Working Capital Management

WORKING CAPITAL MANAGEMENT
INDEX TABLE
SL.N CONTENTS PAGE

O NO.
1 PART – I
 INTRODUCTION
 MEANING
2 PART – II
3 PART - III

4 PART - IV

6 PART - V

7 PART - VI 67 TO
 DATA ANALYSIS AND INTERPRETATION 85
8 PART – VII 86 TO
 89

 CONCLUSIONS.
ANNEXURE
9
90 TO
92
 FINANCIAL STATEMENT.
 BIBILOGROPHY.
INTRODUCTION.
INTRODUCTION.
MEANIG OF CAPITAL.
MEANIG OF CAPITAL.
MEANING OF WORKING CAPITAL.
MEANING OF WORKING CAPITAL.
NEED OF WORKING CAPITAL.
NEED OF WORKING CAPITAL.
CLASSIFICATION OF WORKING CAPITAL.
CLASSIFICATION OF WORKING CAPITAL.
ESTIMATION OF “WC” REQIUREMENTS
ESTIMATION OF “WC” REQIUREMENTS
OPERATING CYCLE OF WORKING CAPITAL.
OPERATING CYCLE OF WORKING CAPITAL.
FINANCING OF WORKING CAPITAL.
FINANCING OF WORKING CAPITAL.
DETERMINANTS OF “WC” REQUIREMENTS.
DETERMINANTS OF “WC” REQUIREMENTS.
COMPONENTS OF “W C M”.
COMPONENTS OF “W C M”.
CAPITAL
Introduction:
Capital is the keynote of economic development. In this modern age, the level of
economic development is determined by the proportion of capital available.
Meaning of Capital:
In the ordinary sense of the word Capital means initial investment invested by businessman
or owner at the time of commencing the business.
Capital (economics), a factor of production that is not wanted for itself but for its ability to
help in producing other goods.
Definition:
Capital is a factor of production with a specific, changeable value attached to it that could,
potentially, provide its owner with more wealth. It is an abstract economic concept, and, as such,
has many different definitions and classifications, but the unifying feature of capital is that it has a
certain value, so it in itself is a type of wealth, and it has the potential of generating more wealth.
Features of Capital:
Capital has the following features.
1. Capital is a man made.
2. Capital is a perishable.
3. Capital is a human control possible.
4. Capital is a mobile.
5. Capital is a human sacrifice.
6. Capital is a scarce.
7. Capital is a passive factor.
INTRODUCTION OF WORKING CAPITAL:
Working capital is the life blood and nerve centre of a business. Just as circulation of 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.
There is operative aspects of working capital i.e. current assets which is known as funds also
employed to the business process from the gross working capital Current asset comprises cash
receivables, inventories, marketable securities held as short term investment and other items nearer
to cash or equivalent to cash. Working capital comes into business operation when actual operation
takes place generally the requirement of quantum of working capital is determined by the level of
production which depends upon the management attitude towards risk and the factors which
influence the amount of cash, inventories, receivables and other current assets required to support
given volume of production.
Working capital management as usually concerned with administration of the current assets as
well as current liabilities. The area includes the requirement of funds from various resources and to
utilize them in all result oriented manner. It can be stated without exaggeration that effective
working capital management is the short requirement of long term success.
MEANING OF WORKING CAPITAL
Working capital means the funds (i.e.; capital) available and used for day to day operations
(i.e.; working) of an enterprise. It consists broadly of that portion of assets of a business which are
used in or related to its current operations. It refers to funds which are used during an accounting
period to generate a current income of a type which is consistent with major purpose of a firm
existence.
In accounting term working capital is defined as the difference between current assets and
current liabilities. If we break down the components of working capital we will find working capital
as follows:
Working Capital = Current Assets – Current Liabilities
Current Assets: An asset is classified as current when:
(i) It is expected to be realised or intends to be sold or consumed in normal
operating cycle of the entity or within twelve months after the reporting
period whichever is longer; and
(ii) The asset is held primarily for the purpose of trading in the ordinary course of
business.
Current Liabilities: A liability is classified as current when:
(i) It is expected to be settled in normal operating cycle of the entity or within
twelve months after the reporting period whichever is longer; and
(ii) It is settled either by the use of current assets or by creation of new current
liability.
The goal of working capital management is to manage the firm’s current assets and
current liabilities in such way that the satisfactory level of working capital is mentioned.
DEFINITIONS:
Many scholars’ gives many definitions regarding term working capital some of these are
given below :
According to Weston & Brigham
“Working capital refers to a firm’s investment in short-term assets cash, short term
securities, accounts receivables and inventories.
Mead Mallott & Field
“Working capital means current assets”.
Guttmann & Dougall-
“Excess of current assets over current liabilities”.
Park & Gladson-
“The excess of current assets of a business (i.e. cash, accounts receivables, inventories)
over current items owned to employees and others (such as salaries & wages payable,
accounts payable, taxes owned to Government)”.
Capital required for a business can be classified under two main categories via,
1) Fixed Capital 2) Working Capital
Bonnerille
“Any acquisition of funds which increases the current assets increases working capital
for they are one and the same”.
Positive working capital means that the company is able to pay off its short-term liabilities
companies that have a lot of working capital will be more successful since they can expand and
improve their operations.

Negative working capital means that a company currently is unable to meet its short-term
liabilities with its current assets. . Companies with negative working capital may lack the funds
necessary for growth.
OBJECTIVES OF WORKING CAPITAL MANAGEMENT
Effective management of working capital is means of accomplishing the firm’s goal of adequate
liquidity. It is concerned with the administration of current assets and current liabilities. It has the
main following objectives-
1. To maximize profit of the firm.
2. To help in timely payment of bills.
3. To maintain sufficient current assets.
4. To ensure adequate liquidity of the firms.
5. It protects the solvency of the firm.
6. To discharge current liabilities.
7. To increase the value of the firm.
8. To minimize the risk of business.

THE NEED FOR THE WORKING CAPITAL
The need for working capital arises due to the time gap between production and realization of
cash from sales. Working capital is must for every business for purchasing raw-materials, semi
finished goods, stores & spares etc and the following purposes.
1. To purchase raw materials, spare parts and other component.

A manufacturing firm needs raw-materials and other components parts for the
purpose of converting them in to final products, for this purpose it requires working capital.
Trading concern requires less working capital.
2. To meet over head expenses.

Working capital is required to meet recurring over head expenses such as cost
of fuel, power, office expenses and other manufacturing expenses.
3. To hold finished and spare parts etc.
Stock represents current asset. A firm that can afford to maintain stock of required
finished goods, work in progress & spares in required quantities can operate successfully. So
for that adequate quantity of working capital is required.
4. To pay selling & distribution expenses.

Working capital is required to pay selling & distribution expenses. It includes cost of
packing, commission etc.
5. Working capital is required for repairs & maintenance both machinery as well as factory
buildings.
6. Working capital is required to pay wages, salaries and other charges.
7. It is helpful in maintain uncertainties involved in business field.

Working Capital Management refers to management of current assets and current

Liabilities. The major thrust of course is on the management of current assets .This
Is understandable because current liabilities arise in the context of current assets.
Working Capital Management is a significant fact of financial management. Its
Importance stems from two reasons:-
 Investment in current assets represents a substantial portion of total investment.
 Investment in current assets and the level of current liabilities have to be geared quickly to
change in sales. To be sure, fixed asset investment and long term financing are responsive to
variation in sales. However, this relationship is not as close and direct as it is in the case of working
capital components.
CLASSIFICATION OF WORKING CAPITAL
WORKING
CAPITAL
On The Basis of On The Basis of Time

Concepts
Gross Net Permanent / Temporary /

Working Capital Working Fixed Working Fluctuating
Capital Capital Working Capital
Initial Regular
Working Capital Working
Capital
Seasonal Special Working

Working Capital Capital
I. On The Basis of Concepts

1) Gross Working Capital
Gross working capital is the amount of funds invested in various components of current
assets. Current assets are those assets which are easily / immediately converted into cash within a
short period of time say, an accounting year. Current assets includes Cash in hand and cash at bank,
Inventories, Bills receivables, Sundry debtors, short term loans and advances.
This concept has the following advantages:-
i. Financial managers are profoundly concerned with the current assets.
ii. Gross working capital provides the correct amount of working capital at the right time.
iii. It enables a firm to realize the greatest return on its investment.

iv. It helps in the fixation of various areas of financial responsibility.
v. It enables a firm to plan and control funds and to maximize the return on investment.
For these advantages, gross working capital has become a more acceptable concept in
financial management.
2) Net Working Capital

This is the difference between current assets and current liabilities. Current liabilities are
those that are expected to mature within an accounting year and include creditors, bills payable and
outstanding expenses.
Working Capital Management is no doubt significant for all firms, but its significance is
enhanced in cases of small firms. A small firm has more investment in current assets than fixed
assets and therefore current assets should be efficiently managed.
The working capital needs increase as the firm grows. As sales grow, the firm needs to invest
more in debtors and inventories. The finance manager should be aware of such needs and finance
them quickly.
CONSTITUENTS OF CURRENT ASSETS

1) Cash in hand and cash at bank
2) Bills receivables
3) Sundry debtors
4) Short term loans and advances
5) Inventories of stock as:
a. Raw material
b. Work in process
c. Stores and spares
d. Finished goods
6. Temporary investment of surplus funds.
7. Prepaid expenses
8. Accrued incomes.
9. Marketable securities.
In a narrow sense, the term working capital refers to the net working.
Net working capital is the excess of current assets over current liability, or,
say:
NET WORKING CAPITAL = CURRENT ASSETS – CURRENT LIABILITIES.
Net working capital can be positive or negative.

When the current assets exceeds the current liabilities are more than the
current assets.
Current liabilities are those liabilities, which are intended to be paid in the
ordinary course of business within a short period of normally one accounting
year out of the current assts or the income business
CONSTITUENTS OF CURRENT LIABILITIES

1. Accrued or outstanding expenses.
2. Short term loans, advances and deposits.
3. Dividends payable.
4. Bank overdraft.
5. Provision for taxation, if it does not amt. to app. of profit.
7. Sundry creditors
II. On The Basis of Concepts
1) Permanent / Fixed Working Capital

Permanent or fixed working capital is minimum amount which is required to ensure
effective utilization of fixed facilities and for maintaining the circulation of current assets. Every firm
has to maintain a minimum level of raw material, work- in-process, finished goods and cash balance.
This minimum level of current assts is called permanent or fixed working capital as this part of
working is permanently blocked in current assets. As the business grow the requirements of working
capital also increases due to increase in current assets.
a) Initial working capital
At its inception and during the formative period of its operations a company must
have enough cash fund to meet its obligations. The need for initial working capital is for every
company to consolidate its position.
b) Regular working capital

Regular working capital refers to the minimum amount of liquid capital required to keep
up the circulation of the capital from the cash inventories to accounts receivable and from
account receivables to back again cash. It consists of adequate cash balance on hand and at
bank, adequate stock of raw materials and finished goods and amount of receivables.
2) Temporary / Fluctuating Working Capital

Temporary / Fluctuating working capital is the working capital needed to meet seasonal as
well as unforeseen requirements. It may be divided into two types.
a) Seasonal Working Capital
There are many lines of business where the volume of operations are different and
hence the amount of working capital vary with the seasons. The capital required to meet the
seasonal needs of the enterprise is known as seasonal Working capital.
b) Special Working Capital

The Capital required to meet any special operations such as experiments with new
products or new techniques of production and making interior advertising campaign etc, are also
known as special Working Capital.
IMPORTANCE OF WORKING CAPITAL

1. Solvency of the business: Adequate working capital helps in maintaining the solvency of the
business by providing uninterrupted of production.
2. Goodwill : Sufficient amount of working capital enables a firm to make prompt payments
and makes and maintain the goodwill.
3. Easy loans: Adequate working capital leads to high solvency and credit standing can arrange
loans from banks and other on easy and favorable terms.
4. Cash discounts: Adequate working capital also enables a concern to avail cash discounts on
the purchases and hence reduces cost.
5. Regular Supply of Raw Material: Sufficient working capital ensures regular supply of raw
material and continuous production.
6. Regular payment of salaries, wages and other day to day commitments : It leads to the
satisfaction of the employees and raises the morale of its employees, increases their
efficiency, reduces wastage and costs and enhances production and profits.
7. Exploitation of favorable market conditions: If a firm is having adequate working capital
then it can exploit the favorable market conditions such as purchasing its requirements in
bulk when the prices are lower and holdings its inventories for higher prices.
8. Ability to Face Crises: A concern can face the situation during the depression.
9. Quick and regular return on investments : Sufficient working capital enables a concern to
pay quick and regular of dividends to its investors and gains confidence of the investors and
can raise more funds in future.
10. High morale: Adequate working capital brings an environment of securities, confidence, high
morale which results in overall efficiency in a business.

ADEQUACY OF WORKING CAPITAL:

Working capital should be adequate so as to protect a business from the adverse effects
of shrinkage in the values of current assets. It ensures to a greater extent the maintenance of a
company’s credit standing and provides for such emergencies as strikes, floods, fire etc. It permits
the carrying of inventories at a level that would enable a business to serve satisfactorily the needs of
its customers. It enables a company to operate its business more efficiently because there is no
delay in obtaining materials etc; because of credit difficulties.
INADEQUATE OF WORKING CAPITAL:

When working capital is inadequate, a company faces many problems. It stagnates the
growth and it becomes difficult for the firm to undertake profitable projects for non-availability
of working capital funds. Difficulty in implementing operating plans and achieving the firm’s
profit targets. Operating inefficiencies creep in when it becomes difficult even to meet day-to-
day commitments. Fixed assets are not utilized efficiently thus the firm’s profitability would
deteriorate. Paucity of working capital funds renders the firm unable to avail attractive credit
opportunities. The firm loses its reputation when it is not in a position to honor it short-term
obligations thereby leading to tight credit terms.
DANGERS OF EXCESSIVE WORKING CAPITAL:
Too much working capital is as dangerous as too little of it. Excessive working capital raises
problems.
1. It results in unnecessary accumulation of inventories. Thus chances of inventory
mishandling, waste, theft and losses increase.
2. Indication of defective credit policy and slack collection period. Consequently, it results
in higher incidence of bad debts, adversely affecting profits,
3. Makes the management complacent which degenerates in to managerial inefficiency.
4. The tendencies of accumulating inventories to make a speculative profit, which tends to
liberalize the dividend policy, make it difficult for the concern to cope in the future when
it is not able to make speculative profits.

DETERMINANTS OF WORKING CAPITAL REQUIREMENTS

In order to determine the amount of working capital needed by the firm a number of factors
have to be considered by finance manager. These factors are explained below.
1. Nature of Business:
The Nature of the business effects the working capital requirements to a great
extent. For instance public utilities like railways, electric companies, etc. need very little
working capital because they need not hold large inventories and their operations are
mostly on cash basis, but in case of manufacturing firms and trading firms, the requirement
of working capital is sufficiently large as they have to invest substantially in inventories and
accounts receivables .
2. Production Policies:
The production policies also determine the Working capital requirement. Through the
production schedule i.e. the plan for production, production process etc.
The BCM has small production process.
3. Credit Policy:
The credit policy relating to sales and affects the working capital.
The credit policy influence the requirement of working capital in two ways:
1. Through credit terms granted by the firm to its customers/buyers.
2. Credit terms available to the firm from its creditors.
The credit terms granted to customers have a bearing on the Magnitude of Working capital by
determining the level of book debts. The credit sales results is higher book debts (re available)
higher book debt means more Working capital.
4. Changes in Technology:
Technology used in manufacturing process is mainly determined need of working capital.
Modernize technology needs low working capital, where as old and traditional technology needs
greater working capital.

5. Size of the Business Unit:
The size of the business unit is also important factor in influencing the working capital needs
of a firm. Large Scale Industries requires huge amount of working capital compared to Small scale
Industries.
6. Growth and Expansion:
The growth in volume and growth in working capital go hand in hand, however, the change
may not be proportionate and the increased need for working capital is felt right from the initial
stages of growth.
7. Dividend Policy:
Another appropriation of profits which has a bearing on working capital is dividend payment.
Payment of dividend utilizes cash while retaining profits acts as a source as working capital Thus
working capital gets affected by dividend policies.

8. Supply Conditions:
If supply of raw material and spares is timely and adequate, the firm can get by with a
comparatively low inventory level. If supply is scarce and unpredictable or available during particular
seasons, the firm will have to obtain raw material when it is available. It is essential to keep larger
stocks increasing working capital requirements.
9. Market Conditions:
The level of competition existing in the market also influences working capital requirement.
When competition is high, the company should have enough inventories of finished goods to meet a
certain level of demand. Otherwise, customers are highly likely to switch over to competitor’s
products. It thus has greater working capital needs. When competition is low, but demand for the
product is high, the firm can afford to have a smaller inventory and would consequently require
lesser working capital. But this factor has not applied in these technological and competitive days.
10. Business Cycle:
The working capital requirements are also determined by the nature of the business cycle.
Business fluctuations lead to cyclical and seasonal changes which, in turn, cause a shift in the
working capital position, particularly for temporary working capital the variations in the business
conditions may be in two directions:
1. Upward phase when boom condition prevail,
2. Downswing phase when economic activity is marked by a decline.
11. Profit Level:
Profit level also affects the working capital requirements as a concern higher
profit margin results in higher generation of internal funds and more contributing to working
capital.
C
ash
Price Level
Changes Inven
tory
Operating Factors to be
Efficiency Receiva
considered while
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planning for
Working Capital
requirement
Technol
Short-term
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MANAGEMENT OF WORKING CAPITAL

The importance of working capital for an entity can be
compared to importance of life blood for a living body or of a
lubricant/ fuel for an engine. Working capital is required for
smooth functioning of the business of an entity as lack of this
may interrupt the ordinary course of activities. Hence, the
working capital needs adequate attention and efficient
management. When we talk about the management, it
involves 3 Es i.e. Economy, Efficiency and Effectiveness and all
these three are required for the working capital management.
The scope of working capital management can be grouped into

two broad areas (i) Profitability and Liquidity and (ii) Investment
and Financing Decision.
Scope of Working Capital Management
Liquidity and Investment and

Profitability Financing
10.4.1 Liquidity and Profitability

For uninterrupted and smooth functioning of the day to day
business of an entity it is important to maintain liquidity of funds
evenly. As we have already learnt in previous chapters that each
rupee of capital bears some cost. So, while maintaining liquidity the
cost aspect needs to be borne in mind. Also, a higher working capital
may be intended to increase the revenue & hence profitability,
but at the same time unnecessary tying up of funds in idle assets
not only reduces the liquidity but also reduces the opportunity to
earn better return from a productive asset. Hence, a trade-off is
required between the liquidity and profitability which increases the
profitability without disturbing the day to day functioning. This
requires 3Es as discussed above i.e. economy in financing, efficiency
in utilisation and effectiveness in achieving the intended
objectives.
The trade-off between the components of working capital can
be summarised as follows:
Compon Advantages of Trade-off Advantages of

ent of higher side (between lower side
Working (Profitability) Profitability and (Liquidity)
Capital Liquidity)
Inventory Fewer stock-outs Use Lower inventory

increase the techniques like requires less capital
profitability. EOQ, JIT etc. to but endangered
carry optimum stock-out and loss of
level of inventory. goodwill.
Receivabl Higher Credit Evaluate the Cash sales
es period attract credit policy; use provide liquidity but
fails to
customers and the boost sales and

increase revenue services of revenue (due to
debt management lower credit period)
(factoring)
agencies.
Pre- Reduces Cost-benefit Improves or
payment of uncertainty and analysis required maintains liquidity.
expenses profitable in
inflationary
environment.
Cash and Payables are Cash budgets Cash can be
Cash honoured in time, and other cash invested in some
equivalents improves the management other investment
goodwill and techniques can be avenues
helpful in getting used
future discounts.
Payable Capital can be Evaluate the Payables are
s and used in some other credit policy and honoured in time,
Expenses investment avenues related cost. improves the
goodwill and helpful
in getting future
discounts.
10.4.1 Approaches of working capital investment
Based on the organisational policy and risk-return trade off, working capital investment
decisions are categorised into three approaches i.e. aggressive, conservative and moderate:
Approaches of Working Capital Investment
Aggres Moder Conserva

sive ate tive
(a)Aggressive: Here investment in working capital is kept

at minimal investment in current assets which means the entity
does hold lower level of inventory, follow strict credit policy,
keeps less cash balance etc. The advantage of this approach
is that lower level of fund is tied in the working capital which
results in lower financial costs but the flip side could be risk of
stock-outs & that the organisation could not
grow which leads to lower utilisation of fixed assets and
long-term debts.
(b)Conservative: In this approach, organisation choose to

invest high capital in current assets. Organisations use to keep
inventory level higher, follows liberal credit policies, and cash
balance as high as to meet any current liabilities immediately.
The advantages of this approach are higher sales volume,
increased demand due to liberal credit policy and increase
goodwill among the suppliers due to payment in short time.
The disadvantages are increase cost of capital, inventory
obsolescence, higher risk of bad debts, shortage of liquidity in
long run due to longer operating cycles.
(c) Moderate: This approach is in between the above two
approaches. Under this approach a balance between the risk and
return is maintained to gain more by using the funds in very
efficient manner.
ESTIMATING WORKING CAPITAL NEEDS

Operating cycle is one of the most reliable methods of Computation of Working
Capital.
However, other methods like ratio of sales and ratio of fixed investment may
also be used to determine the Working Capital requirements. These methods are
briefly explained as follows:
(i) Current Assets Holding Period: To estimate working capital needs based
on the average holding period of current assets and relating them to costs
based on the company’s experience in the previous year. This method is
essentially based on the Operating Cycle Concept.
(ii) Ratio of Sales: To estimate working capital needs as a ratio of sales on the
assumption that current assets change with changes in sales.
(iii) Ratio of Fixed Investments: To estimate Working Capital requirements as

a percentage of fixed investments.
A number of factors will, however, be impacting the choice of method of
estimating Working Capital. Factors such as seasonal fluctuations, accurate sales
forecast, investment cost and variability in sales price would generally be considered.
The production cycle and credit and collection policies of the firm will have an
impact on Working Capital requirements. Therefore, they should be given due
weightage in projecting Working Capital requirements.
10.6 OPERATING OR WORKING CAPITAL CYCLE

A useful tool for managing working capital is the operating cycle.
The operating cycle analyses the accounts receivable, inventory and accounts
payable cycles in terms of number of days. For example:
 Accounts receivables are analyzed by the average number of days it takes
to collect an account.
 Inventory is analyzed by the average number of days it takes to turn over
the sale of a product (from the point it comes in the store to the point it
is converted to cash or an account receivable).
 Accounts payables are analyzed by the average number of days it takes to
pay a supplier invoice.
Operating/Working Capital Cycle Definition
Working Capital cycle indicates the length of time between a company’s paying
for materials, entering into stock and receiving the cash from sales of finished
goods. It can be determined by adding the number of days required for each stage in
the cycle. For example, a company holds raw materials on an average for 60 days,
it gets credit from the supplier for 15 days, production process needs 15 days,
finished goods are held for 30 days and 30 days credit is extended to debtors. The
total of all these, 120 days, i.e., 60 – 15 + 15 + 30 + 30 days is the total working
capital cycle.
If you……………… Then ………………….
Collect receivables (debtors) faster You release cash from the cycle
Collect receivables (debtors) slower Your receivables soak up cash.

Get better credit (in terms of duration or You increase your cash resources.
amount) from suppliers.
Shift inventory (stocks) faster You free up cash.
Move inventory (stocks) slower. You consume more cash.
The duration of working capital cycle may vary depending on the nature of the
business.
In the form of an equation, the operating cycle process can be expressed as follows:
Operating Cycle = R + W + F + D – C
Where,
R = Raw material storage period
W = Work-in-progress holding period
F = Finished goods storage period
D= Receivables (Debtors) collection period.
C= Credit period allowed by suppliers (Creditors).
The various components of Operating Cycle may be calculated as shown

below:
(( Raw Material
Receivables Averagestock ofrawmaterial
AverageReceivables
1) Storage Period
4) (Debtors) collection = Average
Average Costof
Credit Raw Material Consumptionper
Salesper
day day
period
( Work-in-Progress Average Work - in- progress inventory
( Credit period AveragePayables
= AverageCostof
2) holding period Production per day
= Average CreditPurchasesper
5) allowed by suppliers day
( (Creditors)
Finished Goods Averagestock of finishedgoods
3) storage period = Average Costof GoodsSoldper day
Estimation of amount of Different Components of Current Assets and Current

Liabilities
The various constituents of current assets and current liabilities have a direct
bearing on the computation of working capital and the operating cycle. The holding
period of various constituents of Current Assets and Current Liabilities cycle may
either contract or expand the net operating cycle period.
Shorter the operating cycle period, lower will be the requirement of working
capital and vice-versa.
Estimation of Current Assets
The estimates of various components of gross working capital or current assets
may be made as follows:
(i) Raw Materials Inventory: The funds to be invested in raw materials

inventory may be estimated on the basis of production budget, the estimated cost
per unit and average holding period of raw material inventory by using the
following formula:
EstimatedProduction(units)
x Estimated cost per unit x Average raw material storage period
12months /
365days *
(ii) Work-in-Progress Inventory: The funds to be invested in work-in-progress

can be estimated by the following formula:
x Estimated WIP cost per unit x Average WIP holding period
12months /
365days *
(iii) Finished Goods: The funds to be invested in finished goods inventory can
be estimated with the help of following formula:
12months / x Estimated cost of producton per unit x Average finished goods storage period
365days *
(iv) Receivables (Debtors): Funds to be invested in trade receivables (debtors)

may be estimated with the help of following formula:
EstimatedCredit sales(units)
12months / x Estimated cost of sales (Excl. Dep.) per unit x Average receivable collection period
365days *
(v) Cash and Cash equivalents: Minimum desired Cash
and Bank balance to be maintained by the firm has to be
added in the current assets for the computation of
working capital.
Estimation of Current Liabilities
Current liabilities are deducted from the current assets
to get working capital. Hence, the amount of working
capital is lowered to the extent of current liabilities (other
than bank credit) arising in the normal course of business.
The important current liabilities like trade payables, wages
and overheads can be estimated as follows:
(i) Trade Payables: Trade payable can be estimated on
the basis of material purchase budget and the credit
purchase.
Estimatedcreditpurchase
× Credit period allowed by suppliers
12months /
365days *
(ii) Direct Wages: It is estimated with the help of direct wages

Estimatedlabourhours×wagesrateperhour
× Average time lag in payment of wages
12months /
365days *
budget.
(ii) Overheads (other than depreciation and amortization):
EstimatedOverheads
× Average time lag in payment of overheads
12months / 360
days *
*Number of days in a year may be taken as 365 or 360 days.

Estimation of Working Capital Requirements
Amo Amo Amo

unt unt unt
I Current Assets:
.
Inventories:
-Raw Materials ---
-Work-in-process ---
-Finished goods --- ---
Receivables:
-Trade debtors ---
-Bills --- ---
Minimum Cash Balance ---
Gross Working Capital --- ---
I Current Liabilities:
I.
Trade Payables ---
Bills Payables ---
Wages Payables ---
Payables for overheads --- ---
I Excess of Current ---
II. Assets over Current
Liabilities [I – II]
I Add: Safety Margin ---
V.
V Net Working Capital [III + IV] ---
.
10.6.1 Working Capital Requirement Estimation based on Cash Cost
We have already seen that working capital is the

difference between current assets and current liabilities. To
estimate requirements of working capital, we have to
forecast the amount required for each item of current
assets and current liabilities.
In practice another approach may also be useful in
estimating working capital requirements. This approach is
based on the fact that in the case of current assets, like
sundry debtors and finished goods, etc., the exact
amount of funds blocked is less than the amount of
such current assets. For example:
 If we have sundry debtors worth ` 1 lakh and our cost of
production is
` 75,000, the actual amount of funds blocked in
sundry debtors is ` 75,000 the cost of sundry
debtors, the rest (` 25,000) is profit.
 Again some of the cost items also are non-cash costs;
depreciation is a non-cash cost item. Suppose out
of ` 75,000, ` 5,000 is depreciation; then it is
obvious that the actual funds blocked in terms of
sundry debtors totaling ` 1 lakh is only ` 70,000.
In other words, ` 70,000 is the amount of funds
required to finance sundry debtors worth ` 1 lakh.
 Similarly, in the case of finished goods which are
valued at cost, non-cash costs may be excluded to
work out the amount of funds blocked.
Many experts, therefore, calculate the working capital
requirements by working out the cash costs of finished
goods and sundry debtors. Under this approach, the
debtors are calculated not as a percentage of sales value
but as a percentage of cash costs. Similarly, finished
goods are valued according to cash costs.
10.6.2 Effect of Double Shift Working on Working Capital
Requirements
The greatest economy in introducing double shift is the
greater utilization of fixed assets. Although production
increases, little or very marginal funds may be required for
additional assets.
But increase in the number of hours of production has
an effect on the working capital requirements. Let’s see the
impact of double shift on some of the components of
working capital:-
 It is obvious that in double shift working, an increase
in stocks will be required as the production rises.
However, it is quite possible that the increase may
not be proportionate to the rise in production since
the minimum level of stocks may not be very much
higher. Thus, it is quite likely that the level of stocks
may not be required to be doubled as the production
goes up two-fold.
 The amount of materials in process will not change
due to double shift working since work started in
the first shift will be completed in the second;
hence, capital tied up in materials in process will
be the same as with single shift working. As such the
cost of work-in-process will not change unless the
second shift’s workers are paid at a higher rate.
COMPONENTS OF WORKING CAPITAL
The components of working capital are:

 CASH MANAGEMENT
 RECEIVABLES MANAGEMENT
 INVENTORY MANAGEMENT
 PAYABLE MANAGMENT
 CASH MANAGEMENT:
Cash is the important current asset for the operation of the business. Cash is the
Basic input needed to keep the business running in the continuous basis, it is also the
ultimate output expected to be realized by selling or product manufactured by the firm.
The firm should keep sufficient cash neither more nor less. Cash shortage will disrupt the
firm’s manufacturing operations while excessive cash will simply remain ideal without
contributing anything towards the firm’s profitability. Thus a major function of the financial
manager is to maintain a sound cash position. Cash is the money, which a firm can disburse
immediately without any restriction. The term cash includes coins, currency and cheques held by
the firm and balances in its bank account.
NEED FOR HOLDING CASH

The need for holding Cash arises from a variety of reasons which are,
1. Transaction Motive:
A company is always entering into transactions with other entities. While some of
these transactions may not result in an immediate inflow/outflow of cash (E.g. Credit purchases
and Sales), other transactions cause immediate inflows and outflows. So firms keep a certain
amount of cash so as to deal with routine transactions where immediate cash payment is
required.
2. Precautionary Motive:
Contingencies have a habit of cropping up when least expected. A sudden fire may
break out, accidents may happen, employees may go on a strike, creditors may present bills
earlier than expected or the debtors may make payments earlier than warranted. The company
has to be prepared to meet these contingencies to minimize the losses. For this purpose
companies generally maintain some amount in the form of Cash.
3. Speculative Motive:
Firms also maintain cash balances in order to take advantage of opportunities that
do not take place in the course of routine business activities. For example, there may be a sudden
decrease in the price of Raw Materials which is not expected to last long or the firm may want to
invest in securities of other companies when the price is just right. These transactions are purely
of speculative nature for which the firms need cash.
OBJECTIVES OF CASH MANAGEMENT
Primary object of the cash management is to maintain a proper balance between liquidity
and profitability. In order to protect the solvency of the firm and also to maximize the
profitability. Following are some of the objectives of cash management.
1. To meet day to day cash requirements.

2. To provide for unexpected payments.
3. To maximize profits on available investment opportunities.
4. To protect the solvency of the firm and build up image.
5. To minimize operational cost of cash management.
6. To ensure effective utilization of available cash resources.
CASH BUDGETING
Cash budgeting is an important tool for controlling the cash. It is prepared for future
period to know the estimated amount of cash that may be required. Cash budget is a statement
of estimated cash inflows and outflows relating to a future period. It gives information about the
amount of cash expected to be received and the amount of cash expected to be paid out by a
firm for a given period.
METHODS OF CASH FLOW BUDGETING
A cash budget can be prepared in the following ways:
1. Receipts and Payments Method: In this method all the expected receipts and
payments for budget period are considered. All the cash inflow and outflow of all
functional budgets including capital expenditure budgets are considered. Accruals and
adjustments in accounts will not affect the cash flow budget. Anticipated cash
inflow is added to the opening balance of cash and all cash payments are deducted
from this to arrive at the closing balance of cash. This method is commonly used in
business organizations.
2. Adjusted Income Method: In this method the annual cash flows are calculated by
adjusting the sales revenue and cost figures for delays in receipts and payments
(change in debtors and creditors) and eliminating non-cash items such as
depreciation.
3. Adjusted Balance Sheet Method: In this method, the budgeted balance sheet is
predicted by expressing each type of asset (except cash & bank) and short-term
liabilities as percentage of the expected sales. The profit is also calculated as a
percentage of sales, so that the increase in owner’s equity can be forecasted.
Known adjustments, may be made to long-term liabilities and the balance sheet will
then show if additional finance is needed (if budgeted assets exceed budgeted
liabilities) or if there will be a positive cash balance (if budgeted liabilities exceed
budgeted assets).
Format of Cash Budget
__________Co. Ltd.
Cash Budget
Period______________
Mont Mont Mont Month

h1 h2 h3 12
Receipts:
1. Opening balance
2. Collection from
debtors
3. Cash sales
4. Loans from banks
5. Share capital
6. Miscellaneous
receipts
7. Other items
Total
Payments:
1. Payments to
creditors
2. Wages
3. Overheads
(a)
(b)
(c)
4. Interest
5. Dividend
6. Corporate tax
7. Capital
expenditure
8. Other items
T
otal
Closing balance
[Surplus (+)/Shortfall
(-)]
 RECEIVABLES MANAGEMENT:
Receivables or debtors are the one of the most important parts of the current
Assets which is created if the company sells the finished goods to the customer but not
receive the cash for the same immediately . Trade credit arises when a company sales its
products or services on credit and does not receive cash immediately. It is an essential
marketing tool, acting as a bridge for the moment of goods through production and distribution
stages to customers.
The receivables include three characteristics
1) It involve element of risk which should be carefully analysis.
2) It is based on economic value. To the buyer, the economic value in goods or services
passes immediately at the time of sale, while seller expects an equivalent value to be received
later on.
3) It implies futurity. The cash payment for goods or serves received by the buyer will be
made by him in a future period.
A company gives trade credit to protect its sales from the competitors and to attract the
potential customers to buy its products at favorable terms. Trade credit creates receivables or
book debts that the company is accepted to collect in the near future. The customers from who
receivables have to be collected are called as “Trade Debtors” receivables constitute a
substantial position of current assets.
Nature
The term credit policy is used to refer to the combination of three
decision variables:
1. Credit standards:
It is the criteria to decide the type of customers to whom goods could

be sold on credit. If a firm has more slow –paying customers, its investment
in accounts receivable will increase. The firm will also be exposed to higher
risk of default.
2. Credit terms:
It specifies duration of credit and terms of payment by Customer
Investment in accounts receivable will be high if customers are allowed
extended time period for making payments.
3. Collection efforts:
It determine the actual collection period. The lower the collection
period, the lower the investment in accounts receivable and vice versa.
APPROACHES TO EVALUATION OF CREDIT POLICIES

There are basically two methods of evaluating the credit policies to be adopted by a
Company – Total Approach and Incremental Approach. The formats for the two approaches
are given as under:
Statement showing the Evaluation of Credit Policies (based on Total Approach)
Particulars Presen Propos Propos Propos
t Policy ed Policy I ed Policy ed Policy
II III
` ` ` `
A. Expected Profit:
(a) Credit Sales ………. …………. ……….. ……….
(b) Total Cost other than Bad
Debts
(i)Variable Costs ……… ………… ………. ……….
(ii) Fixed Costs ……… ………… ………. ……….
……… ………. ………. ……..
(c) Bad Debts ……… ………… ……… ……….
(d) Cash discount
(e) Expected Net Profit .…….. ……….. ……… ……….
before Tax (a-b-c-d)
(f) Less: Tax ……... ……….. ………. ………
(g) Expected Profit after Tax ..……. ……… ……… ………
B. Opportunity Cost of ..…… ……… ………. ………
Investments in Receivables
locked up in Collection
Period
Net Benefits (A – B) ……… ……… ……… ……….
Advise: The Policy……. should be adopted since the net benefits under this policy are
higher as compared to other policies.
Here
(i) Total Fixed Cost = [Average Cost per unit – Variable Cost per unit] × No. of
units sold on credit under Present Policy
(ii) Opportunity Cost = Total Cost of Credit Sales ×
Collection period (Days) Required Rate of Return
365 (or 360) × 100
Statement showing the Evaluation of Credit Policies (based on Incremental Approach)
Particu Pre Propo Propo Propo

lars sent sed sed sed
Policy Policy I Policy II Policy III
days days days days
` ` ` `
A. Incremental Expected
Profit:
Credit Sales ………. …………. … …
…….. …….
(a) Incremental Credit Sales ………. …………. … …
…….. …….
(b) Less: Incremental Costs of
Credit Sales
(i) Variable Costs ………. …………. … …
…….. …….
(ii) Fixed Costs ………. …………. … …
…….. …….
(c) Incremental Bad Debt Losses ………. …………. … …
…….. …….
(d) Incremental Cash Discount ………. …………. … …
…….. …….
(e) Incremental Expected Profit ………. …………. … …
(a-b-c-d) …….. …….
(f)Less: Tax ………. …………. … …
…….. …….
(g) Incremental Expected Profit ………. …………. … …
after Tax …….. …….
………. …………. … …
…….. …….
B. Required Return on
Incremental Investments:
(a) Cost of Credit Sales ………. …………. … …
…….. …….
(b) Collection Period (in days) ………. …………. … …
…….. …….
(c) Investment in Receivable (a × ………. …………. … …
b/365 or 360) …….. …….
(d) Incremental Investment in ………. …………. … …
Receivables …….. …….
(e) Required Rate of Return (in ………. …………. … …
%) …….. …….
(f) Required Return on ………. …………. … …
Incremental Investments (d × …….. …….
e)
Incremental Net Benefits (A – ………. …………. … …
B) …….. …….
MANAGEMENT OF WORKING CAPITAL 10.
91
Advise: The Policy ……should be adopted since net benefits under this policy are
higher as compared to other policies.
Here:
(i) Total Fixed Cost = [Average Cost per unit – Variable Cost per unit] × No. of
units sold on credit under Present Policy
(ii) Opportunity Cost = Total Cost of Credit Sales ×
Collection period (Days) Required Rate of Return
365 (or 360) × 100
© The Institute of Chartered Accountants of

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 INVENTORY MANAGEMENT:
Inventories are goods held for eventual sale by a firm. Inventories are thus
one of the major elements, which help the firm in obtaining the desired level of sales.
Inventories includes raw materials, semi finished goods, finished products.
The main objectives of inventory management are operational and financial.
The operational mean that means that the materials and spares should be available in
sufficient quantity so that work is not disrupted for want of inventory. The financial objective
means that investments in inventories should not remain ideal and minimum working capital
should be locked in it.
The following are the objectives of inventory management:-
 To ensure continuous supply of materials, spares and finished goods.

 To avoid both over and under stocking of inventory.
 To maintain investments in inventories at the optimum level as required by the operational
and sale activities.
 To keep material cost under control so that they contribute in reducing cost of production
and overall purchases.
 To minimize losses through deterioration, pilferage, wastages and damages.
 To design proper organization for inventory control so that management. Clear cut account
ability should be fixed at various levels of the organization.
 To ensure perpetual inventory control so that materials shown in stock ledgers should be
actually lying in the stores.
 To ensure right quality of goods at reasonable prices.

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BENEFITS OF HOLDING INVENORIES: 93
Holding of large and adequate inventories is very beneficial to every firm. The
benefits or advantages of holding inventories area as follows.
1. Reducing orders cost.
2. Continuous production.
3. To avoid loss.
4. Availing quantity discount.
5. It enables the firm to avoid scarcity of goods meant for either production o sale.
COST OF HOLDING INVENTORIES:

Holding of inventory exposes the firm to a number of risks and costs. Risks of
holding inventories can be put as follows.
1. Material cost
2. Order cost
3. Storage cost
4. Insurance
5. Obsolescence
6. Spoilage
Each of the above mentioned costs have to be controlled through efficient inventory
management technique. That is:
Economic Order Quantity (EOQ):
This refers to the optimal ordering quantity that will incur the minimum total cost (order
cost and carrying cost) for an item of inventory. With the increase in the order size, the
ordering cost decreases but the carrying cost increases and the optimal order, quantity is
determined where these two costs are equal. The company is always tried to keep an eye on
the level of safety stock and the lead-time associated with the orders made.
E.O.Q = √ 2AO
C
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Here, A= Annual consumption. O= Ordering cost per order. C= Carrying cost per unit.

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Management of Payables/Creditors:
INTRODUCTION
There is an old age saying in business that if you can buy well then you can sell
well. Management of your creditors and suppliers is just as important as the management
of your debtors.
Trade creditor is a spontaneous source of finance in the sense that it arises from
ordinary business transaction. But it is also important to look after your creditors - slow
payment by you may create ill-feeling and your supplies could be disrupted and also
create a bad image for your company.
Creditors are a vital part of effective cash management and should be managed carefully
to enhance the cash position.
10.24 COST AND BENEFITS OF TRADE CREDIT

(a) Cost of Availing Trade Credit
Normally it is considered that the trade credit does not carry any cost. However,
it carries the following costs:
(i) Price: There is often a discount on the price that the firm undergoes when
it uses trade credit, since it can take advantage of the discount only if it pays
immediately. This discount can translate into a high implicit cost.
(ii) Loss of goodwill: If the credit is overstepped, suppliers may discriminate
against delinquent customers if supplies become short. As with the effect of
any loss of goodwill, it depends very much on the relative market strengths of
the parties involved.
(iii) Cost of managing: Management of creditors involves administrative and
accounting costs that would otherwise be incurred.
(iv) Conditions: Sometimes most of the suppliers insist that for availing the credit
facility the order should be of some minimum size or even on regular basis.

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(b) Cost of Not Taking Trade Credit
On the other hand, the costs of not availing credit facilities are as under:
(i) Impact of Inflation: If inflation persists then the borrowers are favored over the
lenders as they were better off to pay the fixed outstanding amount later than
sooner. Also, the subsequent transactions shall be at higher prices.
(ii) Interest: Trade credit is a type of interest free loan, therefore failure to avail this
facility has an interest cost. This cost is further increased if interest rates are
higher.
(iii) Inconvenience: Sometimes it may also cause inconvenience to the supplier if the
supplier is geared to the deferred payment.
10.25 COMPUTATION OF COST OF PAYABLES

By using the trade credit judiciously, a firm can reduce the effect of growth or
burden on investments in Working Capital.
Now question arises how to calculate the cost of not taking the discount.
The following equation can be used to calculate nominal cost, on an annual basis of
not taking the discount:
d

100
365days t
d
However, the above formula does not take into account the compounding effect and
therefore, the cost of credit shall be even higher. The cost of lost cash discount can be
estimated by the formula:
3
 10065
 
 t
 100 1

d
Where,
d = Size of discount i.e. for 6% discount, d = 6
t = The reduction in the payment period in days, necessary to obtain the early
discount or Days Credit Outstanding – Discount Period.

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10.26 INTRODUCTION
After determining the amount of working capital required, the next step to be taken by
the finance manager is to arrange the funds.
The permanent working capital is always needed irrespective of sales fluctuation; hence
it should be financed by the long-term sources such as debt and equity. On the contrary the
temporary working capital may be financed by the short-term sources of finance.
the working capital finance may be classified between the two categories:
(i) Spontaneous sources; and
(ii) Negotiable sources.
Spontaneous Sources: Spontaneous sources of finance are those which naturally arise in
the course of business operations. Trade credit, credit from employees, credit from
suppliers of services, etc. are some of the examples which may be quoted in this respect.
Negotiated Sources: On the other hand, the negotiated sources, as the name implies, are
those which have to be specifically negotiated with lenders say, commercial banks, financial
institutions, general public etc.
The finance manager has to be very careful while selecting a particular source, or a
combination thereof for financing of working capital.
10.27 SOURCES OF FINANCE
10.27.1 Spontaneous Sources of Finance

( a ) Trade Credit: This source of financing working capital is more important since it
contributes to about one-third of the total short-term requirements. The dependence on
this source is higher due to lesser cost of finance as compared with other sources. Trade
credit is guaranteed when a company acquires supplies, merchandise or materials and
does not pay immediately.
( a ) Bills Payable: On the other hand, in the case of “Bills Payable” the purchaser will have
to give a written promise to pay the amount of the bill/invoice either on demand or at a
fixed future date to the seller or the bearer of the note.
(b) Accrued Expenses: Another spontaneous source of short-term financing is the

accrued expenses or the outstanding expenses liabilities. The accrued expenses refer to the
services availed by the firm, but the payment for which has yet to be made. It is a built in
and an automatic source of finance as most of the services like wages, salaries, taxes,
duties etc., are paid at the end of the period.
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10.27.2 Inter-corporate Loans and Deposits

Sometimes, organizations having surplus funds invest for short-term period with other
organizations. The rate of interest will be higher than the bank rate of interest and depends
on the financial soundness of the borrower company. This source of finance reduces
dependence on bank financing.

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10.27.3 Commercial Papers
Commercial Paper (CP) is an unsecured promissory note issued by a firm to raise funds
for a short period. This is an instrument that enables highly rated corporate borrowers for
short-term borrowings and provides an additional financial instrument to investors with a
freely negotiable interest rate. The maturity period ranges from minimum 7 days to less
than 1 year from the date of issue. CP can be issued in denomination of ` 5 lakhs or
multiples thereof.
10.27.4 Funds Generated from Operations
Funds generated from operations, during an accounting period, increase working capital
by an equivalent amount. The two main components of funds generated from operations
are profit and depreciation.

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10.27.5 Public Deposits

Deposits from the public are one of the important sources of finance particularly
for well-established big companies with huge capital base for short and medium- term.
10.27.6 Bills Discounting
Bill discounting is recognized as an important short-term Financial Instrument and it is
widely used method of short-term financing. In a process of bill discounting, the supplier
of goods draws a bill of exchange with direction to the buyer to pay a certain amount of
money after a certain period, and gets its acceptance from the buyer or drawee of the bill.
10.27.7 Bill Rediscounting Scheme
The Bill rediscounting Scheme was introduced by Reserve Bank of India with effect from
1st November, 1970 in order to extend the use of the bill of exchange as an instrument for
providing credit and the creation of a bill market in India with a facility for the
rediscounting of eligible bills by banks. Under the bills rediscounting scheme, all licensed
scheduled banks are eligible to offer bills of exchange to the Reserve Bank for rediscount.
10.27.8 Factoring
Students may refer to the unit on Receivable Management wherein the concept of
factoring has been discussed. Factoring is a method of financing whereby a firm sells its
trade debts at a discount to a financial institution. In other words, factoring is a continuous
arrangement between a financial institution, (namely the factor) and a firm (namely the
client) which sells goods and services to trade customers on credit. As per this
arrangement, the factor purchases the client’s trade debts including accounts receivables
either with or without recourse to the client, and thus, exercises control over the credit
extended to the customers and administers the sales ledger of his client. To put it in a
layman’s language, a factor is an agent who collects the dues of his client for a certain fee.

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10.28 WORKING CAPITAL FINANCE FROM BANKS
Banks in India today constitute the major suppliers of working capital credit to any
business activity. Recently, some term lending financial institutions have also announced
schemes for working capital financing. The two committees viz., Tandon Committee and
Chore Committee have evolved definite guidelines and parameters in working capital
financing, which have laid the foundations for development and innovation in the area.
10.28 FORMS OF BANK CREDIT
The bank credit will generally be in the following forms:

 Cash Credit: This facility will be given by the banker to the customers by giving
certain amount of credit facility on continuous basis. The borrower will not be
allowed to exceed the limits sanctioned by the bank.
 Bank Overdraft: It is a short-term borrowing facility made available to the companies
in case of urgent need of funds. The banks will impose limits on the amount they
can lend. When the borrowed funds are no longer required they can quickly and
easily be repaid. The banks issue overdrafts with a right to call them in at short
notice.
 Bills Discounting: The Company which sells goods on credit will normally draw a bill
on the buyer who will accept it and sends it to the seller of goods. The seller, in turn
discounts the bill with his banker. The banker will generally earmark the discounting
bill limit.
 Bills Acceptance: To obtain finance under this type of arrangement a company
draws a bill of exchange on bank. The bank accepts the bill thereby promising to pay
out the amount of the bill at some specified future date.
 Line of Credit: Line of Credit is a commitment by a bank to lend a certain amount of
funds on demand specifying the maximum amount.
 Letter of Credit: It is an arrangement by which the issuing bank on the instructions of
a customer or on its own behalf undertakes to pay or accept or negotiate or
authorizes another bank to do so against stipulated documents subject to
compliance with specified terms and conditions.
 Bank Guarantees: Bank guarantee is one of the facilities that the commercial banks
extend on behalf of their clients in favour of third parties who will be the
beneficiaries of the guarantees.

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10.30 MAXIMUM PERMISSIBLE BANK FINANCE (MPBF)- TANDON
COMMITTEE
The Reserve Bank of India set up in 1974 a study group under the chairmanship of Mr.
P.L. Tandon, popularly referred to as The Tandon Committee.

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Recommendations of the Committee

1. A proper fund discipline has to be observed by the borrowers. They should supply to
the banker information regarding his operational plans well in advance. The banker
must carry out a realistic appraisal of such plans.
2. The main function of the banker as a lender is to supplement the borrower’s
resources to carry on acceptable level of current assets. This has two implications: (a)
current assets must be reasonable and based on norms, and
(b) a part of funds requirement for carrying out current assets must be financed
from long term funds.
3. The bank should know the end use of bank credit so that it is used only for purposes
for which it was made available.
4. The bank should follow inventory and receivable norms and also leading norms. It
has suggested inventory and receivable norms for fifteen major industries. It has also
suggested three lending norms which are as follows:
Lending Norms
1st Method
Total current assets required xxx
Less: Current Liabilities xxx
Working Capital Gap xxx
Less: 25% from Long-term sources xxx
Maximum permissible bank borrowings xxx
nd
2 Method
Current assets required xxx
Less: 25% to be provided term long-term funds xxx
xxx
Less: Current Liabilities xxx
Maximum permissible bank borrowings Xxx
rd
3 Method
Current assets Xxx
Less: Core Current assets Xxx
Xxx
Less: 25% to be provided from long-term funds Xxx
Xxx

India
Less: Current Liabilities X

xx
Maximum permissible bank borrowings X
xx
I. The borrower has to contribute a minimum of 25% of working capital gap from long
term funds.
MPBF = 75% of [Current Assets Less Current Liabilities] i.e. 75% of Net Working Capital
II. The borrower has to contribute a minimum of 25% of the total current assets from
long term funds.
MPBF = [75% of Current Assets] Less Current Liabilities

III. The borrower has to contribute the entire hard core current assets and a minimum
of 25% of the balance of the current assets from long term funds.
MPBF = [75% of Soft Core Current Assets] Less Current Liabilities
The RBI vide its credit policy (beginning of 1997) scrapped the concept of MPBF.
The salient features of new credit system were:
If borrowing requirements is upto ` 25 lakhs, credit limit will be computed after
detailed discussions with the borrower, without going into detailed evaluation.
For borrowers with requirements above ` 25 lakhs, but upto ` 5 crore, credit limit can
be offered upto 20% of the projected gross sales of the borrower.
For borrowers not falling in the above categories, the cash budget systems may be used
to identify the working capital needs.
Core current assets is permanent component of current assets which are required
throughout the year for a company to run continuously and to stay viable. The term “Core
Current Assets” was framed by Tandon Committee while explaining the amount of stock
a company can hold in its current assets. Generally, such assets are financed by long
term funds. Sometimes core current assets are also referred to as “Hardcore Working
Capital”.
VKS
- 104 -
FINDINGS.
FINDINGS.
SUGGESTIONS
SUGGESTIONS&&
CONCLUSIONS.
CONCLUSIONS.
VKS
- 105 -
WORKING CAPITAL ANALYSIS
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.
WORKING CAPITAL ANALYSIS

There are so many methods for analysis of financial statements but ITC
LTD. used the
following techniques:-
 Comparative size statements
 Trend analysis
 Cash flow statement
 Ratio analysis
A detail description of these methods is as follows:
COMPARATIVE SIZE STATEMENTS:-

When two or more than two years figures are compared to each other
than we called comparative size statements in order to estimate the future
progress of the business, it is necessary to look the past performance of the
company. These statements show the absolute figures and also show the
change from one year to another.
TREND ANALYSIS:-
To analyze many years financial statements ITC LTD. uses this method.
This indicates the direction on movement over the long time and help in the
financial statements.
Procedure for calculating trends:-
1. Previous year is taken as a base year
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2. Figures of the base year are taken 100.

3. Trend % are calculated in relation to base year.
CASH FLOW STATEMENT:-

Cash flow statements are the statements of changes in the financial
position prepared on
the basis of funds defined in cash or cash equivalents. In short cash flow
statement
summaries the cash inflows and outflows of the firm during a particular
period of time.
RATIO ANALYSIS:-
Ratio analysis is the process of the determining and presenting the
relationship of the items and group of items in the statements.
Benefits :-
1. Helpful in analysis of financial statements.
2. Helpful in comparative study.
3. Helpful in locating the weak spots of the ITC LTD.
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
VKS
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A] NET WORKING CAPITAL

An analysis of the net working capital will be very help full for knowing the operational
efficiency of the company. The following table provides the data relating to the net working
capital of BCM.
NET WORKING CAPITAL = CURRENT ASSETS-CURRENT LIABILITIS
Years Current Current NWC

Asset Liabilities
2005-06 4563099.00 2041543.00 2521556.00
2006-07 9599646.00 3887765.00 5711881.00
2007-08 9077617.00 2829079.00 6248538.00
2008-09 11003428.00 3889899.00 7113529.00
2009-10 11946666.00 4165659.00 7781007.00
Chart showing NWC

9000000
8000000
7000000
6000000
NWC
5000000
NWC
4000000
3000000
2000000
1000000
0
2005-06 2006-07 2007-08 2008-09 2009-10
Year
INTERPRETATION:-
The above chart shows that during the year 2005-06 the company has 2521556.00 N.W.C. In
the year 2006-07 huge increase in the N.W.C is 5711881.00 and in the year 2007-08 the
company has 6248538.00 N.W.C in the year 2008-09 the company has 7113529.00 N.W.C the
N.W.C of the company is increasing compared to the previous years, in the year 2009-10 the
company has 7781007.00 N.W.C this means the company in a positive position & N.W.C has
improved vary fast as compared to the previous years which show liquidity Position of the
Bahety chemicals & minerals Pvt Ltd has always more & sufficient working capital available to
pay off its current liabilities.
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B] RATIO ANALYSIS
Note: I have used the ratio analysis in this project in order to substantiate the managing of
working capital. For this, I used some of the ratios to get the required output.
Various working capital ratios used by me are as follows:
1. LIQUIDITY RATIOS:
Liquidity refers to the ability of a firm to meet its current obligations as and when
these become due. The short-term obligations are met by realizing amounts from current,
floating or circulating assets.
Following are the ratios which can help to assess the ability of a firm to meet its
current liabilities.
1. Current ratio
2. Acid Test Ratio / Quick Ratio / Liquidity Ratio
3. Absolute liquid ratio
2. TURNOVER/ACTIVITY RATIOS:
These are the ratios which indicate the speed with which assets are converted or
turned over into sales.
1. Inventory Turnover Ratio.
2. Debtors/ Accounts receivables Turnover Ratio.
3. Creditors/Accounts Payables Turnover Ratio.
4. Working Capital Turnover Ratio.
1. CURRENT RATIO:-
It is a ratio, which express the relationship between the total current Assets and current
liabilities. It measures the firm’s ability to meet its current liabilities. It indicates the availability
of current assets in rupees for every one rupee of current liabilities. A ratio of greater than one
means that the firm has more current assets than current liabilities claims against them. A
standard ratio between them is 2:1.
Current Ratio: Current Assets
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Current Liabilities
Year Current Current Current

Assets Liabilities Ratio
2005-06 4563099.00 2041543.00 2.23
2006-07 9599646.00 3887765.00 2.47
2007-08 9077617.00 2829079.00 3.21
2008-09 11003428.00 3889899.00 2.83
2009-10 11946666.00 4165659.00 2.87
Chart showing Current Ratio

3.5
2.5
C u rren n t R a tio
2
Current Ratio
1.5
0.5
0
2005-06 2006-07 2007-08 2008-09 2009-10
Year
INTERPRETATION:-
It is seen from the above chart that during the year 2005-06 the current ratio was
2.23, during the year 2006-07 it was 2.47 and in the year 2007-08 it was 3.21. This shows
the current ratio increases every year but in the year 2008-09 the current ratio was
dropped to 2.83 due to increase in current liabilities. In the year 2009-10 the current ratio
has increases 2.87. The current ratio is above the standard ratio i.e., 2:1. Hence it can be
said that there is enough current assets in Bahety chemicals & minerals Pvt Ltd to meet its
current liabilities.
2. ACID TEST RATIO / QUICK RATIO / LIQUIDITY RATIO:-
. The standard quick ratio is 1:1. Is considered satisfactory.
Quick Ratio = Quick Assets (current assets - Inventory)

Current Liabilities
Y Current Inventorie Quick Assets Current Quick

ear Assets s Liabilities Ratio
2005-06 4563099. 1532455.0 3030644.0 2041543 1.48
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00 0 0 .00
2006-07 9599646. 2161071.0 7438575.0 3887765 1.91
00 0 0 .00
2007-08 9077617. 3336430.0 5741187.0 2829079 2.03
00 0 0 .00
2008-09 11003428. 2622901.0 8380527.0 3889899 2.15
00 0 0 .00
2009-10 11946666. 2360611.0 9586055.0 4165659 2.30
00 0 0 .00
Chart showing Quick Ratio
2.5
2
Q u ic k R a tio
1.5
Quick Ratio
0.5
0
2005-06 2006-07 2007-08 2008-09 2009-10
Ye ar
INTERPRETATION:-
During the year 2005-06 the quick ratio was 1.48, in the year 2006-07 it increases to 1.91
This shows the company maintains satisfactory quick ratio, in the year 2007-08 the quick ratio
increases to 2.03, in the year 2008-09 it increases 2.15, in the year 2009-10 it increases 2.30, due
to increase in quick assets. The quick ratio is above the standard ratio i.e., 1:1. Hence it shows
that the liquidity position of the company is adequate.
3. ABSOLUTE LIQUID RATIO:-
Absolute Liquidity Ratio = Cash & Bank Balance

Current Liabilities
Year Cash & Bank Current Absolute Liquidity

Ratio
s Balance Liabilities
2005-06 493742.00 2041543.0 0.24
0
2006-07 1205660.00 3887765.0 0.31
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0
2007-08 1033152.00 2829079.0 0.36
0
2008-09 1720815.00 3889899.0 0.44
0
2009-10 1978938.00 4165659.0 0.47
0
Chart showing Absolute Liquidity Ratio
0.5
0.45
0.4
Absolute Liquidity Ratio
0.35
0.3 Absolute
0.25 Liquidity
0.2 Ratio
0.15
0.1
0.05
0
2005-06 2006-07 2007-08 2008-09 2009-10
Year
INTERPRETATION:
During the year 2005-06 the Absolute liquidity ratio was 0.24, during the year 2006-07 it
was 0.31 and in the year 2007-08 it was 0.36, in the year 2008-09 it was 0.44 This shows the
Absolute liquidity ratio increases every year but it is below the standard ratio. In the year 2009-
10 the Absolute liquidity ratio has increases 0.47.
Hence it shows that the liquidity position of the company is satisfactory.
1. INVENTORY TURNOVER RATIO:-
Inventory Turnover Ratio = Net Sales

Closing Inventory
Y Net Sales Closing Inventory Turnover

ear inventory ratio
2005-06 19542081.00 1532455.00 12.75 Times
2006-07 31321229.00 2161071.00 14.49 Times
2007-08 27894285.00 3336430.00 8.36 Times
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2008-09 38496046.00 2622901.00 14.68 Times

2009-10 42345651.00 2360611.00 17.94 Times
Chart showing Inventory Turnover Ratio
20
18
16
14
12
ITR
10 Inventory
8
Turnove r Ratio
6
4
2
0
2005-06 2006-07 2007-08 2008-09 2009-10
Ye ar
INTERPRETATION:
It is seen from the above chart that During the year 2005-06 the Inventory t/o ratio is
12.75 times, in the year 2006-07 it increased to 14.49 times, But in the year 2007-08 it
decreased to 8.36 times . There was a subsequent increase in the year 2008-09 and 2009-10 to
14.68 times and 17.94 times respectively.
This shows the company has more sales.
2. INVENTORY HOLDING PERIOD :-
This period measures the average time taken for clearing the stocks. It indicates that
how many days’ inventories take to convert from raw material to finished goods.
Inventory Holding Period = Days in a year

Inventory turn over ratio
Yea Days in a Inventory Turnover Inventory Holding Period

r Year Ratio
2005- 365 12.75 Times 28.63 Days
06
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2006- 365 14.49 Times 25.19 Days

07
2007- 365 8.36 Times 43.66 Days
08
2008- 365 14.68 Times 24.86 Days
09
2009- 365 17.94 Times 20.34 Days
10
Chart showing Inventory Holding Period
50
45
40
Number of days
35
30
25 Inventory
Holding
20
Period
15
10
5
0
2005-06 2006-07 2007-08 2008-09 2009-10
Year
INTERPRETATION:
Inventory holding period fluctuating over the years. It was 28.63 days in the year 2005-
06. It decreased to 25.19 days in the year 2006-07, it increased to 43.66 days in the year 2007-
08, there was a subsequent decrease in the year 2008-09 and 2009-10 to 24.86 days and 20.34
days respectively.
This shows the company is minimizing these inventory-holding days thereby to increase the
sales.
3. DEBTORS / ACCOUNTS RECEIVABLES TURNOVER RATIO:-
Debtors Turnover Ratio = Net Sales

Average Debtors
Ye Net Sales Average Debtors Turnover
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ar Debtors Ratio
2005-06 19542081.0 2201381.00 8.88 Times
0
2006-07 31321229.0 4958527.00 6.32 Times
0
2007-08 27894285.0 1805948.00 15.44 Times
0
2008-09 38496046.0 3787274.00 10.16 Times
0
2009-10 42345651.0 4355365.00 9.72 Times
0
Chart showing Debtors Turnover Ratio

18
16
14
12
De btors
DTR
10 Turnove r
Ratio
8
6
4
2
0
2005-06 2006-07 2007-08 2008-09 2009-10
Ye ar
INTERPRETATION:
It is clear that debtor turnover ratio fluctuating over the years. It was 8.88 times in the
year 2005-06. It decreased to 6.32 times in the year 2006-07, It again increased to 15.44 times in
the year 2007-08 but it decreased to 10.16 times and 9.72 Times in the year 2008-09 and 2009-
10 respectively. This shows the company is not collecting debt rapidly.
4. DEBTORS COLLECTION PERIOD :-
Average Collection Period = Days in a Year

Debtors Turnover Ratio
Yea Days in a Debtors Turnover Debtors Collection

r Year Ratio Period
2005-06 365 8.88 Times 41.10 Days
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2006-07 365 6.32 Times 57.75 Days

2007-08 365 15.44 Times 23.64 Days
2008-09 365 10.16 Times 35.92 Days
2009-10 365 9.72 Times 37.55 Days
Chart showing Debtors Collection Period

70
60
50
Number of days
Debtors
40 Collection
Period
30
20
10
0
2005-06
INTERPRETATION: 2006-07 2007-08 2008-09 2009-10
Year
Debt collection period changing over the years. It was 41.10 days in the year 2005-06. It
increased to 57.75 days in the year 2006-07, but in the year 2007-08 it decreased to 23.64 days.
There was a subsequent increase in the year 2008-09 and 2009-10 to 35.92 days and 37.55 days
respectively.
This shows the inefficient credit collection performance of the company.
5. CREDITORS/ACCOUNTS PAYABLES TURNOVER RATIO:-
Creditor’s turnover ratio is the ratio, which indicates the number of times the debts are
paid in the year. This ratio is calculated as follows.
Creditors Turnover Ratio = Net Purchases

Average Creditors
Note: In the BCM, we have taken the total Purchases instead of the credit purchases,
because the credit purchases information has not available for the calculations of CTR.
Y Net Average Creditors Turnover Ratio

ear Purchases Creditors
2005-06 11691090.0 1673515.00 6.98 Times
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0
2006-07 17778675.0 3492127.00 5.09 Times
0
2007-08 18896828.0 2649781.00 7.13 Times
0
2008-09 23605773.0 2658999.00 8.88 Times
0
2009-10 27146639.0 3057849.00 8.88 Times
0
Chart showing Creditors Turnover Ratio
10
9
8
7
6
Creditors
CTR
5 Turnover
4 Ratio
3
2
1
0
2005-06 2006-07 2007-08 2008-09 2009-10
Year
INTERPRETATION:
It is clear that creditor turnover ratio changing over the years. It was 6.98 times in the
year 2005-06. It decreased to 5.09 times in the year 2006-07, there was a subsequent increase
in the year 2007-08 and 2008-09 to 7.13 times and 8.88 times respectively. In the year 2009-10
it is same as compared to 2008-09. It shows that company has making prompt payment to the
creditors.
6. CREDITORS PAYMENT PERIOD:-
The Creditors Payment Period represents the average number of days taken by the
firm to pay the creditors and other bills payables.
Average Payment Period = Days in a Year

Creditors Turnover Ratio
VKS
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Yea Days in a Creditors Turnover Ratio Average Payment

r Year Period
2005-06 365 6.98 Times 52.29 Days
2006-07 365 5.09 Times 71.71 Days
2007-08 365 7.13 Times 51.19 Days
2008-09 365 8.88 Times 41.10 Days
2009-10 365 8.88 Times 41.10 Days
Chart showing Creditors Payment Period
80
70
60
Number of days
50
Creditors
40 Payment
Period
30
20
10
0
2005-06 2006-07 2007-08 2008-09 2009-10
Year
INTERPRETATION:
Average payment period changing over the years. It was 52.29 days in the year 2005-06.
It increased to 71.71 days in the year 2006-07, But in the year 2007-08 and 2008-09 it decreased
to 51.19 days and 41.10 days respectively. In the year 2009-10 it is same as compared to 2008-
09. It indicates that the company has taken the steps to prompt payment to the creditors.
7. WORKING CAPITAL TURNOVER RATIO:-
Working Capital Turnover Ratio = Net Sales

Net Working Capital
Yea Net Sales Net Working WCTR

r Capital
2005-06 19542081 2521556.00 7.75 Times
.00
2006-07 31321229 5711881.00 5.48 Times
.00
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2007-08 27894285 6248538.00 4.46 Times

.00
2008-09 38496046 7113529.00 5.41 Times
.00
2009-10 42345651 7781007.00 5.44 Times
.00
Chart showing Warking Capital Turnover Ratio

9
8
7
5
WCTR
WCTR
4
0
2005-06 2006-07 2007-08 2008-09 2009-10
Year
INTERPRETATION:
The working capital t/o ratio is fluctuating year to year that was high in the year 2005-
06, 7.75 times; there was a subsequent decrease in the year 2006-07 and 2007-08 to 5.48 times
and 4.46 times. But it increases in the year 2008-09 and 2009-10 to 5.41 and 5.44 times
respectively. This shows the company is utilizing working capital effectively.
C] FUND FLOW STATEMENTS
Principles of working capital for calculation purpose
CURRENT ASSETS
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0 If the current assets increase as a result of this, working capital also increases.
1 If the current assets decreases as a result of this working capital decreases.
CURRENT LIABILITIES
If the current liabilities increases as a result of this working capital decreases.
If the current liabilities decreases as a result of this working capital Increase.
Statement of Changes in Working Capital:
The purpose of preparing this statement is for finding out the increase or decrease in
working capital and to make a comparison between two financial years.
Table 1: Statement of Changes in Working Capital for the Year 2005 -2006
Effect on working capital

Particulars As on 31- As on
3- 2005 31-3-2006
Increase Decrease
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CURRENT ASSETS
Inventories 2001305.0 1532455. __ 468850.00
0 00
Sundry debtors 1438810.0 2201381. 762571.0 __
0 00 0
Cash & Bank balance 503667.00 493742.0 __ 9925.00
0
Other current assets 134364.00 148822.0 14458.00 __
0
Loans and Advances 193081.00 186699.0 __ 6382.00
0
(A)Total Current Assets 4271227. 4563099
00 .00
CURRENT LIABILITIES
Sundry creditors 1606195.0 1673515. __ 67320.00
0 00
Provisions 511561.00 368028.0 143533.0 __
0 0
(B)Total Current Liabilities 2117756. 2041543
00 .00
(A)-(B) Net Working Capital 2153471. 2521556
00 .00
Increase in Working Capital 368085.0 __ __ 368085.0

0* 0*
TOTAL 2521556. 2521556 920562. 930487.0

00 .00 00 0
INTERPRETATION:
In the above table, it is seen that during the year 2004-05 and 2005-06 there was a net
increase in working capital of Rs 368085.00. It indicates an adequate working capital in Bahety
chemicals & minerals pvt ltd.,
This is because of
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- 121 -
1. Increase current assets such as Sundry debtors by Rs 762571.00, other current assets by Rs
14458.00. And decrease in Inventories by Rs 468850.00, Cash & Bank balance by Rs 9925.00,
Loans and Advances by Rs 6382.00.
2. Increase in current liabilities such as in Sundry creditors by Rs 67320.00 and decrease in

Provisions by Rs 143533.00.
PART - VII
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 FINANCIAL STATEMENT.
 BIBILOGROPHY.
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- 123 -
FINANCIAL STATEMENT 2009-2010
PROVISIONAL BALANCE SHEET AS AT 31st MARCH, 2010

LIABILITY AMOUNT ASSETS AMOUNT
SOURCES OF FUNDS FIXED ASSETS
Share capital 1000000.0 Gross block 10913360.00
0
Reserves and surplus 9827210.0 Less: Depreciation 5135959.00
0
LOAN FUNDS Net Block 5777401.00
Secured Loans 2574672.0 Capital WIP 3693764.00
0
Unsecured Loans 3049192.0 CURRENT ASSETS
0
Deferred tax liability 801098.00 Inventories 2360611.00
CURRENT LIABILITIES Sundry debtors 4355365.00
Sundry creditors 3057849.0 Cash & bank balance 1978938.00
0
Provisions 1107810.0 Other current assets 185585.00
0
Loans and Advances 3066167.00
TOTAL 21417831. 21417831.00
00
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BIBLIOGRAPHY
TEXT BOOKS

WEB SITE VISITED
www.google.com
www.wikipedia.org
www.transtutors.com
VKS
- 125 -

Working Capital Management

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WORKING CAPITAL MANAGEMENT

SL.N CONTENTS PAGE

economic development is determined by the proportion of capital available.

or owner at the time of commencing the business.

help in producing other goods.

3. Capital is a human control possible.

5. Capital is a human sacrifice.

7. Capital is a passive factor.

INTRODUCTION OF WORKING CAPITAL:

MEANING OF WORKING CAPITAL

Working Capital = Current Assets – Current Liabilities

Current Assets: An asset is classified as current when:

(i) It is expected to be realised or intends to be sold or consumed in normal

period whichever is longer; and

Current Liabilities: A liability is classified as current when:

(i) It is expected to be settled in normal operating cycle of the entity or within

twelve months after the reporting period whichever is longer; and

According to Weston & Brigham

securities, accounts receivables and inventories.

Mead Mallott & Field

“Working capital means current assets”.

Guttmann & Dougall-

“Excess of current assets over current liabilities”.

Park & Gladson-

accounts payable, taxes owned to Government)”.

1) Fixed Capital 2) Working Capital

for they are one and the same”.

improve their operations.

Negative working capital means that a company currently is unable to meet its short-term

necessary for growth.

OBJECTIVES OF WORKING CAPITAL MANAGEMENT

main following objectives-

1. To maximize profit of the firm.

2. To help in timely payment of bills.

3. To maintain sufficient current assets.

4. To ensure adequate liquidity of the firms.

5. It protects the solvency of the firm.

6. To discharge current liabilities.

7. To increase the value of the firm.

8. To minimize the risk of business.

THE NEED FOR THE WORKING CAPITAL

1. To purchase raw materials, spare parts and other component.

Trading concern requires less working capital.

2. To meet over head expenses.

3. To hold finished and spare parts etc.

for that adequate quantity of working capital is required.

4. To pay selling & distribution expenses.

packing, commission etc.

6. Working capital is required to pay wages, salaries and other charges.

7. It is helpful in maintain uncertainties involved in business field.

WORKING CAPITAL MANAGEMENT

Working Capital Management refers to management of current assets and current

CLASSIFICATION OF WORKING CAPITAL

On The Basis of On The Basis of Time

Gross Net Permanent / Temporary /

Seasonal Special Working

I. On The Basis of Concepts

This concept has the following advantages:-

i. Financial managers are profoundly concerned with the current assets.

iii. It enables a firm to realize the greatest return on its investment.

iv. It helps in the fixation of various areas of financial responsibility.

2) Net Working Capital

CONSTITUENTS OF CURRENT ASSETS

Net working capital can be positive or negative.