. Cash outflows

The main source for thses flows are given here under:

1. Cash Sales

2. Cash received from debtors

3. Cash received from Loans, deposits etc.

4. Cash receipts other revenue income

5. Cash received from sale of investment or assets.

CASH OUTFLOWS:

1. Cash Purchase

2. Cash payments to Creditors

3. Cash payment for other revenue expenditure

4. Cash payment for assets creation

5. Cash payments for withdrawals, taxes.

61
 6. Repayments of Loan etc.

A suggestive for, at for cash budget is given below:

Cash forecast

A cash forecast is an estimate of cash receipts and payments for a future period under existing
conditions. Every type of cash inflow and receipt, along with their timings,must be forecast.
Cash receipts and payments differ from sales and cost of sales in the income statement because:

• not all cash receipts or payments affect the income statement

• some income statement items are derived from accounting conventions and are not cash
flows

• the timing of cash receipts and payments does not coincide with the income statement
accounting period

Short-term borrowing

Short-term cash requirements can also be funded by borrowing from the bank. There are two
main sources of bank lending:

• bank overdraft

• bank loans.

Bank overdrafts

62
A common source of short-term financing for many businesses is a bank overdraft. These are
mainly provided by the clearing banks and represent permission by the bank to write cheques
even though the firm has insufficient funds deposited in the account to meet the cheques.

An overdraft limit will be placed on this facility, but provided the limit is not exceeded, the firm
is free to make as much or as little use of the overdraft as it desires. The bank charges interest on
amounts outstanding at any one time, and the bank may also require repayment of an overdraft at
any time.

The advantages of overdrafts are the following.

• Flexibility as they can be used as required.

• Cheapness as interest is only payable on the finance actually used, usually at 2-5% above
base rate (and all loan interest is a tax deductible expense).

The disadvantages of overdrafts are as follows.

• Overdrafts are legally repayable on demand. Normally, however, the bank will give
customers assurances that they can rely on the facility for a certain time period, say six
months.

• Security is usually required by way of fixed or floating charges on assets or sometimes, in

private companies and partnerships, by personal guarantees from owners.

• Interest costs vary with bank base rates. This makes it harder to forecast and exposes the
business to future increases in interest rates.

Bank loans

Bank loans are a contractual agreement for a specific sum, loaned an agreed rate of interest.
They are less flexible and more expensive than overdrafts but provide greater security.

63
A bank loan represents a formal agreement between the bank and the borrower, that the bank
will lend a specific sum for a specific period (one to seven years being the most common).
Interest must be paid on the whole of this sum for the duration of the loan.

This source is, therefore, liable to be more expensive than the overdraft and is less flexible but,
on the other hand, there is no danger that the source will be withdrawn before the expiry of the
loan period. Interest rates and requirements for security will be similar to overdraft lending

64
CREDITORS MANAGEMENT

Managing creditors / payables is a key part of working capital management.

Trade credit is the simplest and most important source of short-term finance for many
companies. The objectives of payables management is to ascertain the optimum level of trade
credit to accept from suppliers.

By delaying payment to suppliers companies face possible problems:

• supplier may refuse to supply in future

• supplier may only supply on a cash basis

• there may be loss of reputation

• supplier may increase price in future.

Early settlement discounts

A proportion of the firm's suppliers will normally offer early settlement discounts which should
be taken up where possible by ensuring prompt payment within the specified terms where
settlement discount is allowed. However, if the firm is short of funds, it might wish to make
maximum use of the credit period allowed by suppliers regardless of the settlement discounts
offered.

Annual cost of a discount

The calculation of the annual cost of a discount can be expressed as a formula:

Notice that the annual cost calculation is always based on the amount left to pay, i.e. the amount
net of discount.

65
If the annual cost of the discount exceeds the rate of overdraft interest then the discount should
not be accepted.

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.

66
WORKING CAPITAL ANALYSIS OF COMPANY

1.CALCULATION OF CURRENT RATIO

                                                                              (Rupees in crore)

Year 2012 2013 2014

Current Assets 92.29 93.14 146.57

Current Liabilities 37.42 30.58 43.48

Current Ratio 2.46:1 3-04:1 3.37

3.5

2.5

2
Series 3

1.5

0.5

0
2012 2013 2014

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 2012 to 2014. 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.

67
2. QUICK RATIO

Quick ratio is a more rigorous test of liquidity than current ratio. Quick ratio may be defined as
the relationship between quick/liquid assets and current or liquid liabilities. An asset is said to be
liquid if it can be converted into cash with a short period without loss of value. It measures the
firms’ capacity to pay off current obligations immediately.

QUICK RATIO = QUICK ASSETS

                     CURRENT LIABILITES

Where Quick Assets are:

1)           Marketable Securities

2)           Cash in hand and Cash at bank.

3)           Debtors.

A high ratio is an indication that the firm is liquid and has the ability to meet its current liabilities
in time and on the other hand a low quick ratio represents that the firms’ liquidity position is not
good.

As a rule of thumb ratio of 1:1 is considered satisfactory. It is generally thought that if quick
assets are equal to the current liabilities then the concern may be able to meet its short-term
obligations. However, a firm having high quick ratio may not have a satisfactory liquidity
position if it has slow paying debtors. On the other hand, a firm having a low liquidity position if
it has fast moving inventories.

2.CALCULATION OF QUICK RATIO

68
                                                               (Rupees in Crore)

Year 2012 2013 2014

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

2.5

1.5

Series 3
1

0.5

0
2012 2013 2014

Interpretation

A quick ratio is an indication that the firm is liquid and has the ability to meet its current
liabilities in time. The ideal quick ratio is   1:1. Company’s quick ratio is more than ideal ratio.
This shows company has no liquidity problem.

3. ABSOLUTE LIQUID RATIO

Although receivables, debtors and bills receivable are generally more liquid than inventories, yet
there may be doubts regarding their realization into cash immediately or in time. So absolute

69
liquid ratio should be calculated together with current ratio and acid test ratio so as to exclude
even receivables from the current assets and find out the absolute liquid assets. Absolute Liquid
Assets includes :

ABSOLUTE LIQUID RATIO =      ABSOLUTE LIQUID ASSETS

                                                       CURRENT LIABILITES

ABSOLUTE LIQUID ASSETS = CASH & BANK BALANCES.

                                                          (Rupees in Crore)

Year 2012 2013 2014

Absolute Liquid Assets 4.69 1.79 5.06

Current Liabilities 27.42 20.58 33.48

Absolute Liquid Ratio .17 : 1 .09 : 1 .15 : 1

70
 0.18

0.16

0.14

0.12

0.1
Series 3
0.08

0.06

0.04

0.02

0
2012 2013 2014

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.

71
B) CURRENT ASSETS MOVEMENT RATIOS

Funds are invested in various assets in business to make sales and earn profits. The efficiency
with which assets are managed directly affects the volume of sales. The better the management
of assets, large is the amount of sales and profits. Current assets movement ratios measure the
efficiency with which a firm manages its resources. These ratios are called turnover ratios
because they indicate the speed with which assets are converted or turned over into sales.
Depending upon the purpose, a number of turnover ratios can be calculated. These are :

1.                 Inventory Turnover Ratio

2.                 Debtors Turnover Ratio

3.                 Creditors Turnover Ratio

4.                 Working Capital Turnover Ratio

The current ratio and quick ratio give misleading results if current assets include high amount of
debtors due to slow credit collections and moreover if the assets include high amount of slow
moving inventories. As both the ratios ignore the movement of current assets, it is important to
calculate the turnover ratio.

 DEBTORS TURNOVER RATIO :

A concern may sell its goods on cash as well as on credit to increase its sales and a liberal credit
policy may result in tying up substantial funds of a firm in the form of trade debtors. Trade
debtors are expected to be converted into cash within a short period and are included in current
assets. So liquidity position of a concern also depends upon the quality of trade debtors. Two
types of ratio can be calculated to evaluate the quality of debtors.

a)       Debtors Turnover Ratio

b)      Average Collection Period

DEBTORS TURNOVER RATIO = TOTAL SALES (CREDIT)

                                                         AVERAGE DEBTORS

72
Debtor’s velocity indicates the number of times the debtors are turned over during a year.
Generally higher the value of debtor’s turnover ratio the more efficient is the management of
debtors/sales or more liquid are the debtors. Whereas a low debtors turnover ratio indicates poor
management of debtors/sales and less liquid debtors. This ratio should be compared with ratios
of other firms doing the same business and a trend may be found to make a better interpretation
of the ratio.

AVERAGE DEBTORS= OPENING DEBTOR+CLOSING DEBTOR

                                                        2

Year 2012 2013 2014

Sales 166.0 151.5 169.5

Average Debtors 17.33 18.19 22.50

Debtor Turnover Ratio 9.6 times 8.3 times 7.5 times

73
 12

10

6
Series 3

0
2012 2013 2014

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.

74
  AVERAGE COLLECTION PERIOD :

Average Collection Period =    No. of Working Days

                                             Debtors Turnover Ratio

The average collection period ratio represents the average number of days for which a firm has to
wait before its receivables are converted into cash. It measures the quality of debtors. Generally,
shorter the average collection period the better is the quality of debtors as a short collection
period implies quick payment by debtors and vice-versa.

Average Collection Period =    365 (Net Working Days) 

                                             Debtors Turnover Ratio

Year 2012 2013 2014

Days 365 365 365

Debtor Turnover Ratio 9.6 8.3 7.5

Average Collection Period 38 days 44 days 49 days

75
 60

50

40

30
Series 3

20

10

0
2012 2013 2014

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.

76
5.    WORKING CAPITAL TURNOVER RATIO :

Working capital turnover ratio indicates the velocity of utilization of net working capital. This
ratio indicates the number of times the working capital is turned over in the course of the year.
This ratio measures the efficiency with which the working capital is used by the firm. A higher
ratio indicates efficient utilization of working capital and a low ratio indicates otherwise. But a
very high working capital turnover is not a good situation for any firm.

Working Capital Turnover Ratio =           Cost of Sales

                                                        Net Working Capital

Working Capital Turnover       =         Income from services        

                                                  Networking Capital

Year 2012 2013 2014

Sales 166.0 151.5 169.5

Networking Capital 53.87 62.52 103.09

Working Capital Turnover 3.08 2.4 1.64

77
 3.5

2.5

Series 3
1.5

0.5

0
2012 2013 2014

Interpretation : This ratio indicates low much net working capital requires for sales. In 2014,
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 income from services.

CASH BANK BALANCE :

78
 (Rs. in Crores)

Year 2011-2012 2012-2013 2013-2014

Cash Bank Balance 4.69 1.79 5.05

CASH AND BANK BALANCE

2012
2013
2014

Interpretation :       Cash is basic input or component of working capital. Cash is needed to keep
the business running on a continuous basis. So the organization should have sufficient cash to
meet various requirements. The above graph is indicate that in 2012 the cash is 4.69 crores but in
2013 it has decrease to 1.79. The result of that it disturb the firms manufacturing operations. In
2008, it is increased upto approx. 5.1% cash balance. So in 2008, the company has no problem
for meeting its requirement as compare to 2007.

DEBTORS :

(Rs. in Crores)

79
 Year 2011-2012 2012-2013 2013-2014

Debtors 17.33 19.05 25.94

30

25

20

15
Series 3

10

0
2012 2013 2014

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)

80
 Year 2011-2012 2012-2013 2013-2014

Current Assets 81.29 83.15 136.57

160

140

120

100

80
Series 3

60

40

20

0
2012 2013 2014

Interpretation :

  This graph shows that there is 64% increase in current assets in 2014. 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)

81
 Year 2011-2012 2012-2013 2013-2014

Current Liability 27.42 20.58 33.48

40

35

30

25

20
Series 3

15

10

0
2012 2013 2014

Interpretation :       Current liabilities shows company short term debts pay to outsiders. In 2014
the current liabilities of the company increased. But still increase in current assets are more than
its current liabilities.

NET WOKRING CAPITAL :

(Rs. in Crores)

82
 Year 2011-2012 2012-2013 2013-2014

Net Working Capital 53.87 62.53 103.09

120

100

80

60
Series 3

40

20

0
2012 2013 2014

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.

FINDINGS AND SUGGESSTIONS

83
  Making available just adequate quantum of working capital. Some of the existing

machinery is new with absolute equipments requiring modernization and rebuilding.

 The company should administrate their credit on the basis of certain well recognized and

established principle of credit administration.

 The company should maintain an optimum level of cash in the company in order to
maintain a proper liquidity in the business

After the analysis of the company status is better, because the Net working capital of the
company is doubled from the last year’s position .The company profits are huge in the current
year; it is better to declare the dividend to shareholders .The company is utilising the fixed assets,
which majorly help to the growth of the organisation. The company should maintain that
perfectly .The company fixed deposits are raised from the inception, it gives the other income
i.e., Interest on fixed deposits

The company’s overall position is at a good position. Particularly the current year’s position is
well due to raise in the profit level from the last year position. It is better for the organization to
diversify the funds to different sectors in the present market scenario.

84
85
86
87
 CONCLUSION

Working capital management is an important aspect of any business. Every business concern
should have adequate working capital to run its business operation. Every concern should have
neither redundant of excess working capital nor inadequate or shortage of working capital. Both
excess as well as short working capital positions are bad for any business.

The three elements of working capital management are cash management receivable
management and inventory management. If a finance manager maintains these three elements of
working capital management properly means the concern will get dramatic improvement in their
sales volume and also in business. Working capital policies of a firm have a great effect on its
profitability, liquidity and structured health of the organization.

Every concern should adopt some new tread management strategies that will help in greater
productivity, inventory optimization and also better working capital management. So, it is noted
that working capital is a means to run business smoothly and profitability. Thus, the concept of
working capital has its own important in a going concern.

Good management of working capital is part of good finance management effective use of
working capital will contribute to the operational efficiency of a department; optimum use will
help to generate maximum return.

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 BIBLIOGRAPHY

• www.wikipedia.com

• www.google.com

• Financial Management theory and practice by Prassanna

Chandra.

• Official website of the company www.birlasunlife.com

• ANNEXURES

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