WORKING CAPITAL MANAGEMENT WORKING CAPITAL INTRODUCTION Effective Financial Management is the outcome, among other things, of proper

management of investment of funds in business. Funds can be invested for permanent or long-term purposes such as acquisition of fixed assets, diversification and expansion of business, renovation or modernization of plant and machinery, and research and development. Funds are also needed for short-tem purposes, that is, for current operations of the business. For example, if you are managing a manufacturing unit you will have to arrange for procurement of raw material, payment of wages to your wor men and for meeting routine expenses. !ll the goods which are manufactured in a given time period may not be sold in that period. "ence, some goods remain in stoc , eg., raw material, semi-finished #manufacturing-in-process$ goods and finished mar etable goods. Funds are thus bloc ed in different types of inventory. !gain, the whole of the stoc of finished goods may not be sold against ready cash, some of it may be sold on credit. %he credit sales also involve bloc ing of funds with debtors till cash is received or the bills are cleared. &or ing 'apital refers to a firm(s investment in short-term assets) viz., cash, short-term securities, amount receivables #debtors$ and inventories of raw materials, wor -inprocess and finished goods. *t can also be regarded as that portion of the firm(s total capital which is employed in short-term operations. *t refers to all aspects of current assets and current liabilities. *n simple words, we can say that wor ing capital is the investment needed for carrying out day-to-day operations of the business smoothly. %he management of wor ing capital is no less important than the management of long-term financial investment.

SIGNIFICANCE OF WORKING CAPITAL +ne will hardly find an operating business firm which does not require some amount of wor ing capital. Even a fully equipped manufacturing firm is sure to collapse without #a$ an adequate supply of raw materials to process, #b$ cash to meet the wage bill, #c$ the capacity to wait for the mar et for its finished products, and #d$ the ability to grant credit to its customers. ,imilarly, a commercial enterprise is virtually good for nothing without merchandise to sell. &or ing capital, thus, is the life-blood of a business. !s a matter of fact, any organization, whether profit-oriented or otherwise, will not be able to carry on day-to-day activities without adequate wor ing capital. Operating Cycle %he time between purchase of inventory items #raw material or merchandise$ and their conversion into cash is nown as operating cycle or wor ing capital cycle. %he

successive events which are typically involved in an operating cycle are depicted in Figure *. ! perusal of the operating( cycle would reveal that the funds invested in operations are re-cycled bac into cash. %he cycle, of course, ta es some time to

complete. %he longer the period of this conversion the longer is the operating cycle. ! standard operating cycle may be for any time period but does not generally exceed a financial year. +bviously, the shorter the operating cycle, the larger will be the turnover of funds invested for various purposes. %he channels of the investment are called current assets. ,ometimes the available funds may be in excess of the needs for investment in these assets, eg., inventory, receivables and minimum essential cash balance. !ny surplus may be invested in government securities rather than being retained as idle cash balance.

Concept o! Wor"ing Capital %here are two types of wor ing capital, namely -ross and .et wor ing capital. Gro Wor"ing Capital

!ccording to this concept, wor ing capital refers to the firm(s investment in current assets. %he amount of current liabilities is not deducted from the total of current assets. %his concept views &or ing 'apital and aggregate of 'urrent !ssets as two interchangeable terms. %his concept is also referred to as /'urrent 'apital( or /'irculating 'apital(. %he proponents of the gross wor ing capital concept advocate this for the following reasons) 0. 1rofits are earned with the help of assets which are partly fixed and partly current. %o a certain degree, similarity can be observed in fixed and current assets so far as both are partly financed by borrowed funds, and are expected to

yield earnings over and above the interest costs. 2ogic then demands that the aggregate of current assets should be ta en to mean the wor ing capital. 3. Management is more concerned with the total current assets as they constitute the total funds available for operating purposes than with the sources from which the funds come. 4. !n increase in the overall investment in the enterprise also brings about an increase in the wor ing capital. Net Wor"ing Capital %he net wor ing capital refers to the difference between current assets and current liabilities. 'urrent liabilities are those claims of outsiders which are expected to mature for payment within an accounting year and include creditors( dues, bills payable, ban overdraft and outstanding expenses. .et wor ing capital can be positive or negative. ! positive net wor ing capital will arise when current assets exceed current liabilities. ! negative net wor ing capital occurs when current liabilities are in excess of current assets. Kin# o! Wor"ing Capital +rdinarily, wor ing capital is classified into two categories) Fixed, 5egular or 1ermanent &or ing 'apital6 and 7ariable, Fluctuating, ,easonal, %emporary or ,pecial &or ing 'apital. Fi$e# Wor"ing Capital %he need for current assets is associated with the operating cycle is a continuous process. !s such, the need for current assets is felt constantly. %he magnitude of investment in current assets however may not always be the same. %he need for investment in current assets may increase or decrease over a period of time according to the level of production. Fl%ct%ating Wor"ing Capital

8epending upon the changes in production and sales, the need for wor ing capital, over and above the permanent wor ing capital, will fluctuate. %he need for wor ing capital may also vary on account of seasonal changes or abnormal or unanticipated conditions. For example, a rise in the price level may lead to an increase in the amount of funds invested in stoc of raw materials as well as finished goods. Figures ** and *** give an idea about fixed and fluctuating wor ing capital.

!ig%re II& !i$e# 'or"ing capital re(aining con tant o)er ti(e *t is shown in Figure ** that fixed wor ing capital is stable overtime, while variable &or ing capital is fluctuating9sometimes increasing and sometimes decreasing. %he permanent wor ing capital line, however, may not always be horizontal. For a growing firm, permanent wor ing capital may also eep on increasing over time as has been shown in Figure ***. :oth these inds of wor ing capital9permanent and temporary9are required to

facilitate production and sales through the operating cycle, but temporary wor ing

capital is arranged by the firm to meet liquidity requirements that are expected to be temporary. Co(ponent o! Wor"ing Capital *t is already noted that wor ing capital has two components) 'urrent assets and 'urrent liabilities. 'urrent assets comprise several items. %he typical items are) 'ash to meet expenses as and when they occur. !ccounts receivables or sundry trade debtors. *nventory of raw materials, stores, supplies and spares, wor -in-process, and finished goods. !dvance payments towards expenses or purchases, and other short-term advances, which are recoverable. %emporary investment of surplus funds which could be converted into cash whenever needed. !part from these, the need for funds to finance the current assets may be met from supply of goods on credit, and deferment, on account of custom, usage or arrangement, of payment for expenses. %he remaining part of the need for wor ing capital may be met from short-term borrowing from financiers li e ban s. %hese items arc collectively called current liabilities. %ypical items of current liabilities are) -oods purchased on credit Expenses incurred in the course of the business of the organization #eg., wages or salaries, rent, electricity bills, interest etc.$ which are not yet paid for. %emporary or short-term borrowings from ban s, financial institutions or other parties. !dvances received from parties against goods to be sold or delivered, or as shortterm deposits. +ther current liabilities such as tax and dividends payable. I(portance o! Wor"ing Capital Manage(ent :ecause of its close relationship with day-to-day operations of a business, a study of wor ing capital and its management is of ma;or importance to internal, as well as external analysts. *t is being increasingly realised that inadequacy or mismanagement of wor ing capital is the leading cause of business failures. &e must not lose sight of the fact that management of wor ing capital is an integral part of the overall Financial

Management and, ultimately, of the overall corporate management. &or ing capital management thus throws a challenge and should be a welcome opportunity for a finance manager who is ready to play a pivotal role in his organization. ! firm may have to face the following adverse consequences from inadequate wor ing capital) 0. -rowth may be stunted. *t may become difficult for the firm to underta e profitable pro;ects due to non-availability of funds. 3. *mplementation of operating plans may become difficult and consequently the firm(s profit goals may not be achieved. 4. +perating inefficiencies may creep in due to difficulties in meeting even day-today commitments. <. Fixed assets may not be efficiently utilised due to lac of wor ing funds, thus lowering the rate of return on investments in the process. =. !ttractive credit opportunities may have to be lost due to paucity of wor ing capital. >. %he firm loses its reputation when it is not in a position to honour its short-term obligations. !s a result, the firm is li ely to face tight credit terms. +n the other hand, excessive wor ing capital may pose the following dangers) 0. Excess of wor ing capital may result in unnecessary accumulation of inventories, increasing the chances of inventory mishandling, waste, and theft. 3. *t may provide an undue incentive for adopting too liberal a credit policy and slac ening of collection of receivables, causing a higher incidence of bad debts. %his has an adverse effect on profits. 4. Excessive wor ing capital may ma e management complacent, leading eventually to managerial inefficiency.

<. *t may encourage the tendency to accumulate inventories for ma ing speculative profits, causing a liberal dividend policy which becomes difficult to maintain when the firm is unable to ma e speculative profits. !n enlightened management, therefore, should maintain the right amount of wor ing capital on a continuous basis. Financial and statistical techniques can be helpful in predicting the quantum of wor ing capital needed at different points of time. Deter(inant o! Wor"ing Capital Nee# %here are no set rules or formulas to determine the wor ing capital requirements of a firm. %he corporate management has to consider a number of factors to determine the level of wor ing capital. %he amount of wor ing capital that a firm would need is affected not only by the factors associated when the firm itself but is also affected with economic, monetary and general business environment. !mong the various factors the following are important ones. Nat%re an# Si*e o! +% ine %he wor ing capital needs of a firm are basically influenced by the nature of its business. %rading and financial firms generally have a low investment in fixed assets, but require a large investment in wor ing capital. 5etail stores, for example, must carry large stoc s of a variety of merchandise to satisfy the varied demand of their customers. ,ome manufacturing businesses li e tobacco, and construction firms also have to invest substantially in wor ing capital but only a nominal amount in fixed assets. *n contrast, public utilities have a limited need for wor ing capital and have to invest abundantly in fixed assets. Man%!act%ring Cycle %he manufacturing cycle starts with the purchase of raw materials and is completed with the production of finished goods. *f the manufacturing cycle involves a longer period the need for wor ing capital will be more, because an extended manufacturing time span

means a larger tie-up of funds in inventories. !ny delay at any stage of manufacturing process will result in accumulation of wor -in-process and will enhance the requirement of wor ing capital. ?ou may have observed that firms ma ing heavy machinery or other such products, involving long manufacturing cycle, attempt to minimise their investment in inventories #and thereby in wor ing capital$ by see ing advance or periodic payments from customers. +% ine Fl%ct%ation

,easonal and cyclical fluctuations in demand for a product affect the wor ing capital requirement considerably, especially temporary wor ing capital requirements of the firm. !n upward swing in the economy leads to increased sales, resulting in an increase in the firm(s investment in inventory and receivables or boo debts. +n the other hand, a decline in the economy may register a fall in sales and, consequently, a fall in the levels of stoc s and boo debts. Pro#%ction Policy *f a firm follows steady production policy, even when the demand is seasonal, inventory will accumulate during off-season periods and there will be higher inventory costs and ris s. *f the costs and ris s of maintaining a constant production schedule are high, the firm may adopt the policy of varying its production schedule in accordance with the changes in demand. Firms whose physical facilities can be utilised for manufacturing a variety of products can have the advantage of diversified activities. T%rno)er o! Circ%lating Capital %he speed with which the operating cycle completes its round raw materials finished product accounts receivables cash plays a decisive role in influencing the wor ing capital needs. Cre#it Ter(

%he credit policy of the firm affects the size of wor ing capital by influencing the level of boo debts. %hough the credit terms granted to customers in a large measure depend upon the norms and practices of the industry or trade to which the firm belongs, yet it may endeavour to shape its credit policy within such constrains. ! long collection period will generally mean tying of larger funds in boo debts. ,lave collection procedures may even increase the chances of bad debts. Gro't, an# E$pan ion Acti)itie !s a company grows, logically, larger amount of wor ing capital will be needed, %hough it is difficult to state any firm rules regarding the relationship between growth in the volume-of a firm(s business and its wor ing capital needs. Operating E!!iciency +perating efficiency means optimum utilisation of resources. %he firm can minimise its need for wor ing capital by efficiently controlling its operating costs. &ith increased operating efficiency application use of wor ing capital is improved Price Le)el C,ange -enerally, rising price level requires a higher investment in wor ing capital. *ncreasing prices for the same levels of current assets need enhanced investment. "owever, firms which can immediately revise prices of their products upwards may not face a severe wor ing capital problem in periods of rising price levels. %he effects of increasing price level may, however, be felt differently by different firms.

Ot,er Factor %here are some other factors which affect the determination of the need for wor ing capital. ! high net profit margin contributes towards the wor ing capital. %he net profit is a source of wor ing capital to the extent it has been earned. %he cash inflow can be calculated by ad;usting non-cash items such as depreciation. +utstanding expenses, losses written off, etc. from the net profit. Approac,e to Managing Wor"ing Capital %wo approaches are generally followed for the management of wor ing carpet #i$ the conventional approach and #ii$ the operating cycle approach. T,e Con)entional Approac, %his approach implies managing the individual components of wor ing capital #ii$ the inventory, receivables, payables, etc. efficiently and economically so that there are neither idle funds nor paucity of funds. %echniques have been evolved for the management of each of these components. T,e Operating Cycle Approac, %his approach views wor ing capital as a function of the volume of operating expenses. @nder this approach the wor ing capital is determined by the duration of the operating cycle and the operating expenses needed for completing the cycle. %he duration of the operating cycle is the number of days involved in the various stages, commencing with acquisition of raw materials to the realisation of proceeds from debtors. %he credit period allowed by creditors will have to be set off in the process. T-E FOLLOWING INDICES CAN +E USED FOR MEASURING T-E EFFICIENC. IN MANAGING WORKING CAPITAL/ C%rrent Ratio 0CR1 '5 A'urrent !ssetsB'urrent 2iabilities

*t indicates the ability of a company to manage the current affairs of business. *t is useful to study the trend of wor ing capital over a period of time. %hough the current ratio of 3)0 is considered ideal, this may have to be modified depending on the peculiar conditions prevailing in a particular trade or industry. *t is not only the quantum of current ratio that is important but also its quality. i.e., extent to which assets and liabilities are really current. 2%ic" Ratio 02R1 C5A2iquid !ssetsB'urrent 2iabilities 2iquid assets mean current assets minus those which are not quic ly realisable. *nventory and stic y debts are generally treated as non-quic assets. %he relationship of 0)0 between quic assets and current liabilities is considered ideal, but, li e current ratio, it also varies from industry to industry, depending on the peculiar conditions of a particular industry. Ca , to C%rrent A et

*f cash alone is a ma;or item of current assets then it may be a good indicator of the profitability of the organization, as cash by itself does not earn any profit, the proportion should usually be ept low. Sale to Ca , Ratio ,ales to 'ash 5atioA,alesB!verage cash balance during the period. 'ash should be turned over as many times as possible, in order to achieve maximum sales with minimum cash on hand. A)erage Collection Perio# #8ebtorsB'redit ,ales$ D 4>= %his ratio explains how many days of credit a company is allowing to its customers to settle their bills. A)erage Pay(ent Perio#

!verage payment periodA#'reditorsB'redit purchases$ x 4>= *t indicates how many days of credit is being en;oyed by the company from its suppliers. In)entory T%rno)er Ratio 0ITR1 *%5A,alesB!verage *nventory *t shows how many times inventory has turned over to achieve the sales. *nventory should be maintained at a level which balances production facilities and sales needs. Wor"ing Capital to Sale @sually expressed in terms of percentage, it signifies that for any amount of sales a relative amount of wor ing capital is needed. *f any increase in sales is contemplated it has to be seen that wor ing capital is adequate. %herefore, this ratio helps management in maintaining wor ing capital which is adequate for the planned growth in sales. Wor"ing Capital to Net Wort, %his ratio shows the relationship between wor ing capital and the funds belonging to the owners. &hen this ratio is not carefully watched, it may lead to) a$ +ver trading when the conditions are in the upswing. *ts symptoms being #*$ "igh *nventory %urnover 5atio #ii$ 2ow 'urrent 5atio6 or b$ @ndertrading when the conditions of mar et are not good. *ts ma;or symptoms are) i$ 2ow *nventory %urnover 5atio ii$ "igh 'urrent 5atio. Efficient wor ing capital management should, therefore, avoid both over-trading and under-trading. So%rce o! Wor"ing Capital ,ources of wor ing capital are many. %here are both external or internal sources. %he external sources are both short-term and long-term. %rade credit, commercial ban s, finance companies, indigenous ban ers, public deposits, advances from customers, accrual accounts, loans and advances from directors are external short-term sources.

'ompanies can also issue debentures and invite public deposits for wor ing capital which are external long-term sources. Equity funds may also be used for wor ing capital. Tra#e cre#it %rade credit is a short-term credit facility extended by suppliers of raw materials and other suppliers. *t is a common source. *t is an important source. Either open account credit or acceptance credit may be adopted. *n the former as per business custom credit is extended to the buyer. %he buyer is not giving any debt instrument as such. Co((ercial 3an" are the next important source of wor ing capital finance.

'ommercial ban ing system in the country is broad based and fairly developed. ,traight loans, cash credits, hypothecation loans, pledge loans, overdrafts and bill purchase and discounting are the principal forms of wor ing capital finance provided by commercial ban s. Finance co(panie in t,e co%ntry !bout =EEEE companies exist at present. %hey provide services almost similar to ban s. %hey provide need-based loans and sometimes arrange loans from others for customers. *nterest rate is higher. :ut timely assistance may be obtained. In#igeno% 3an"er also provide financial assistance to small business and trades.

%hey charge exorbitant rates of interest by very much understanding. P%3lic #epo it are unsecured deposits raised by businesses for periods exceeding a year but not more than 4 years by manufacturing concerns and not more than = years by non-ban ing finance companies. A#)ance !ro( c% to(er are normally demanded by producers of costly goods at the time of accepting orders for supply of goods. 'ontractors might also demand advance from customers. &here sellers mar et prevails, advances from customers may

be insisted. *n certain cases, to ensure performance of contract an advance may be insisted. Accr%al acco%nt are simply outstanding suppliers of overhead service requirements. Loan !ro( #irector , loans from group companies etc. constitute another source of wor ing capital. 'ash rich companies lend to liquidity companies under liquidity crunch. Co((ercial paper are usance promissory notes negotiable by endorsement and

delivery. ,ince 0FFE '1s came into existence. %here are restrictive conditions as to the issue of commercial paper. '1s are privately placed after 5:*(s approval with any firm, incorporated or not, any ban generally float '1s. De3ent%re an# e4%ity !%n# can be issued to finance wor ing capital so that the or financial institution. :ig and sound companies

permanent wor ing capital can be matchingly financed through long term funds.

ACCOUNTS RECEI5A+LES MANAGEMENT Intro#%ction &hen the finished goods are sold on credit, the entire sales #both on cash and credit bases$ are recorded as sales in the profit and loss account. :ut, while the cash sales get represented in terms of cash in hand or in ban or some assets purchased on cash basis, etc, the credit sales are reflected in the value of sundry debtors #,8s$ #as referred to in *ndia$,are also nown as %rade 8ebtors #%8s$. !ccounts 5eceivable

#!5s$, :ills 5eceivable #:5s$ on the assets side of the balance sheet. %his is what happens in the boo s of the seller. :ut, in the boo s of the buyer, the purchases made on credit basis are accounted for as sundry creditors #,'s$ also 'reditors #%'s$, !ccounts 1ayables #!1s$ and :ills 1ayable #:1s$. Further, with a view to fully understand and appreciate the high need for effective monitoring and follow-up of sundry debtors, it may be very pertinent to mention here that generally spea ing, after the company(s investment in plant and machinery, and stoc s of inventory #mostly in that order$, the sundry debtors constitute the third largest and most important item of assets of the company. %herefore, the imperative need of effective monitoring and control of all the items of ,undry 8ebtors assume a highly important and strategic position in the area of 'orporate Financial Management. Cre#it Policy &hile formulating credit policies, we should vary the quantum and period of credit, party-wise. For this purpose, we may broadly classify our parties #customers, clilentele$ under four different categories, on the basis of their integrity and ability #both intention and strength$ to pay in full and in due time. !ccordingly, these may be classified as under) nown as %rade

Category Degree o! Ri " ! .o ris : 2ittle ris ' ,ome ris 8 "igh ris :ut, such an exercise should not be ta en as ;ust a onetime exercise. ,uch classifications must, instead, be reviewed periodically, and revised upward or downward, as the case may be. %hat is, if the performance of a particular party in category ! seems to be declining, in terms of promptness in payment, it could well be brought down from 'ategory ! to say, 'ategory :. !nd, similarly, based upon the past performance, as per the company(s records, if some perceptible improvement is observed in some category :, or even category ' parties, these could as well be promoted to 'ategory ! and : respectively, as the case be. Step an# Strategie Step 6 Pro(pt #e patc, o! goo# an# in)oice/ %he very first step towards effective supervision and follow-up of sundry debtors is that the goods must be despatched promptly, as also the relative invoice. :ecause, the 0=th day or >Eth, whatever, can be counted only after the day one begins, i.e., when the goods invoice have been despatched. %hus, a slight delay of even a day or two delays the payment of the sundry debtors at least by so many day#s$. Step 7 Correct an# %na(3ig%o% in)oicing/ *t is of crucial importance that the order number, particulars #quality and quantity$ of goods, and such other details are incorporated in the invoice correctly, so as to facilitate the buyer company to connect the matter appropriately. !ny error in these particulars,

howsoever all, may result in a significant financial loss, sometimes, due to the avoidable correspondence and the resultant delay in payment. Step 8 A)oi# #i p%te / Extra care and due precaution must be ta en by and at all times, in despatching the goods of the agreed quality only, #not even a shade less or more$, so that may eep all the possible disputes avoided, ways. Step 9 Stan#ar# 0printe#1 in)oice por!or(a 'it, a tear:o!! portion ) &ith a view to ensuring that all the relevant particulars have been incorporated in the invoice, #of course, meticulously and correctly$, it would augur well if the company ta es care to evolve an all - comprehensive proforma of its invoices, such that no relevant particulars may be lost sight of. :esides, with a view to ensuring that the invoice, along with the relative bill of exchange and such other documents, have been duly received by the party, an ac nowledgement slip could also be provided as a tear off portion of the relative forwarding letter itself, wherein all the relevant particulars details of the various documents, etc., as also the full and correct postal address of the seller company, are computer-printed at the appropriate place. %his way, the buyer company, at the receiving end, would have to ;ust put its rubber stamp #not even signature$ on the ac nowledgement slip, and to slip the #ac nowledgement$ slip in the window envelop and post it. !nd, that is it. ! specimen proforma of the suggested forwarding letter along with the tear off portion containing the ac nowledgement slip, is placed in !nnexure =.0 at the end of the 'hapter. &hen the efforts of typing ac nowledgement letter are involved, mostly the buyer companies are found to be adopting the easiest course of action. %hat is, they ;ust do not send any ac nowledgement, whatsoever.

Step ; Entrie in t,e 0i1 Ma ter Regi ter 0all co(pre,en i)e1 an# 0ii1 Le#ger Acco%nt

0party:'i e1/ &ith a view to exercising effective control on all the &or ing 'apital Management sales effected, on a day-to-day basis, the companies may maintain a Master 5egister6 wherein all the particulars of all the sales effected on a particular day may be entered, in serial order. A General Pattern o! Follo':%p Mea %re ! general pattern of follow-up of sundry debtors are discussed hereafter, followed by some special strategies to be evolved for some special and specific cases, desiring special attention and specific treatment. %he idea behind having different sections or registers #or different folios in the computer$ is that the actual due date can easily be calculated from the date of sale, as the same section B file will have the same due date for the same date of sale. %hat is, in a section B file of 4E days credit period, the due date will be 4E days after the date of sale and so on. Step 6 :y way of a general follow-up, usually a wee before the due date of payment, a routine type of computer printed reminder could be sent. Step 7 Further, if the bill does not appear to have been paid even after a wee or a fortnight, of the stipulated due date, a second reminder may be sent with a slightly firm language used, and a copy thereof may be endorsed to the ,ales +fficerB,ales 5epresentative for necessary follow-up action.

Step 8 *f, even such reminder does not evo e the desired results, a third strict reminder may have to be sent, with a copy thereof endorsed to the ,ales +fficerB,ales Manager concerned, to personally follow-up the matter with the party concerned, during their immediately next visit to the area, so as to obtain the payment, at the earliest. !nd, in the mean time, the goods despatch section may be instructed to suspend the supply of goods to such party , till further fuctions, so as to avoid the situation of accumulation of some huge over- amounts. Step 9 !nd, if even such strict and firm dealings do not bestir #activate$ the parties, legal notice#s$ may have to be served on some of them, ;ust as test cases, so that they #and even other buyers$ may not get an impression that they may go scot free so easily. Step ; ,imilarly, in some cases, ;ust by way of setting an example, and creating some sense of fear, even civil suits may be filed, though not with the intention of bringing it to its logical conclusion, but only as a demonstration of strong will that mean business. For(%lation o! Cre#it Policy 'redit policies need to be formulated by the top management, of course, in consultation with the lower levels of management, as they are expected to have the real feel and first-hand experience and information about the mar et trends as also about the traders and the competitors. Ca , Di co%nt 'ash discount is a very common mechanism of effecting and encouraging speedy payments but of course, at a price. %herefore, before ta ing a decision about the period and quantum of giving cash discount, we must first try to understand and appreciate the

financial implications of such a stand ta en, mainly in terms of the quantum of interest gained or lost. %his can be best understood by ta ing some illustrative examples. Day< Sale O%t tan#ing 0DSO1 %here is yet another method of monitoring and follow-up of sundry debtors, commonly nown as G8ay(s ,ales +utstandingG #8,+$. %he /day(s sales outstanding( at a given time GtG may be said to be the ratio of sundry debtors outstanding at the material time to the average daily #credit$ sales Hnot total salesI during the preceding month or two months period or quarter, or say 4E days, >E days and FE days, or such other suitable period. *t may be represented as under) 8,+t A ,undry 8ebtors at time GtG * !verage daily #'redit$ ,ales. 2et us try to understand this method B tool better with the help of an illustrative example. DECISION : MAKING ,undry debtors management requires a lot of decision-ma ing exercises, in several areas, by the personnel at different levels) top level, middle level and ;unior level. Cre#it Policy Formulation of credit policy comes within the purview of the top management. *t comprises various aspects of credit policy, which are discussed hereafter, one by one. A& A e (ent o! cre#it:'ort,ine o! t,e %n#ry #e3tor

%his decision is the most crucial one to ma e, as it is the starting point of the whole chain of events, right from the point of sales on credit to the point of final realization of the proceeds of the credit sales. "ere, also the main problem area is to ta e a decision while selecting a new party for dealings for the first time. %his may involve various facets of enquiries and studies, with a view to assessing and evaluating the credit-worthiness and financial stability and strength of each company under consideration. &hile assessing the extent and

quantum of credit ris s involved, which differ from case to case, one must guard against some usual types of errors of ;udgement that may ta e place sometimes. %hey are) #i$ Either a class ! category of customer may be classified as category : or even '. #i$ +r vice versa, i.e., a category : #or even category '$ customer may be erroneously classified as ! category one. !nd, both these errors may prove a little costly in that either a good business may be lost, #and the financial gains therewith$, or the company may accumulate some more bad debts, eating into its profitability. ,uch errors may ta e place but only in some cases, and not in general, provided due care is ta en at the time of the evaluation of the credit-worthiness of the parties. *n such cases, the periodical review of the payment pattern of the respective parties may be helpful in reclassification of some parties, and thereby rectifying the error, if any, hopefully well in time. Type o! Cre#it Policy 8ifferent dimensions of the credit policy may vary in different degrees and shades. *t may be categorised under three broad types) 0i1 Li3eral Cre#it Policy/ ! credit policy may be termed as liberal wherein some other concessions and facilities are granted to the buyers, with the expectation that this way the sales may pic up, and thereby, the cost of extra concessions granted can well be ta en care of, by the additional yield, resulting from the extra sales achieved therewith. :ut then, such liberalization may as well lead to some additional quantum of bad debts, related with the extra sales effected, as also the resultant higher bloc age of funds in sundry debtors, and a higher cost of collection, too. %herefore, all such inter-related facts and factors must be duly considered while ta ing a decision regarding adoption and execution of a specific credit policy, most suited under the given circumstances.

0ii1 Strict Cre#it Policy/ @nder such credit policy, as against the liberal one, the minimum possible concessions and relaxations are granted to the customers. !nd, as a result thereof, the sales may get somewhat adversely affected. :ut, at the same time, the ris of bad debts may as well be minirnized, and so will be the extent of bloc age of funds in sundry debtors and the collection efforts and expenses, too. %hus, the decision should be based on the trade-off position of the positive and negative factors. 0iii1 Me#i%( 0Mo#erate1 Cre#it Policy/ ,uch credit policy adopts the middle of the road approach whereby a balance is tried to be struc in such a way that both the quantum of additional sales and the resultant ris of bad debts may be ept at the optimal levels, i.e., neither too high nor too low, but in about ;ust the right measure. Para(eter o! Cre#it Policy %he various dimensions on the basis of which a company may be said to be adopting a rather liberal, strict or medium #moderate$ credit policy may broadly be classified under four different parameters. %hey are) #i$ ,tandard of credit, #ii$ 1eriod of credit, #iii$ 'ash discount, and #iv$ Effective monitoring and follow-up Ji.e., 'ollection EffortsK. A& Stan#ar# o! Cre#it %he main and most important question that may arise, while arriving at the credit policy decision, is what standard could be considered as the most appropriate and optimal one, with a view to accepting or re;ecting a customer for credit sales. "ere, the company has a variety of choices, of offering credit sales, ranging from /none( to /all( and to Gsome onlyG. %he first two options, obviously, do not seem to be right, as these may either adversely affect the volume and value of the sales, or else may run the high ris of the quantum of bad debts. %hus, both these steps are generally not advisable

unless either the company en;oys the envious privilege of being in the sellers( mar et or else it is in such a disparate situation that its sales may drastically drop down unless a very liberal credit policy is adopted. 0+1 Perio# o! Cre#it %he duration of time #say 4E days, <= days. >E days, etc.$ allowed to the customers, to ma e the payment of the bill, representing the cost of the goods, supplied on credit, is referred to as the credit period. *t has generally been seen that the credit period ranges from 0= days to >E days or even more. !nd, in the case of government departments, it may be even FE days, 0LE days, or even more. %he credit period, however, varies mainly on two considerations) #i$ %he trade practices in the particular line of business, and #ii$ %he degree of trust and credit-worthiness on the part of the customers concerned 0C1 Ca , Di co%nt 'ash discount is given by some companies with a view to giving some financial incentive to the customers so as to reduce them to pay the bills well before the usual credit period granted. @nder such arrangement, the term of payment will be such that the buyer will get a cash discount at a certain percentage #say 3M$, if he ma es the payment well before the usual credit period granted, #eg., if he pays within 0E days, while the usual credit period granted is say, 4E days$. *f such would be the stipulation, it is usually represented, as per the prevailing practice, as G3B0E net 4E.G %o say it again, it means that the buyer will get a discount of 3 per cent, if he ma es the payment within 0E days from the date of the bill, or else he will have to pay the full amount of the bill, if the payment is made after 0E days but within 4E days. &e must, therefore, appreciate that to obtain an early payment of the bill, some discount is being given, which means that there is a price to be paid to obtain an early payment.

.ow, let us compute the price, #or the rate of interest, as it, in effect, is the interest only$, that is being paid by the seller, to the buyer, for ma ing an early payment. &e are here, presuming that all the buyers are prudent enough to pay the bill, only on the 0Eth day #and not earlier$ so as to reap the maximum benefit out of the cash discount offered. !nd, if they were to decide, not to avail of the cash discount, they would, invariably, pay the bill on the very last day, i.e., on the 4Eth day only. Manage(ent o! S%n#ry De3tor In#ia &e have so far discussed about the various principles of management and control of sundry debtors. .ow, we would li e to critically examine as to what are the actual practices and policies that are, generally being followed by the various companies in *ndia. For the purpose of the study we shall ta e up the issues under three broad categories) #!$ 'redit 1olicy #:$ !ssessment of 'redit-worthiness of the customers #present and prospective$, and #'$ Monitoring and 'ontrol of ,undry 8ebtors. 0A1 Cre#it Policy #i$ 7ery few companies have been found to have systematically formulated and documented their credit policies. *n most of the cases these are made on an ad hoc basis and mostly remain as unwritten conventions and practices. #ii$ *n some of the companies, the credit policy and philosophy have been stated, in too general terms, which do not signify any specific stand or standard, to be followed by the operating staff. For example, if a company states its credit policy, in general terms, li e G+ur credit policy aims at maximising the growth of sales with the minimal bad debt ris sG, it does not convey much as a guideline or guiding principle of any practical use and utility. 0+ill Recei)a3le or Acco%nt Recei)a3le1 in

#iii$ %he credit period offered by various companies differs to a very great extent, ranging from E day to >E days or even FE days. For example, a company, which is privileged to be in the seller(s mar et, may not give a single day(s credit, i.e., may insist on cash down payments, while the companies li e 1remier Motors or 8aewoo Motors may offer a much longer credit period, to boost up the sales. Further, while some of the companies, manufacturing consumer products #with the exception of textile and garment manufacturing companies$ may give nil or a limited credit period, other companies may have to give a much longer credit period, to be able to sell their products. #iv$ :esides, the practice of offering cash discount #with a view to ensuring early payments$ does not seem to be very popular in *ndian business scenario. 0+1 A e (ent o! Cre#it:Wort,ine o! C% to(er

0. %here does not seem to be any systematic and scientific study made, by using different tools and techhiques, to determine the creditworthiness or financial strength and stability of the customers - both present and prospective. *n fact, the financial position of the present customers should also be reviewed and revised on a regular basis, based upon out) own experiences of their past performance and dealings with us. :ut this seldom seems to have been resorted to, in most of the companies. 3. .o serious and sincere effort seems to have been made to meticulously analyse the balance sheet and profit and loss account of the companies, with a view to ma ing a realistic assessment and appraisal of their financial position. *t has hardly been observed that some companies have as ed for some brea -ups of certain items #say, of inventories or bad debts$, to see through the elements of window dressing, if any.

4. 1rospective customers are required to give, at least, two or three references, but no serious attempt seems to have been made by most of the companies to verify the position from such references. <. *ndependent credit rating agencies have, of late, appeared on the scene li e '5*,*2, *'5!, etc., but the credibility and dependability of their credit ratings may be a little doubtful. %he credit rating agencies had given satisfactory credit rating to /M, ,hoes( and /'5: Finance 'ompany(, but their assessment had proved to be totally wrong and contrary to facts. :esides, the practice of see ing professional help from such credit rating companies to ascertain and assess the financial position of the prospective customers does not seem to be very common, as opposed to the conditions prevailing in the @,!, and other developed countries. =. ,ome companies attempt to get the opinion of the ban ers on the prospective customers from the letters( ban , but, as has already been observed earlier, their opinions, though given in strict confidence and without any obligation, are written in such general and vague terms that these do not seem to be of much help and practical utility. 0C1 E!!ecti)e Monitoring an# Control o! S%n#ry De3tor %hough the various tools and techniques, systems and strategies, of effective monitoring of sundry debtors, are very well nown to the executives of most of the companies, very few companies have been found to have evolved some systematic mechanism of effective monitoring and follow-up of sundry debtors on some sound, systematic and scientific lines. ! lot seems to have been left to be desired. ,ome companies have been found to be wor ing out the average collection period, but not party-wise. %hey may do the ageing analysis but only in absolute terms and not in terms of percentage, etc.

Factoring Factoring is a unique financial innovation. *t is both a financial as well as a management support to a client. *t is a method of converting a non-productive, inactive asset #i.e., hoo debts$ into a productive asset #viz., cash$ by selling boo debts #receivables$ to a company that specialises in their collection and administration.( For a number of companies, cash may become a scarce resource if it ta es a long time to receive payment for goods and services supplied by them. ,uch a current asset in the balance sheet is, in fact, illiquid and serves no business purpose6 it is much better to sell that asset for cash which can be immediately employed in the business. ! GfactoN( ma es the conversion of receivables into cash possible. %he term factor has its origin in the 2atin word /facere(, meaning to ma e or do, or to get things done. +riginally, factors acted as selling agents. %hey facilitated the flow of merchandise from the manufacturers to customers. %he functions of a factor included finding out customers for the manufacturer(s products, stoc his goods, sell them and finally collect sales proceeds and remit them to the manufacturer. %hus, the function of factors in olden days included stoc ing, mar eting and distribution as well as administration and financing of credit. %he modem factor has specialized in credit collection and financial services, leaving the mar eting and distribution functions to the manufacturer. Factoring Ser)ice &hile purchase of boo debts is fundamental to the functioning of factoring, the factor provides the following three basic services to clients) 0. ,ales ledger administration and credit management. 3. 'redit collection and protection against default and bad-debt losses. 4. Financial accommodation against the assigned boo debts.

Cre#it a#(ini tration ! factor provides full credit administration services to his clients. "e helps and advises them from the stage of deciding credit extension to customers to the final stage of boo debt collection. %he factor maintains an account for all customers of all items owing to them, so that collections could be made on due date or before. "e helps clients to decide whether or not and how much credits to extend to customers. "e provides clients with information about mar et trends, competition and customers and helps them to determine the credit worthiness of customers. "e ma es a systematic analysis of the information regarding credit for its proper monitoring and management. "e prepares a number of reports regarding credit and collection, and supplies them to clients for their perusal and action. Cre#it collection an# protection &hen individual boo debts become due from the customer, the factor underta es all collection activity that is necessary. "e also provides full or partial protection against bad debts. :ecause of his dealings with the variety of customers and defaults with different paying habits, he is better position to develop appropriate strategy to guard against possible defaults. Financial a i tance

+ften factors provide financial assistance to the client by extending advance cash against boo debts. 'ustomers of GclientsG become debtors of a factor and have to pay to him directly in order to settle their obligations. Factoring thus involves an outright purchase of debts, allowing full credit protection against any bad debts and providing financial accommodation against the firm(s boo debts. *n the @.,.!., the maximum advance a factor provides is equal to the amount of factored receivables less the sum of #i$ the factoring commission, #ii$ interest on advance, and #iii$ reserve that the factor

requires covering bad-debts losses. %he amount of reserve depends on the quality of factored receivables and usually ranges between = to 3E per cent in the @.,.!. *n view of the services provided by a factor, factoring involved the purchase of a client(s boo debts with the purpose of facilitating credit administration, collection and

protection. *t is also a means of short-term financing. *t provides protection against the default in -paying for boo debts. For these services, the factor, however, charges a fee from the client. %hus factoring has a cost. Ot,er er)ice *n developed countries li e the @.,.! factors provide many other services. %hey include) #i$ providing information on prospective buyers6 #ii$ providing financial counselling6 #iii$ assisting the client in managing its liquidity and preventing sic ness6 #iv$ financing acquisition of inventories6 #v$ providing facilities for opening letters of credit by the client etc. Factoring an# S,ort:Ter( Financing !lthough, factoring provides short-term financial accommodation to the client, it differs from other types of short-term credit in the following manner) Factoring involves sale of boo debts. %hus the client obtains advance cash against the expected debt collection and does not incur a debt. Factoring provides flexibility as regards credit facility to the client. "e can obtain cash either immediately or on due date or from time to time, as and when he needs cash such flexibility is not available from formal sources of credit. Factoring is a unique mechanism, which not only provides credit to the client but also underta es the total management of client(s boo debts. Factoring an# +ill Di co%nting Factoring should be distinguished from bill discounting. :ill discounting or invoice discounting consists of the client discounting bills of exchange for goods and services on buyers, and then discounted it with ban for a charge. %hus, li e factoring, bill

discounting is a method of financing. "owever, it falls short of factoring in many respects. Factoring is of bills discounting plus much more. :ills discounting has the following limitations in comparison with factoring) :ills discounting is a sort of borrowing while factoring is the efficient and specialized management of boo debts along with enhancement of the client(s liquidity. %he client has to underta e the collection of boo debts. :ill discounting is always /with recourse, and as such the client is not protected from bad debts. :ills discounting is not a convenient method for companies having large number of buyers with small amounts since it is quite inconvenient to draw a large number of bills. Type o! Factoring %he factoring facilities available worldwide can be broadly classified into four main groups 0. Full service non-recourse #old line$ 3. Full service recourse factoring 4. :ul Bagency factoring <. .on-notification factoring IN5ENTOR. MANAGEMENT INTRODUCTION %he importance and imperative need for effectively managing and controlling all the items of inventory in a company can be ;udged from the fact that generally these comprise the largest component of the total assets of a company, second only to the items of plant and machinery. *n terms of percentage of the total assets of a manufacturing company, all the three components of inventory, ta en together, generally account for around 3= to 4E per cent of the total assets of the company. %hus, the importance of effectively managing and controlling the inventory of a company can hardly be over-emphasised.

COMPONENTS OF IN5ENTORIES %he term /inventory( comprises three components. %hey are) 0. 5aw materials #also consumable stores and spares$, 3. &or -in-process #also nown as stoc -in-process, process$, and 4. Finished goods. 2et us now discuss all these three items, one by one. 0. 5aw Materials are those basic inputs, which are used to manufacture the finished products. 3. &or -in-process, however, is the intermediary stage that comes after the stage of raw materials, but ;ust before the stage of finished goods. 4. %he finished goods, in turn, comprise the end products, that is, the goods at their final stage of production, ready for sale in the mar et. ,upposing, a company is in the business of production of breads. *n this case, the wheat flour, ba ing powder, etc., would comprise the raw materials. !nd, when the flour is put in the relative moulds, which in turn, are placed in the furnace, this stage is nown as the wor -in-process stage. !nd, when the bread is fully ba ed and is ready for sale, of course, after being wrapped in the pac ing paper, it comprises the finished goods of the company. *t may be noted that in the case of manufacturing companies, inventory comprises raw materials, wor -in-process and finished goods, while in the case of trading concerns or trade merchants or retail traders, the inventory comprises only the finished goods. %hus, while all the three components, as aforesaid, comprise the items of inventory for the manufacturing concerns, only the finished goods, li e the breads alone, comprise the inventory for a retail trader, selling breads. "ere, it may be pertinent to mention that the tas of inventory management and control is the ;oint responsibility of the purchase department, materials department, production

department and mar eting department. Further, while the policy pertaining to the raw materials is to be formulated by the purchase department, in coordination with the materials and production departments, the policy in regard to the inventory of finished goods is to be formulated by the production department in coordination with the mar eting department. %he policy in regard to the wor -in-process, however, is finalised by the production department alone. !nd, as we have already seen earlier, eeping in view the vital importance of inventory management and control, in financial terms, the role of finance manager can be said to be the central coordinating role, among all the aforesaid four different departments, with a view to ensuring that the inventory management and control are being exercised effectively at the various stages and departments, on the desired lines. "ere, the main responsibility of the finance manager comprises apprising the non-finance executives so as to, at least, understand the basis of the mechanism and its overall implication in regard to the control of various items of inventory, as these have direct effect on the financial gains of the company. %hat is why it is said that the management of inventory, and for that matter, the management of wor ing capital as a whole, is not the responsibility of the finance manager alone, but also of the purchase department, materials department, production department, and mar eting department. Proce In)entorie

%hese inventories comprise the various items of raw materials, lying at the various stages of production, till these reach the final stage, to become the finished goods. ,upposing, a company is manufacturing iron nails, and its basic raw material is iron rods. *n the drawing machine, these rods may be drawn total time required for completing all the involved processes #stretched$ and, thus, these may become thinner and thinner in three to four processes, when these may come to the required diameter. %hen, these thinner n rods will be cut into pieces of the required length of the nails. !nd

then, while one end may be made pointed, the other end may be flattened to become the head of the nail. !nd, after all these required processes are completed in full, the stoc s of finished goods are ready for transportation #movement$ to the godown#s$ or to the company(s sales outlets. %hus, as the production process involves several stages of production, the aggregate quantum and value of the raw materials, lying at the different stages of production, all ta en together, comprise the stoc s of process inventory. !nd, thus, if the entire process #from the raw material stage till the stage immediately preceding the finished goods stage$ ta es say, ten days, and the average production of the item is 0EEE units per day, the average quantity of such process inventories would be equal to) !verage stoc s-in-process, multiplied by the time days required to complete all the processes, i.e., 0EEE x 0E days A 0E,EEE units. Mo)e(ent In)entorie Movement inventories are usually referred to the inventories of finished goods, to be transferred from the factory to the company(s godowns, warehouses, or sales depots. %hus, if the average daily sales at the company(s sales depot are 3=E units and the transit time #for transporting the finished goods from the factory to the sales depots$ is 0E days, the average movement inventories, as per the aforesaid formula, would be) 3=E units x 0E days A 3=EE units, or 3=E units x 5s. =B- x 0E days A 5s. 03,=EEBOrgani*ation In)entorie +rganization inventories, on the other hand, comprise the items of raw materials and finished goods stored and stoc ed in the company(s godowns, to be supplied to the factory or to the sales depots, as and when they would requisition for the required

number, weight, volume, etc., of the specific items of raw materials and finished goods, respectively. "ere, it may be mentioned that the moment the stoc s of raw materials and finished goods are issued from the company(s godown#s$, these items are excluded from the organisation inventories and these, in turn, are included in the &or ing 'apital process inventories #though these raw materials may actually be put into the production process a little later$, or in the movement inventories #even if the stoc s of the finished goods may be lying in the company(s show-rooms, unsold$. .ow, a natural question, that may arise, could be that if the inventory carrying cost is so huge and material to affect the profitability of the company, favourably or unfavourably, why should the companies, at all, have organization inventories, too, inaddition to the process inventories and movement inventories. !nd, the answer, too, is very simple and logical. %hat is, to ma e the decision-ma ing process of planning #of purchases of raw materials and level of stoc ing of various items of finished goods$ and scheduling of successive operations of production, even more free and flexible. %his also facilitates bifurcation of the functions of purchase of raw materials and production plan into two separate departments, to be managed by the respective experts in each department. %hus, while the production department may ;ust give its production schedule to the purchase department, it would be the sole responsibility of the purchase department to decide about the quantum of such purchases and the stoc ists to purchase them from. %hat is, if the stoc s sometimes are available at a cheaper price during the harvesting seasons of the respective agricultural products, etc., the purchase department may even purchase the materials in much larger quantity than required by the production department #;ust for a fortnight or a month$. 8ecision could as well be ta en by the purchase department whether to go in for such purchases to avail of the bul discount, or to avail of the cash discount, etc., whenever offered. ,imilarly, the purchase

department may ma e purchases for a wee

only locally, to meet the immediate

demands of production, if, by that time, bul purchases may be made available at a much cheaper rate. ,imilarly, in an inflationary condition, the purchase people may exercise their prudence and expertise to ma e the purchases of a larger quantity than required, if such purchases are going to be sufficiently cheaper today, ta ing into account the quantum of inflation, etc. %hat is, it would augur well if the purchase people could as well now the fundamentals of cost-benefit analysis, to be made in this regard, as also as to what factors should be ta en into consideration #li e time-value of money, rate of inflation and the total inventory carrying costs, etc.$. %his much about the rationale behind eeping the organisation inventory of stoc s of raw materials, and delin ing the purchase functions and the production functions. .ow, let us discuss about the rationale behind finished goods. *t is a well eeping organization inventories of

nown fact that, in order to have some edge over the

competitors, companies have to eep some items in ready stoc so as to be able to supply these to the customers from the shelf, at least to meet their immediate requirements, and the balance to be supplied in a wee (s time or so. %his is important because eeping huge numbers of items in ready stoc is fraught with grave ris s of obsolescence, expiry of shelf life, etc. Further, by virtue of having some organisation inventory of finished foods, the companies are able to delin the production schedule from mar eting activities. %hus, we can very well appreciate that by delin ing the purchase activities and production activities, as also production activities from mar eting activities, companies may be able to optimise their profitability, by enabling the experts different departments, to plan things in such a way that the profitability of the company could be optimized and each departmental experts can concentrate on their respective wor , of course, eeping

the overall interests and requirements if the other departments, too, in the fore front, inasmuch as all the departments inter-dependent with each other. !t this stage, it may be quite pertinent to examine the rationale behind eeping the inprocess inventory, too, #though these do not constitute a part of organization inventory, as such$. 2et us, at the very outset, clarify that though the in-process inventory refers to wor -inprocess inventory only, it is different from the process or movement inventory, discussed earlier, even though a part of the wor -in-process inventory may represent process or movement inventory, too. .ow, as regards the rationale behind eeping the in-process inventory, it may be

mentioned here that it provides some flexibility and latitude in the scheduling of production, so as to ensure efficient production schedule and higher capacity utilisation of plant and machinery. Further, in case there is no stoc of in-process inventory, some bottlenec s may be caused sometime somewhere in the production process, which may ultimately result in delay in production and non utilisation of the installed capacity at the optimum possible level. %hese factors, naturally, will culminate in adversely affecting the financial gains of the company. Econo(ic Or#er 2%antity 0EO21 *n regard to the management of inventories #specially the inventories of raw materials$ two primary questions naturally arise. %hey are) #a$ +rder size, i.e., what should be the ideal size of the orderN #b$ +rder 2evel, i.e., at what level of the stoc s should the next order be placedN :ut, before deliberating to find out the answers to the above questions, let us first try to understand the distinguishing features of the three types of costs involved in the management of inventories) #i$ +rdering costs,

#ii$ #*nventory$ carrying costs, and #iii$ ,hortage costs. 2et us now discuss these costs, in detail, one by one. %hese include the expenses in respect of the following items) #i$ 'ost of requisitioning items#s$ 6&Or#ering Co t +rdering costs pertain to placing an order for the purchase of certain items of raw. %hese include the expenses in respect of the following items) #i$ 'ost of requisitioning the items#s$ #ii$ 'ost of preparation of purchase order #i.e. drafting, typing, despatch, postage, etc$ #iii$ 'ost of sending reminders to get the dispatch of the items#s$ expedited #iv$ 'ost of transportation of goods #v$ 'ost of receiving and verifying the goods #vi$ 'ost of unloading of the item#s$ of goods #vii$ ,torage and stac ing charges, etc. "owever, in case of items manufactured in-house #i.e., by the same company$, the ordering costs would comprise the following costs) #i$ 5equisitioning cost #ii$ ,et-up cost #iii$ 'ost of receiving and verifying the items #iv$ 'ost of placing and arrangingBstac ing of the items in the store, etc. 7& Carrying Co t 0o! in)entorie 1 *nventory carrying costs include the expenses incurred on the following items) #i$ 'apital cost #i.e., interest on capital loc ed up in inventories$ #ii$ ,torage cost #iii$ 'ost of insurance #fire and theft insurance of stoc s$

#iv$ +bsolescence cost #v$ %axes, etc. *t may, however, be mentioned here that the carrying costs usually constitute around 3= per cent of the value of inventories held. 8& S,ortage Co t 0or co t o! toc" o%t1 ,hortage costs or costs of stoc out are such costs which the company would incur in case of shortage of certain items of raw materials required for production, or the shortage of certain items of finished goods to meet the immediate demands of the customers. ,hortage of inventories of raw materials may affect the company in one or more of the following ways) #i$ %he company may have to pay somewhat higher price, connected with immediate #crash$ procurements. #ii$ %he company may have to compulsorily resort to some different production schedules, which may not be as efficient and economical. ,toc out of finished goods, however, may result in the dissatisfaction of the customers and the resultant loss of sales. *t, however, is relatively very difficult to actually measure the shortage cost when it results due to the failure to meet the demands of the customers instantaneously, out of the existing stoc s. %his is so because such costs may have ramifications, both in the short-term as also in the long term. :esides, these costs are somewhat intangible in nature, and consequently difficult to assess quantitatively. *t has also been observed that some of the companies, with a view to reducing total ordering costs, prefer to order larger quantities. :ut, this way the level of inventory becomes higher, and thereby the inventory carrying costs also go up. Further, if the

company decides to carry a safety stoc of inventory so as to mitigate or reduce the stoc out costs, or shortage costs, its carrying costs, in turn, would go up further. %hus, with a view to eeping the total costs, pertaining to management of inventory, at the minimum level, we may have to arrive at the optimal level where the total costs, i.e., total ordering costs plus total inventory carrying costs, are minimal. %o achieve this end result, we may have to wor out the Economic +rder Cuantity #E+C$. +a ic Econo(ic Or#er 2%antity 0EO21 Mo#el !t the very outset, it is to clarify here that we are going to discuss only the basic E+C model, one of the simplest inventory models. %here are, in fact, a large number of other inventory models, depending upon various variables and assumptions. A %(ption o! t,e +a ic EO2 Mo#el

*t may further be clarified here that the basic E+C model is based on various assumptions, which are given hereunder) 0. %he estimate of usage #demand or consumption$ of the item of inventory for a given period #usually one year$ is nown accurately. 3. %he usage #demand or consumption of the various items of inventory$ is equal #even$, throughout the period. 4. %here is no lead time involved. %hat is, the item of inventory can be supplied immediately on the receipt of the order itself6 there being virtually no time lag between placing of an order and the receipt of the goods. 'onsequently, there is no li elihood of stoc out, at any stage. %herefore, the shortage cost #or stoc out cost$ is not being ta en into account, as if it is nil. <. %hus, there remain only two distinct costs involved in computing the total costs, pertaining to inventory, viz., a$ +rdering cost, and #b$ *nventory carrying cost. =. Further, the cost of every order remains uniformly the same, irrespective of the size of the order.

>. !nd, finally, that the inventory carrying cost is a fixed percentage of the average value of inventory. Eo4 For(%la ) Trial an# Error Met,o# *t may be observed that the E+C can be ascertained in two distinct ways) #i$ :y trial and error method #discussed immediately hereafter$, and #ii$ :y use of a definite formula #discussed thereafter$. Trial an# Error Met,o# 2et us understand the Gtrial and errorG method with the help of an illustrative example. Econo(ic Or#er 2%antity 0EO21 an# Opti(%( Or#er 2%antity 0OO21 %he standard E+C analysis is based on the assumption that no discount is given, howsoever large the order size be. :ut, in most of the cases, some discount is given by way of an incentive to the buyers to order for a larger quantity so as to avail of some bul discount. %hus, we should try to modify the standard E+C formula so as to find out the E+C as also to assess whether it would be economical to avail of the bul discount or not. Econo(ic Or#er 2%antity 0EO21an# In!lation %he E+C analysis presumes that the cost price per unit is constant. %his implies that the incidence of inflation has not been ta en into account. *n order to account for inflation, what we have to do is, to first substract the rate of inflation from ' #the annual inventory carrying cost, expressed as a percentage$ and apply the standard E+C formula with this simple modification only. :ut, you may as , and rightly so, that why at all do we substract the rate of inflation from 'N %he reason is simple enough. *n an inflationary condition, the purchase price of inventory will also go up and this will, to some extent, offset the inventory carrying cost. Co(ponent o! In)entory Carrying Co t *nventory carrying costs comprise various items, some of which are given hereunder)

0i1 Storage Co t %hat is, the rental payable will be proportionately higher as more space would be required to store higher level of inventory. 0ii1 -an#ling C,arge %hat is, when higher stoc s will be stored, handling charges li e unloading and stac ing charges, at the time of receipt of the goods, etc., involving man power, may also go up. 0iii1 In %rance Pre(i%( ,imilarly, the amount of insurance premium payable, for fire insurance, theft insurance, flood and such other natural calamity insurance, etc., will also be higher. 0i)1 Wa tage *t has generally been observed that if more than sufficient stoc s of inventory are stored, there is a usual tendency to consume more than what is actually required, resulting in extra avoidable wastages. %o bring home the point, let us ta e a common place example. ,upposing there is a huge stoc of medical bills proforma, these may, at times, be used even as paper plates, etc. :ut, if these proforma were in short supply, people may ta e care not to waste a single form. 0)1 Da(age an# Deterioration *n the event of storing more than required level of stoc s of raw materials and finished goods, there is every chance that the goods may deteriorate in quality, li e the whiteness of papers gets diminished #it turns yellowish$ with the passage of time. ,ome chemicals or medicines also have limited shelf-life, where after these may turn useless. ,toc s of cement, in rainy season, are fraught with grave ris of turning into stones, and, thus, becoming useless.

0)i1 Tec,nical O3 ole cence *n the modern age of technological advancements, the pace of goods and commodities becoming obsolete has become fast enough. %hus, more than necessary stoc s run the ris of becoming obsolete and consequently of much lesser value and use. 0)ii1 +loc"age o! F%n# !nd, above all, more than necessary funds, bloc ed in inventory, may pose liquidity problems to the companies. *t may as well involve some loss by way of payment of interest as also opportunity costs. A#)antage o! -ig, In)entorie :ut, at the same time, it may be argued that there are several reasons which may ;ustify stoc ing of higher level of inventories of raw materials and finished goods. +%l" P%rc,a e For example, you may get bul discount, ma ing the average costs of the stoc s much cheaper. :ut then, one should not lose sight of the fact that, in such a case, there are several inventory carrying costs involved #li e wastages, damages and deterioration, loss of interest and opportunity cost, etc.$ which may offset the advantages of bul purchases. Lea# Ti(e W,at i (eant 3y lea#:ti(e= 2ead-time is the time lag that ta es place between the placement of an order and the actual supplyBdelivery made in the company(s godown. ,upposing, an order is processed at our end and is placed to the supplier today. %he supplier(s office will also ta e its own time in processing the order plus loading, transportation and unloading, etc. !nd, supposing it ta es say, around 0= days in completing all these processes and the goods are delivered and stored in our godown#s$ on the 0>th day. %hus, in the instant case, the lead-time would be said to be 0> days.

:ut, as seen earlier, the standard E+C model presumes as if there is no lead-time involved. !nd thus, the order can well be placed when the inventory level comes to zero. :ut, the factual position is otherwise. %herefore, we should decidedly ta e into account the lead-time, too, while computing E+C. %his can well be done by introducing a slight modification in the standard E+C analysis to arrive at a realistic ordering point, so as to ta e care of the lead time involved and thereby to mitigate the ris of shortage of stoc s, involving stoc out costs. Or#er Point %his can well be done by ensuring that the order is placed when sufficient balance of stoc is still left to ta e care of the lead-time. :ut, for doing so accurately, we may have to now the rate of usage of materials as also the lead-time, exactly and in definite terms. *n that case the ordering level would simply be as under) 2ead time #in number of days for procurement$ multiplied by average usage per day. i.e. +rder 1oint A 2ead time #in days$ x 8aily @sage. Sa!ety Stoc" :ut then, in actual practice, one can neither estimate the lead time nor the daily usage so accurately and exactly. &e can, at best, ma e some reasonable estimates. :ut, in that case, the possibility of some error, howsoever small, can hardly be eliminated completely. !nd, therefore, we should, to be on the safer side, ta e into account the element of such uncertainty, too. !ccordingly, we should always eep some safety stoc with us to meet such eventualities. !nd, as such, the order point should be computed by adding the quantum of sufficient safety stoc s, too. %hus, the order point can well be computed as) E+C O Hlead time #in days$ x daily usageI O safety stoc

:ut, how to compute the safety stoc N *n fact, it is a managerial decision and, therefore, it largely depends upon the inventory policy as also the organisational culture of the company. *t may, accordingly, be high or low, or even medium. %his, however, does not mean that we should try to cut it too fine, either. +therwise, a lot of the valuable time of the Materials Manager and the 1urchase 8epartment would get wasted in the fire-fighting operations in procuring the materials, in the nic of time, and incur the avoidable expenses relating to such crash purchases. %he best policy, in regard to eeping the safety stoc , would ideally be - neither Gtoo muchG, nor Gtoo littleG, but G;ust rightG. :ut, it is easy said than done. "owever, the considered opinion that, by some trial and error method, we may be able to arrive at a nearly optimal level of safety stoc s, in due course of time. Ot,er 5aria3le Factor A!!ecting EO2 *n finding out the E+C or order level or safety stoc , etc., we have, in the preceding pages, made certain assumptions that some other factors do not vary, though in the real world they do. %herefore, it would always be prudent enough to consider the following variable factors, too, while ta ing a particular decision. %hey are) 6& Re triction I(po e# 3y t,e Re er)e +an" o! In#ia 0R+I1 an# t,e Go)ern(ent/ %he 5eserve :an of *ndia #5:*$, and the -overnment of *ndia, with a view to arresting inflation or steep rise in the prices of certain essential commodities, li e food grains #rice, wheat, maize, etc.$, onion, etc., may resort to some changes in their ,elective 'redit 'ontrol 1olicies, instructing the ban s to retain higher percentage as margin on the stoc s advanced against, as also by fixing some ceiling on the maximum amount that could be advanced against the security of some commodities specified, to a single borrower, as also to fix a lower ceiling on the holding of such stoc s by a single party, so as to restrict hoarding, and consequently the steep rise in the price. ,uch statutory restrictions exercise limitation on the companies in formulating their inventory policy.

7& E$pecte# Scarcity/ *n case certain material is expected to be in short supply in the near future, it would be a prudent policy to stoc a larger quantity of such material so as to avoid the stoc -out ris , as far as possible. 8& Fl%ct%ating Price / ,ometimes the price of certain commodity is expected to rise or fall, in the near future. !nd, accordingly, the stoc s of inventory of such items should be ept flexible, and ad;usted accordingly, i.e., retaining higher or lower levels of such inventory, respectively. 9& Ri " o! O3 ole cence/ 'ertain items of raw materials may become obsolete with the passage of time. For example, ;ute pac ing has since been replaced by polythene matting in the carpet industries. %he ris of obsolescence may be even higher and costlier in the cases of the finished goods, in the modern age of technological advancements and stiff global competition. ,uch stoc s should naturally be ept at the minimal possible level. "ere, it may be emphasised that even if the policy of meeting the customers( demand immediately is ta en to be the company(s mar eting strategy, instead of having a huge ready stoc s of such finished goods, it would augur well if only a percentage of the mar et requirements could be ept in the ready stoc , to be supplied to the customers immediately, and the balance quantity could be produced on an emergency basis and supplied in a wee (s time or so. %his way, the company may meet the competitive challenges, as also avoid the ris of obsolescence. A+CANAL.SIS 0OR 5ED ANAL.SIS1 !:' analysis is a very effective and useful tool for monitoring and control of inventories. !s you must have observed, generally spea ing, a very small percentage of the total number of items of inventory #say 0EM$ may account for a much larger percentage #say >=M$ in terms of value. !s against this, in cases of certain other items of inventory, a very large percentage of the total number of items of inventory #say PEM$ may account

for a much smaller percentage #say 0EM$ in terms of their total value. !nd, li ewise, a medium percentage of some items #say 3EM$ may account for a medium percentage #say 3=M$ in terms of their total value. %hese are classified as category !, : and ' respectively. !:' analysis is also referred to as 7E8 #7ital, Essential and 8esirable$ analysis. &e may put the aforesaid statements in a tabular form as under)

%he main #or even sole$ purpose of classifying the inventories into these three categories, !, :, and ', is to vary the pressure and intensity of control, in terms of the value of the items of inventory. %o put it differently, while the entire stoc s #say 0EEM$, of the items in category G!G must be very closely monitored and controlled, the monitoring and control of say, 0EM of the items of category G'G, could be considered enough to serve the purpose. !nd, in the case of G:G category of items, the monitoring and control of say 3=M of the item alone may be ta en as sufficient. Categori*ation o! Ite( !or A3c Analy i .ow, let us see how do we usually proceed to classify the various items of inventories into the three categories viz., !, :, and '. %he procedure involves the following steps, in a sequential order) Step 6 5an all the items of inventory, in a descending order, based upon their annual usage value, and serially number them, from * to n.

Step 7 5ecord the totals of annual consumption values of all the items separately and store them as a percentage of the total value of consumption. Step 8 a$ +bserve the percentage column and find out the cut off point where the difference between the two successive percentages is rather significant and mar ed. b$ !t the same time, please do bear in mind that the cut off point so arrived at, comprises a reasonable number of items of inventory, too. Step 9 &e may finalise the classification of the items of inventory into !, :, and ' categories, giving the number of units of inventory and their values in percentage terms, under all the three categories, with the laid down principles and ob;ectives of the !:' analysis #or 7E8 analysis$, in the desired manner. +a ic EO2 Mo#el *t is based on the following assumptions) #i$ %he quantum of the usual annual usage of the items of inventories is nown, in accurate term. #ii$ %he usage is usually uniform throughout the year. #ii$ %he lead-time #i.e, time gap between ordering and receiving$ is .*2. #iv$ %herefore, there is no ris of stoc -out, either. %hat is, the stoc -out cost is .*2. #v$ %hus, only two costs are involved) #a$ +rdering 'ost, and #b$ *nventory 'arrying 'ost. #vi$ Further, #a$ +rdering 'ost is uniform, irrespective of the order size, and

#b$ %he *nventory 'arrying 'ost is a fixed percentage of the average value of *nventories. EO2 For(%la ) & Trial an# Error Met,o#/ %rial and Error Method is a very cumbersome and time-consuming process. %he formula, however, ma es the procedure rather simple enough.

In Practice/ %here is no single Economic +rder 1oint #E+1$. %here is, instead, an Economic +rder 5ange #E+5$. EO2 5 & >>> 0Opti(al Or#er 2%antity1/ H%hat is, when bul #quantity$ discount is availableI. #a$ &hen the quantity discount is available at a lower level than the E+C, then E+C itself will be the EEE, too. #b$ :ut, if it is higher than E+C, EEE will be the E+C or the quantity eligible for bul discount, depending upon which one of these two will be beneficial Hi.e., when the resultant difference will be a positive #Ove$ figureI. A Ne' Cl%e to EO2/ %hat is, after finding out the E+C in terms of the nearest integer figure, we should find out the number of orders. !nd, this again, should be converted into the nearest integer number. :ased on this figure as the number of orders, we should calculate the E+C, which will be the E+C in real terms. :esides, we should bear in mind the concepts of E+1 and E+5, too, at this stage. Co(ponent o! In)entory Carrying Co t / #i$ ,torage 'ost

#ii$ "andling 'harges #iii$ *nsurance 'harges #iv$ &astages #v$ 8amageB8eterioration #vi$ %echnical +bsolescence, :loc age of funds and cost of capital, and opportunity cost connected therewith. A#)antage o! -ig, In)entory/ #a$ "igh ,toc s of 5aw Materials #i$ :ul purchase at cheaper rate with quantity discount. H:etter, if bul annual purchase is ordered, but the delivery and payments are to be made in phases, to the mutual advantages of both the parties. *t is an optimal strategy$. #ii$ ,easonal purchases, being cheaper and sure. #iii$ .o ,toc -out cost and ris . #iv$ *n inflationary economy, it may be gainful. #v$ ,avings of ordering cost and the connected hazels of loading and unloading, etc. 031 -ig, Stoc" o! Fini ,e# Goo# / #i$ *t may facilitate instant delivery, out of the shelf, and, thus, to have an edge over the competitors. H:ut, better to have only a small ready stoc and the rest to be produced on receipt of the order, on priority basisI. #ii$ %hus, the G-olden MeanG is the most basic management mantra, pertaining to the management of inventory, too. 6;& Lea# Ti(e *t represents the time lag between placement of order and the actual receipt of goods. %his could as well be ta en into account by modifying the E+C formula, ;ust slightly.

6?& Or#er Point %hus, as a prudent manager, we should place the next order well in advance, at the point in time, when there is some stoc left, being sufficient enough to ta e care of the lead time. 6@& Sa!ety Stoc" !nd, it would be a better business sense to have some safety stoc , too, so as to ta e care of some possible fluctuations in both #i$ the lead-time, and accordingly6 #ii$ the order point. %hus, +rder 1oint will be A E+C O H2ead-time #in days$ x 8aily @sageI O ,afety ,toc . Estimating and ascertaining the safety stoc is a managerial ;udgement9 decision Q discretion. :ut, the safety stoc sufficient enough, ;ust about right. CAS- MANAGEMENT INTRODUCTION *n the previous unit, various issues regarding management of wor ing capital were discussed. *t was explained that current assets form an important aspect of wor ing capital management. *n fact, each current asset requires a detailed treatment to understand the issues related to the need and method of its management. *n this unit we shall discuss the planning and managing of cash. 'ash to business is li e blood stream in human body. 'ash denotes the liquidity of a business enterprise and plays an important role in nurturing and improving the profitability of an organization. *t is, therefore, essential to ma e a proper estimate of the cash needs and plan for it so as to avoid technical or legal insolvency. "ence, effective management ensuring adequate cash is necessary. %he cash available with the organization should neither be short nor too excessive. should not be too high, nor too low. *t should be

W,y i Ca , Nee#e#= %he demand for liquid assets li e cash, whether by individuals or firms, is normally attributed to three behavioral motives, viz., the transaction motive, the precautionary motive and the speculative motive. %he transaction motive for holding cash is helpful in the conduct of everyday ordinary business such as ma ing of purchases and sales. %he amount of cash needed, however, differs from business to business and from firm to firm depending on the frequency of cash transactions. 5etail trade, for example, requires a higher ratio of cash to sales and of cash to total assets. Firms having seasonal business will need greater amount of cash during the season. %he precautionary motive is concerned with predictability of cash inflows and outflows. "igher the predictability of cash, lower is the amount needed against emergencies or contingencies. %his motive for holding cash is also influenced by the ability of the firm to obtain additional cash on short notice through short-term borrowings. ! minimum reservoir of cash must always be ept in hand to meet the unexpected payments and other contingencies. %he speculative motive for holding cash is concerned with availing the opportunities arising from unexpected developments, e.g. an abnormal increase in prices. "owever, eeping additional cash for speculative purpose is not common in business. Deter(ining Opti(al Ca , +alance "olding of excessive cash is a non-profitable proposition, as idle cash does not earn any income. ,imilarly shortage of cash may deprive the business unit of availing the benefits of cash discounts, and of ta ing advantage of other favorable opportunities. *t may even lead to loss of credit-worthiness on account of default in paying liabilities when the same becomes due. "ence, every organization, irrespective of its size and nature, has to determine the appropriate or optimum cash balance that it would need.

! firm(s cash balance, generally, may not be constant overtime. *t would therefore be worthwhile to investigate the maximum, minimum and average cash needs over a designated period of time. ?ou are aware that cash is needed for various transactions of the organization. Maintenance of a cash balance however has an opportunity cost in the following ways) a$ 'ash can be invested in acquiring assets such as inventory, or for purchasing securities. +pportunities for such investments may be lost if a certain minimum cash balance is held. b$ "olding of cash means that it cannot be used to offset financial ris s from the shortterm debts. c$ Excessive reliance on internally generated liquidity can isolate the firm from the shortterm financial mar et. .ow the Finance Manager should understand the benefits and the opportunity costs for holding cash. %hereafter, he must proceed to wor out a model for determining the optimal amount of cash. First of all, 'ritical minimum cash balance should be conceived below which the firm would incur definite and measurable costs. !part from ris aversion, the existence of the minimum balance is ;ustified by institutional requirements such as credit ratings, chec ing accounts and lines of credit. %he violation of maintaining a minimum cash balance will create shortage costs, which will be determined by the actions of creditors on account of postponing their payments or non-availing of cash discounts. !t any point of time a firm(s #ending$ cash balance can be represented as follows) Ending balanceA:eginning :alance O 5eceipts 9 8isbursements *f receipts and disbursements are equal for any unit of time, no problem is involved. +rdinarily, however, receipts may be more than disbursements or vice versa. "ence,

the ending balance will

eep on fluctuating. *n actual practice, receipts and

disbursements do vary, particularly in case of firms having seasonal activities. ,uppose, the receipts and disbursements are not synchronized but the variation is predictable, then the main problem will be that of minimizing total costs. Ca , Manage(ent 'ash, being a sensitive asset, has to be regulated according to needs. !ny deficits #or inadequacies$ should be rectified and any excess amount be gainfully invested. 'ash management involves two main questions 0. "ow should the collection and disbursement of cash balances be managedN 3. "ow should the appropriate cash balance be determined, and how should any temporary idle cash be invested in interest earning assetsN Managing Collection an# Di 3%r e(ent T,e Ca , Cycle *n order to deal with the problem of cash management, we must have an idea about the flow of cash through a firm(s account. %he entire process of this cash flow is nown as 'ash 'ycle. %his has been illustrated in Figures *** and *7. 'ash is used to purchase materials from which goods are produced. 1roduction of these goods involves use of funds for paying wages and meeting other expenses. -oods produced are sold either on cash or credit. *n the latter case the pending bills are received at a later date. %he firm thus receives cash immediately or later for the goods sold by it. %he cycle continues repeating itself.

%he diagram in above figure only gives a general idea about the channels of flow of cash Managing 'ash in a business. %he magnitude of the flow in terms of time is depicted in the diagram given in Figure *7. %he following information is reflected by Figure *7) a. 5aw material for production is received 0E days after placement of order. b. %he material is converted into goods for sale in 4P days #0=O3O3E$ from point : to E. c. %he payment for material purchased can be deferred to 0P days #0=O3$ after it is received #i.e. the distance of time between points : to 8$, assuming that it ta es 3 days for collection of payment of the cheque. d. %he amount of the bill for goods sold is received 4> days #43O3O3$ after the sale of goods as is depicted by duration of time between point F to ". e. %he recovery of cash spent till point 8 is made after => days #3EO4EO3O3O3$ as shown between points 8 to ". Spee#ing %p Collection *n order to minimize the size of cash holding, the time gap between sale of goods and their cash collection should be reduced and the flow be controlled. .ormally, certain factors creating time lags are beyond the control of management. ?et, in order to improve the efficiency, attention should be paid to the following. !ll cash collected should be directly deposited in one account. *f there are more than one collection centers, all cash receipts should be remitted to the main account with, top speed. 'ompared to a single collection center, the aggregate requirement for cash will

be more when there are several centers. 'oncentration of collections at one place will thus permit the firm to store its cash more efficiently. %he time lag between the dispatch of cheque by the customer and its credit to our account with the ban should be reduced. ,ome firms with large collection transactions introduce loc box system. *n this system the post boxes are hired at different centers where cashBcheques can be dropped in. %he local ban er can daily collect the same from the loc ers. %he collecting ban is paid service charges. *n order to minimize time front ban s may be as ed to devise methods for speeding up the collection of cash. Reco)ering D%e !fter sale of goods on credit, either on account of convention or for promoting sales, receivables are created. *t may however be useful to reduce the amount bloc ed in receivables by seeing to it that they do not become overdue accounts. *ncentive in the form of discounts for early payment may be given. More important than anything else, is a constant follow-up action for the recovery of dues. %his will improve position of cash balance. Controlling Di 3%r e(ent .eedless to assert that speeding up of collections helps conversion of receivables into cash and thus reduces the financing requirements of the firm. ,imilar ind of benefit can be derived by delaying disbursements. %rade credit is a costless source of funds for it allows us to pay the creditors only after the period of credit agreed upon. %he dues can be withheld till the last date. %his will reduce the requirement for holding large cash balances. ,ome firms may li e to ta e advantage of cheque boo float which is the time gap between the date of issue of a cheque and the actual date when it is presented for payment directly or through the ban .

In)e t(ent o! I#le Ca , +alance %wo other important aspects in cash management are how to determine appropriate cash balance and how to invest temporarily idle cash in interest earning assets or securities. %he first part relating to the theory of determining appropriate cash balance has already been discussed earlier. .ow we shall discuss the investment of idle cash balances on temporary basis. 'ash by itself yields no income. *f we now that some cash will be in excess of our need for a short period of time, we must invest it for earning income without depriving ourselves of the benefit of liquidity of funds. &hile doing this, we must weigh the advantages of carrying extra cash #i.e. more than the normal requirement$ and the disadvantages of not carrying it. %he carrying of extra cash may be necessitated due to its requirement in future, whether predictable or unpredictable. %he experience indicates that cash flows cannot be predicted with complete accuracy. 'ompetition, technological changes, unexpected failure of products, stri es and variations in economic conditions ma e it difficult to predict cash needs accurately. In)e t(ent Criteria &hen it is realized that the excess cash will remain idle, it should be invested in such a way that it would generate income and at the same time ensure quic re-conversion of investment in cash. &hile choosing the channels for investment of any idle cash balance for a short period, it should be seen that #i$ the investment is free from default ris , that is, the ris involved due to the possibility of default in timely payment of interest and repayment of principal amount6 #ii$ the investment shall mature in a short span of time6 and #iii$ the investment has adequate mar etability. Mar etability refers to the ease with which an asset can be converted bac into cash. Mar etability has two dimensions price and time-which are inter-related. *f an asset can be sold quic ly in large amounts at a price determinable in advance, the asset will be regarded as highly mar etable and

highly liquid. %he assets, which largely satisfy the aforesaid criteria, are) -overnment ,ecurities, :an ers( !cceptances and 'ommercial 1aper. Ca , +%#geting 1lanning cash and controlling its use are very important tas s. *f the future cash flows are not properly anticipated, it is li ely that idle cash balances may be created which may result in unnecessary losses. *t may also result in cash deficits and consequent problems. %he Finance Manager should therefore, plan the cash needs and uses. 'ash budget is a useful device for this purpose. 'ash budget basically incorporates estimates of future inflows and outflows of cash over a pro;ected short period of time which may usually be a year, a quarter or a halfyear. Effective cash management is facilitated if the cash budget is further bro en down into monthly, wee ly or even daily basis. Preparing a Ca , +%#get %here are two components of a cash budget9cash inflows and cash outflows. *n both these components there are two types of flows, viz. operating cash flows and financial cash flows. ,ome common elements of each are as follows) 'ash *nflows - #a$ +perating) cash sales, receivable collections. #b$ Financial) interest receipts, sale of mar etable securities, issue of new securities. 'ash +utflows -#a$ +perating) wage payments, payments of bills and accounts payable, and capital expenditure #b$ Financial) dividend payments, interest payments, redemption of securities, loan repayments, purchase of mar etable securities and tax payments. Sale Wor" S,eet ,ales bring in a ma;or part of cash inflows. !ll sales may not be against cash6 credit sales are quite common. Each business establishment has its own credit policy for promoting sales. Even when care is ta en to ensure that credit sales do not exceed the

permitted percentage of total sales and that debtors do not default in paying bills in time, it is a common experience that the total amount of sales is recovered over a period of time. -A5E .OU UNDERSTOOD= 0. 8iscuss the concept of wor ing capital. !re the gross and net concepts of wor ing capital exclusiveN Explain. 3. 8istinguish between fixed and fluctuating wor ing capitals. &hat is the significance of such distinction in financing wor ing needs of an enterpriseN 4. 8iscuss the significance of wor ing capital management in a business enterprise. &hat shall be the repercussions if a firm has #a$ shortage of wor ing capital and #b$ excess wor ing capitalN <. ! firm desires to finance its current assets entirely with short-term loans. 8o you thin this pattern of financing would be in the interest of the firmN ,upport your answer with a cogent argument. =. &hat factors a Finance Manager would ordinarily ta e into consideration while estimating wor ing capital needs of his firmN >. &hat is an operating cycle and how a close study of the operating cycle is helpfulN P. "ow would you as a Finance Manager control the need of increased wor ing capital on account of inflationary pressuresN .arrate some real-life examples you might have come across. L. "ow would you ;udge the efficiency of the management of wor ing capital in a business enterpriseN Explain with the help of hypothetical data. F. 8efine wor ing capital and describe its components 0E. :ring out the inds and concepts of wor ing capital and the nature and

significance of each type of wor ing capital

00. &hat do you mean by wor ing capital managementN &hat approaches would you adopt to ensure effectivenessN 03. 8iscuss clearly the factors affecting the size and composition of wor ing capital. 04. "ow would you plan the wor ing capital requirements of a manufacturing underta ing. 0<. &hat is operating cycleN Explain its significance in the context of estimation of wor ing capital and ensuring efficient management of wor ing capital. 0=. Explain the different sources of wor ing capital finance. 0>. %here are several terms of payment prevalent in the business world. .ame the ma;or terms of payment in practice and briefly describe each of them separately. 0P. &hat are the ramifications of enhancing and reducing the credit periodN Explain, by citing some illustrative examples. 0L. 8istinguish between #i$ liberal and #ii$ strict credit standards by citing suitable examples in each case. Explain the effects of liberal and strict credit terms, in each of the cases separately. 0F. &hat do you mean by #i$ liberalizing and #ii$ restricting the credit policies, in terms of the following) 0. 1eriod of credit 3. 'ash discount 4. 'redit standards, and <. 'ollection efforts. 3E. 1roper assessment of credit ris s is considered to be one of the most crucial factors in the area of management of credit. 8o you agreeN -ive reasons for your answer. 30. &hat are the two main types of error that may creep in, while assessing the credit ris sN Explain each of them by citing suitable illustrative examples.

33. 0. :an reference is considered to be one of the ma;or factors for assessing the credit-worthiness of a prospective customer. 8o you agreeN -ive reasons for your answer. 3. &hat are the main shortcomings and limitations connected with obtaining ban references and what are the pragmatic approaches for overcoming themN 34. 0. 'redit management practices, in *ndian 'ompanies, suffer from several deficiencies. &hat are these and what are the adverse effects of each of them in actual practiceN 3. &hat are the specific suggestions that you would li e to ma e with a view to streamlining and strengthening the present practices of management of credit #,undry 8ebtors$ by the industries in *ndiaN 3<. G!geing !nalysisG is an effective tool for monitoring and follow-up of sundry debtors. "owever, for better results, it is desirable to do the ageing analysis) i. ii. .ot only G1eriod-wiseG, but also G1arty-wiseG, and .ot only in Gabsolute termsG #of 5s.$ but also in Gpercentage termsG.

3=. Explain and illustrate, by using suitable examples. 3>. Explain the ob;ective of credit policyN /&hat is an optimum credit policyN 8iscuss. 3P. *s the credit policy that maximizes expected operating profit an optimum credit policyN Explain. 3L. &hat benefits and costs are associated with the extension of creditN 3F. "ow should they be combined to obtain an appropriate credit policyN 4E. &hat is the role of credit terms and credit standards in the credit policy of a firmN 40. &hat are the ob;ectives of the collection policyN "ow should it be establishedN

43. &hat shall be the effect of the following changes on the level of the finn(s receivables) a. b. c. d. *nterest rate increases. %he general economic conditions slac en. 1roduction and selling costs increase. %he firm changes its credit terms from G3B0E, net 4EG to G4B0E, net 4E.G

44. /%he credit policy of a company is criticised because the bad debt losses have increased considerably and the collection period has also increased.( 8iscuss under what conditions thiscriticism may not be ;ustified. 4<. &hat credit and collection procedures should be adopted in case of individual accountsN 8iscuss. 4=. "ow would you monitor boo methods. 4>. &hat is factoringN &hat functions does it performN 4P. Explain the features of various types of factoring. 4L. 8efine factoring. "ow does it differ from bills discounting and short-term financingN 4F. #a$ .ame the three main components of inventory. <E. #b$ &hether bond papers, ceiling fans, woollen suit lengths and Maruti LEE cars are raw materials or finished goodsN -ive specific reasons for your answer, citing illustrative examples to bring home your points of view. <0. &hy, at all, are we required to eep stoc s of inventories of #a$ 5aw materials, and #b$ finished goodsN <3. #a$ 8istinguish between, Gprocess or movementG inventories, and GorganizationG inventories. debtsN Explain the pros and cons of various

<4. #b$ &hat is the rationale behind eeping stoc s of GorganizationG inventories of both raw materials and finished goodsN <<. %he basic E+C model is based on several assumptions. &hat are theyN <=. &rite down the formula for E+C. Explain, how the formula has been derivedN <>. %he basic E+C model does not ta e into account the elements of inflation. &hat ad;ustments of modifications, in your considered view, need to be made in the basic E+C model to ta e care of the elements of inflationN <P. P. &hat do you understand by the termsN <L. #a$ +rdering cost. <F. #b$ *nventory carrying costs. =E. #c$ ,hortage costs or stoc -out costsN =0. 'larify your points, by citing suitable illustrative examples, in each case. =3. L. &hat are the various factors$ elements involved in the inventory carrying costsN Explain with the help of some illustrative examples. =4. F. #a$ Explain the following terms with the help of some illustrative examples) =<. #i$ 2ead time, #ii$ order point, and #iii$ safety stoc . ==. #b$ "ow is the reorder level ascertainedN Explain with the help of an illustrative example. =>. 0E. #a$ &hat do you understand by the term G!:' !nalysisGN Explain with the help of illustrative examples, the procedure adopted for doing the !:' analysis. =P. #b$ &hat purpose does !:' !nalysis serve in the context of inventory policy, monitoring, management and controlN Explain, with the help of some suitable illustrative examples. =L. #c$ *n what other two areas #other than the area of inventory management$ can the !:' !nalysis be used with immense advantageN .ame them and explain each of them with the help of some illustrative examples.

=F. 00. %he state of affairs in the area of management of inventory in most of the *ndian companies leaves a lot to be desired. >E. #a$ &hat are the various factors responsible for such dismal state of affairsN >0. #b$ &hat corrective steps would you suggest to streamline and improve the system of inventory management and control in *ndiaN >3. 03. 8istinguish between E+C and ++C #+ptimum +rder Cuantity$ when quantity discount is available. Elucidate your point by citing suitable illustrative examples. >4. 04. 8istinguish between R*% #Rust *n %ime$ and R*' #Rust *n 'ase$ approaches towards inventory management and control. ><. #i$ 'ite suitable illustrative examples to clarify your point. >=. #ii$ &hich one of the above noted two approaches, in your considered opinion, should be adopted by any companyN -ive reasons for your answer. >>. 0<. #a$ &hat are the comparative advantages and disadvantages of carrying too high or too low stoc s of inventories of) >P. #i$ 5aw materials, and #ii$ finished goodsN >L. Explain, with the help of some illustrative examples. >F. #b$ &hat, in your considered view, would be the right approach in this areaN -ive convincing reasons for your answer. PE. &hat are the three motivations behind holding cashN Explain briefly. P0. G*n managing cash, the Finance Manager faces the problem of compromising the conflicting goals of liquidity and profitabilityG. 'omment. &hat strategy should the Finance Managers develop to solve this problemN P3. &hat is optimum cash balance and how can it be arrived atN P4. &hat is cash cycle and how can it be reducedN P<. *f a firm estimates that it will have some idle cash balances from time to time, what advice would you render to the firmN

P=. &hat is a cash budget and in what way can it be helpful in liquidity planningN P>. "ow would you ;udge the efficiency of cash management of a companyN