WORKING CAPITAL - Meaning of Working

Capital

Capital required for a business can be classified under two main categories via,

1)     Fixed Capital

2)     Working Capital

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

its day- to-day operations. Long terms funds are required to create production facilities

through purchase of fixed assets such as p&m, land, building, furniture, etc. Investments

in these assets represent that part of firm’s capital which is blocked on permanent or fixed

basis and is called fixed capital. Funds are also needed for short-term purposes for the

purchase of raw material, payment of wages and other day – to- day expenses etc.

These funds are known as working capital. In simple words, working

capital refers to that part of the firm’s capital which is required for financing short-

term or current assets such as cash, marketable securities, debtors & inventories.

Funds, thus, invested in current assts keep revolving fast and are being constantly

converted in to cash and this cash flows out again in exchange for other current

assets. Hence, it is also known as revolving or circulating capital or short term

capital.
CONCEPT OF WORKING CAPITAL

There are two concepts of working capital:

1.     Gross working capital

2.     Net working capital

The gross working capital is the capital invested in the total current assets of

the enterprises current assets are those

Assets which can convert in to cash within a short period normally one

accounting year.

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.

6.     Bills payable.

7.     Sundry creditors.

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

net working capital is an accounting concept of working capital. Both the concepts

have their own merits.

The gross concept is sometimes preferred to the concept of working capital for the

following reasons:
1.     It enables the enterprise to provide correct amount of working

capital at correct time.

2.     Every management is more interested in total current assets with

which it has to operate then the source from where it is made

available.

3.     It take into consideration of the fact every increase in the funds of

the enterprise would increase its working capital.

4.     This concept is also useful in determining the rate of return on

investments in working capital. The net working capital concept,

however, is also important for following reasons:

        It is qualitative concept, which indicates the firm’s ability to meet

to its operating expenses and short-term liabilities.

        IT indicates the margin of protection available to the short term

creditors.

        It is an indicator of the financial soundness of enterprises.

        It suggests the need of financing a part of working capital

requirement out of the permanent sources of funds.

CLASSIFICATION OF WORKING CAPITAL

Working capital may be classified in to ways:

o       On the basis of concept.

o        On the basis of time.

On the basis of concept working capital can be classified as gross working

capital and net working capital. On the basis of time, working capital may

be classified as:

     Permanent or fixed working capital.

     Temporary or variable working capital

PERMANENT OR 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.

TEMPORARY 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. Variable

working capital can further be classified as seasonal working capital and special

working capital. The capital required to meet the seasonal need of the enterprise is

called seasonal working capital. Special working capital is that part of working

capital which is required to meet special exigencies such as launching of extensive

marketing for conducting research, etc.

Temporary working capital differs from permanent working capital in the sense

that is required for short periods and cannot be permanently employed gainfully in

the business.

IMPORTANCE OR ADVANTAGE OF ADEQUATE WORKING

CAPITAL

    SOLVENCY OF THE BUSINESS: Adequate working capital helps

in maintaining the solvency of the business by providing uninterrupted of

production.

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

prompt payments and makes and maintain the goodwill.

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

credit standing can arrange loans from banks and other on easy and

favorable terms.

     Cash Discounts: Adequate working capital also enables a concern to

avail cash discounts on the purchases and hence reduces cost.

     Regular Supply of Raw Material: Sufficient working capital

ensures regular supply of raw material and continuous production.

     Regular Payment Of Salaries, Wages And Other Day

TO Day Commitments: 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.

     Exploitation Of Favorable Market   Conditions: If a firm is

having adequate working capital then it can exploit the favorable market

conditions such as purchasing its requirements in bulk when the prices are

lower and holdings its inventories for higher prices.

     Ability To Face Crises: A concern can face the situation during

the depression.
     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.

     High Morale: Adequate working capital brings an environment of

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

business.

EXCESS OR INADEQUATE WORKING CAPITAL

Every business concern should have adequate amount of working capital to run

its business operations. It should have neither redundant or excess working

capital nor inadequate nor shortages of working capital. Both excess as well as

short working capital positions are bad for any business. However, it is the

inadequate working capital which is more dangerous from the point of view of

the firm.

DISADVANTAGES OF REDUNDANT OR EXCESSIVE

WORKING CAPITAL
 1.     Excessive working capital means ideal funds which earn no profit

for the firm and business cannot earn the required rate of return on

its investments.

2.     Redundant working capital leads to unnecessary purchasing and

accumulation of inventories.

3.     Excessive working capital implies excessive debtors and

defective credit policy which causes higher incidence of bad debts.

4.     It may reduce the overall efficiency of the business.

5.     If a firm is having excessive working capital then the relations

with banks and other financial institution may not be maintained.

6.     Due to lower rate of return n investments, the values of shares

may also fall.

7.     The redundant working capital gives rise to speculative

transactions

DISADVANTAGES OF INADEQUATE WORKING CAPITAL

Every business needs some amounts of working capital. The need for working

capital arises due to the time gap between production and realization of cash from
sales. There is an operating cycle involved in sales and realization of cash. There

are time gaps in purchase of raw material and production; production and sales;

and realization of cash.

Thus working capital is needed for the following purposes:

       For the purpose of raw material, components and spares.

       To pay wages and salaries

       To incur day-to-day expenses and overload costs such as office expenses.

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

       To provide credit facilities to the customer.

       To maintain the inventories of the raw material, work-in-progress, stores

and spares and finished stock.

For studying the need of working capital in a business, one has to study the

business under varying circumstances such as a new concern requires a lot of

funds to meet its initial requirements such as promotion and formation etc.

These expenses are called preliminary expenses and are capitalized. The

amount needed for working capital depends upon the size of the company and

ambitions of its promoters. Greater the size of the business unit, generally

larger will be the requirements of the working capital.

The requirement of the working capital goes on increasing with the growth and

expensing of the business till it gains maturity. At maturity the amount of

working capital required is called normal working capital.

There are others factors also influence the need of working capital in a

business.

FACTORS DETERMINING THE WORKING CAPITAL

REQUIREMENTS

1.  NATURE OF BUSINESS: The requirements of working is

very limited in public utility undertakings such as electricity, water

supply and railways because they offer cash sale only and supply

services not products, and no funds are tied up in inventories and

receivables. On the other hand the trading and financial firms requires

less investment in fixed assets but have to invest large amt. of working

capital along with fixed investments.

2.  SIZE OF THE BUSINESS: Greater the size of the

business, greater is the requirement of working capital.

 3.  PRODUCTION POLICY: If the policy is to keep

production steady by accumulating inventories it will require higher

working capital.

4.  LENTH OF PRDUCTION CYCLE: The longer the

manufacturing time the raw material and other supplies have to be

carried for a longer in the process with progressive increment of labor

and service costs before the final product is obtained. So working

capital is directly proportional to the length of the manufacturing

process.

5.  SEASONALS VARIATIONS: Generally, during the busy

season, a firm requires larger working capital than in slack season.

6.  WORKING CAPITAL CYCLE: The speed with which

the working cycle completes one cycle determines the requirements of

working capital. Longer the cycle larger is the requirement of working

capital.

                           DEBTORS

CASH                                 FINISHED GOODS

 

RAW MATERIAL                        WORK IN PROGRESS

  

7.     RATE OF STOCK TURNOVER: There is an inverse co-

relationship between the question of working capital and the velocity or

speed with which the sales are affected. A firm having a high rate of

stock turnover wuill needs lower amt. of working capital as compared to

a firm having a low rate of turnover.

8.     CREDIT POLICY: A concern that purchases its requirements on

credit and sales its product / services on cash requires lesser amt. of

working capital and vice-versa.

9.     BUSINESS CYCLE: In period of boom, when the business is

prosperous, there is need for larger amt. of working capital due to rise in

sales, rise in prices, optimistic expansion of business, etc. On the

contrary in time of depression, the business contracts, sales decline,

difficulties are faced in collection from debtor and the firm may have a

large amt. of working capital.

10. RATE OF GROWTH OF BUSINESS: In faster growing

concern, we shall require large amt. of working capital.

11. EARNING CAPACITY AND DIVIDEND POLICY: Some

firms have more earning capacity than other due to quality of their

products, monopoly conditions, etc. Such firms may generate cash

profits from operations and contribute to their working capital. The

dividend policy also affects the requirement of working capital. A firm

maintaining a steady high rate of cash dividend irrespective of its profits

needs working capital than the firm that retains larger part of its profits

and does not pay so high rate of cash dividend.

12. PRICE LEVEL CHANGES: Changes in the price level also affect

the working capital requirements. Generally rise in prices leads to

increase in working capital.

Others FACTORS: These are:

     Operating efficiency.

     Management ability.

     Irregularities of supply.

     Import policy.

      Asset structure.

     Importance of labor.

     Banking facilities, etc.

MANAGEMENT OF WORKING CAPITAL

Management of working capital is concerned with the problem that arises in

attempting to manage the current assets, current liabilities. The basic goal

of working capital management is to manage the current assets and current

liabilities of a firm in such a way that a satisfactory level of working capital

is maintained, i.e. it is neither adequate nor excessive as both the situations

are bad for any firm. There should be no shortage of funds and also no

working capital should be ideal. WORKING CAPITAL MANAGEMENT

POLICES of a firm has a great on its probability, liquidity and structural

health of the organization. So working capital management is three

dimensional in nature as

1.     It concerned with the formulation of policies with regard to

profitability, liquidity and risk.

2.     It is concerned with the decision about the composition and level

of current assets.

3.     It is concerned with the decision about the composition and level

of current liabilities.

  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.

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 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.

1.     Liquidity ratios.

 2.     Current assets movements ‘ratios.

A)   LIQUIDITY RATIOS

Liquidity refers to the ability of a firm to meet its current obligations as

and when these become due. The short-term obligations are met by

realizing amounts from current, floating or circulating assts. The current

assets should either be liquid or near about liquidity. These should be

convertible in cash for paying obligations of short-term nature. The

sufficiency or insufficiency of current assets should be assessed by

comparing them with short-term liabilities. If current assets can pay off

the current liabilities then the liquidity position is satisfactory. On the

other hand, if the current liabilities cannot be met out of the current assets

then the liquidity position is bad. To measure the liquidity of a firm, the

following ratios can be calculated:

1.     CURRENT RATIO

2.     QUICK RATIO

3.     ABSOLUTE LIQUID RATIO

 

1.   CURRENT RATIO

Current Ratio, also known as working capital ratio is a measure of general

liquidity and its most widely used to make the analysis of short-term

financial position or liquidity of a firm. It is defined as the relation

between current assets and current liabilities. Thus,

CURRENT RATIO = CURRENT ASSETS 

                                     CURRENT LIABILITES

The two components of this ratio are:

1)     CURRENT ASSETS

2)     CURRENT LIABILITES

Current assets include cash, marketable securities, bill receivables, sundry

debtors, inventories and work-in-progresses. Current liabilities include

outstanding expenses, bill payable, dividend payable etc.

A relatively high current ratio is an indication that the firm is liquid and

has the ability to pay its current obligations in time. On the hand a low

current ratio represents that the liquidity position of the firm is not good
 and the firm shall not be able to pay its current liabilities in time. A ratio

equal or near to the rule of thumb of 2:1 i.e. current assets double the

current liabilities is considered to be satisfactory.

CALCULATION OF CURRENT RATIO

                                                                              (Rupees in crore)

e.g.

Year 2006 2007 2008

Current Assets 81.29 83.12 13,6.57

Current Liabilities 27.42 20.58 33.48

Current Ratio 2.96:1 4.03:1 4.08:1

Interpretation:-

As we know that ideal current ratio for any firm is 2:1. If we see the

current ratio of the company for last three years it has increased from

2006 to 2008. The current ratio of company is more than the ideal ratio.

This depicts that company’s liquidity position is sound. Its current assets

are more than its current liabilities.

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.

CALCULATION OF QUICK RATIO

e.g.                                                              (Rupees in Crore)

Year 2006 2007 2008

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

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 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.

e.g.                                                          (Rupees in Crore)

Year 2006 2007 2008

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

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.

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.
1.       INVENTORY TURNOVER OR STOCK TURNOVER

RATIO :

Every firm has to maintain a certain amount of inventory of finished

goods so as to meet the requirements of the business. But the level of

inventory should neither be too high nor too low. Because it is

harmful to hold more inventory as some amount of capital is blocked

in it and some cost is involved in it. It will therefore be advisable to

dispose the inventory as soon as possible.

INVENTORY TURNOVER RATIO =      COST OF GOOD SOLD

                                                     AVERAGE INVENTORY

Inventory turnover ratio measures the speed with which the stock is

converted into sales. Usually a high inventory ratio indicates an

efficient management of inventory because more frequently the

stocks are sold ; the lesser amount of money is required to finance

the inventory. Where as low inventory turnover ratio indicates the

inefficient management of inventory. A low inventory turnover

implies over investment in inventories, dull business, poor quality of

goods, stock accumulations and slow moving goods and low profits

as compared to total investment.

AVERAGE STOCK  =   OPENING STOCK + CLOSING STOCK

                                                                  2

                                                       (Rupees in Crore)

Year 2006 2007 2008

Cost of Goods sold 110.6 103.2 96.8

Average Stock 73.59 36.42 55.35

Inventory Turnover Ratio 1.5 times 2.8 times 1.75 times

Interpretation :

       These ratio shows how rapidly the inventory is turning into

receivable through sales. In 2007 the company has high inventory

turnover ratio but in 2008 it has reduced to 1.75 times. This shows that the

company’s inventory management technique is less efficient as compare

to last year.

2.                 INVENTORY CONVERSION PERIOD:

INVENTORY CONVERSION PERIOD =   365 (net working days)

                                                 INVENTORY TURNOVER RATIO

e.g.

Year 2006 2007 2008

Days 365 365 365

Inventory Turnover Ratio 1.5 2.8 1.8

Inventory Conversion Period 243 days 130 days 202 days

Interpretation :

       Inventory conversion period shows that how many days inventories

takes to convert from raw material to finished goods. In the company

inventory conversion period is decreasing. This shows the efficiency of

management to convert the inventory into cash.

3.                 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

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

e.g.

Year 2006 2007 2008

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

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.

4.                 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 2006 2007 2008

Days 365 365 365

Debtor Turnover Ratio 9.6 8.3 7.5

Average Collection Period 38 days 44 days 49 days

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.

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       =                   Sales        

                                                        Networking Capital

e.g.

Year 2006 2007 2008

Sales 166.0 151.5 169.5

Networking Capital 53.87 62.52 103.09

Working Capital Turnover 3.08 2.4 1.64

Interpretation :

          This ratio indicates low much net working capital requires for

sales. In 2008, the reciprocal of this ratio (1/1.64 = .609) shows that for

sales of Rs. 1 the company requires 60 paisa as working capital. Thus this

ratio is helpful to forecast the working capital requirement on the basis of

sale.

INVENTORIES

(Rs. in Crores)
Year 2005-2006 2006-2007 2007-2008

Inventories 37.15 35.69 75.01

Interpretation :

       Inventories is a major part of current assets. If any company wants to

manage its working capital efficiency, it has to manage its inventories

efficiently. The graph shows that inventory in 2005-2006 is 45%, in 2006-

2007 is 43% and in 2007-2008 is 54% of their current assets. The

company should try to reduce the inventory upto 10% or 20% of current

assets.

CASH BNAK BALANCE :

(Rs. in Crores)

Year 2005-2006 2006-2007 2007-2008

Cash Bank Balance 4.69 1.79 5.05

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 2006 the cash is 4.69 crores but in 2007 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)

Year 2005-2006 2006-2007 2007-2008

Debtors 17.33 19.05 25.94

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)
 Year 2005-2006 2006-2007 2007-2008

Current Assets 81.29 83.15 136.57

Interpretation :

       This graph shows that there is 64% increase in current assets in 2008.

This increase is arise because there is approx. 50% increase in

inventories. Increase in current assets shows the liquidity soundness of

company.

CURRENT LIABILITY :

(Rs. in Crores)

Year 2005-2006 2006-2007 2007-2008

Current Liability 27.42 20.58 33.48

Interpretation :

       Current liabilities shows company short term debts pay to outsiders.

In 2008 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)

Year 2005-2006 2006-2007 2007-2008

Net Working Capital 53.87 62.53 103.09

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.

RESEARCH METHODOLOGY

The methodology, I have adopted for my study is the various tools, which

basically analyze critically financial position of to the organization:

 
             I.               COMMON-SIZE P/L A/C

          II.               COMMON-SIZE BALANCE SHEET

      III.               COMPARTIVE P/L A/C

       IV.               COMPARTIVE BALANCE SHEET

          V.               TREND ANALYSIS

       VI.               RATIO ANALYSIS

The above parameters are used for critical analysis of financial position.  With the

evaluation of each component, the financial position from different angles is tried to be

presented in well and systematic manner. By critical analysis with the help of different

tools, it becomes clear how the financial manager handles the finance matters in

profitable manner in the critical challenging atmosphere, the recommendation are made

which would suggest the organization in formulation of a healthy and strong position

financially with proper management system.

I sincerely hope, through the evaluation of various percentage, ratios and

comparative analysis, the organization would be able to conquer its in efficiencies

and makes the desired changes.

 
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 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.

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.

FINANCIAL STATEMENT ANALYSIS

It is the process of identifying the financial strength and weakness of a firm from the

available accounting data and financial statements. The analysis is done

CALCULATIONS OF RATIOS

Ratios are relationship expressed in mathematical terms between figures, which are

connected with each other in some manner.

CLASSIFICATION OF RATIOS

Ratios can be classified in to different categories depending upon the basis of

classification

The traditional classification has been on the basis of the financial statement to

which the determination of ratios belongs.

 These are:-
        Profit & Loss account ratios

        Balance Sheet ratios

        Composite ratios