CHAPTER 1

INTRODUCTION OF WORKING CAPITAL

Working capital is the employment of current assets and current liabilities in
such a way as to increase short-term liquidity. Working capital management is a
significant fact of financial management due to the fact that it plays a crucial role in
keeping the wheels of business enterprise running. Working capital management is
concerned with the short-term financial decisions, which have been comparatively
neglected in the literature of finance. Shortage of funds for working capital has caused
many businesses to fail. Lack of efficient and effective utilization of working capital
leads to low rate of returns on capital employed or even compels to sustain loses. The
need for skilled working capital has become greater in recent years.
A firm usually invests a part of its permanent capital in fixed assets and keeps a
part of it for working capital, for example meeting day-to-day requirements. The
requirement of working capital varies from firm to firm, depending on the nature of
business, production policy, market conditions, seasonality of operation, condition of
supply etc. Working capital to a company is like a blood of human body. It is the most
vital ingredient of business. Working capital if carried out effectively and efficiently
and consistently, will assure the health of an organization.
Every organization has to arrange for adequate funds for meeting day-to-day
expenditure, apart from investment from fixed assets. Working capital is the flow of
ready funds necessary for the working of the enterprise. It consists of funds invested
in current asset of that asset, which in the ordinary course of business, can be turned
into cash within a brief period without undergoing reduction in value and without
disruption of organization. Current liabilities are those indented to be paid in ordinary
course of business within a short period of time. Working capital serves the fallowing
purposes: -

1. To meet the cost of inventories, raw materials purchases, work in progress,

finished goods etc.
2. To pay wages and salaries.
3. To meet overhead cost, factory cost, office and administration cost, taxes,
selling distribution expense, packing, advertisements etc.

CASH

INVENTORIES

RECEIVABLES

FIG 1 CIRCULATION OF CURRENT ASSET

1.1DEFINITION OF WORKING CAPITAL

In case of gross working capital, it is the concept that focuses attention of two
aspects of current asset management:
1. Optimum investment in current asset.
2. Financing of current assets.
Following definitions of working capital place emphasis on gross working
capital.
1. According to Mead, Mallot & Field. Working capital means current assets.
2. According to Bonneville. Working capital is any acquisition of funds which
increase the current asset, increases working capital, for they are one and the
same.
3. According to J.S Mills. The sum of current asset is the working capital of the
firm.

Now let us look at the definitions of net working capital. It reflects the modern
concept of working capital, which is also most commonly used. According to the new
concept of working capital it refers to the difference between current asset and current
liability. It is the excess of current asset over current liability. Current liabilities refer
to the claims of outsiders, which are expected to mature for payment within an
3

accounting year. It includes creditors for goods, bills payable, bank overdraft etc. The
concept may be better understood in the fallowing equation: WORKING CAPITAL = CURRENT ASSET CURRENT LIABILITY.
The net working capital (a) indicate the liquidity position of the firm and (b)
suggest the extent to which working capital needs to be financed by permanent
sources of fund. Both the net and gross concept of working capital is the two facets of
working capital management.
Net working capital may be of the fallowing type:
Positive and quantitive net working capital: - It arises when current asset
exceeds current liability.

Negative or quantities net working capital: - It occurs when current liabilities are in
excess of current asset.
1.2 OBJECTIVE OF WORKING CAPITAL MANAGEMENT
1. To identify financial strength and weakness of the company.
2. Through the net profit ratio and other profitability ratio, understand the profitability of
the company.
3. Evaluating the companys performance relating to financial statement analysis.
4. To know the liquidity position of the company with the help of current raio.
5. To find out utility of financial ratio in credit analysis and determining the financial
capability of the firm.

1.3SCOPE OF WORKING CAPITAL MANAGEMENT

Working Capital Management is concerned with the problems that arise in
attempting to manage the Current Assets, the Current Liabilities and the interrelationship that exists between them. The term Current Assets refers to those Assets
which in the ordinary course of business can be, or will be, converted into Cash within
one year without undergoing a diminution in value and without disrupting the
operations of the firm. The Major Current Assets are Cash, Marketable Securities,
Current Liabilities are those Liabilities, which are intended at their inception, to be
paid in the ordinary course of business, within a year out of the current assets or the
earnings of the concern .The basic Current Liabilities are Accounts Payable, Bills
Payable, Bank Overdraft and outstanding expense. The goal of Working Capital
Management is to manage the firm's Assets and Liabilities in such a way that a
satisfactory level of working capital is maintained. This is so because if the firm
cannot maintain a

satisfactory level of working capital, it

is likely to become

insolvent and may even be forced into bankruptcy.

The Current Assets should be large enough to cover its current liabilities in order to
ensure a reasonable margin of safety. Each of the current assets must be managed
efficiently in order to maintain the liquidity of the firm while not keeping too high a
level of any one of them. Each of the short term sources of financing must be
continuously managed to ensure that they are obtained and used in the best possible
way. The interaction between current assets and current liabilities is, therefore, the
main theme of the theory of management of the working capital.

1.4CLASSIFICATION OF WORKING CAPITAL

Working capital may be classified on the fallowing basis:
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1. On the basis of concept:

I. Gross working capital (represented by the total current asset).
II. Net working capital (excess of current asset over current liabilities).
2. On the basis of periodicity of requirements:
I. Fixed or permanent working capital: It represents that part of capital permanently
locked up in the current asset to carry out the business smoothly. This investment
in current asset increase as the size of business expands. Examples of such
investment are those required to maintain the minimum stock of raw material,
work in progress, finished products, loose tools and equipments. This
arrangement requires minimum cash balance to be kept in reserve for payment of
wages salaries and all other current expenditure throughout the year. The
permanent fixed working capital may again be subdivided into fallowing:
(A) Regular working capital: It is the minimum amount of liquid capital
required to keep up the circulation of the capital from cash to inventories; to
receivables and again to cash. This includes sufficient minimum cash balance to
discount all bills and to maintain adequate supply of raw material etc.
(B) Reserve margin or cushion working capital: It is the excess capital over the
needs of regular working capital that should be kept in reserve for contingencies
that may arise at any time. These contingencies include rising price, strikes,
business decompressions, special operation such as experiment with new
product etc.
II. Variable working capital: Variable working capital changes with the increase or
decrease in the volume of business. It may be subdivided into fallowing: 6

{A} Seasonal variable working capital: The working capital required to meet
the seasonal liquidity of business is seasonal variable working capital.
II.
COMMON-SIZE BALANCE SHEET

{B} Special variable working capital: It is that part of variable working capital,
which is required for financing special operation such as extensive marketing
campaigns, experiment with product or methods of production, carrying of
special jobs etc.
1.5 RESEARCH METHODOLOGY OF THE STUDY
The methodology, I have adopted for my study is the various tools, which basically
analyze critically financial position of to the organization:

I.

COMMON-SIZE P/L A/C

III.

DATA ANALYSIS

IV.

WORKING CAPITAL REPORT

V.

RATIO ANALYSIS

The above parameters are used for critical analysis of financial position. With the
evaluation of each component, the financial position from different angles is tried to
be presented in well and systematic manner. By critical analysis with the help of
different tools, it becomes clear how the financial manager handles the finance matters
in profitable manner in the critical challenging atmosphere, the recommendation are

made which would suggest the organization in formulation of a healthy and strong
position financially with proper management system.
I sincerely hope, through the evaluation of various percentage, ratios and comparative
analysis, the organization would be able to conquer its in efficiencies and makes the
desired changes.

ANALYSIS OF FINANCIAL STATEMENTS

FINANCIAL STATEMENTS:
Financial statement is a collection of data organized according to logical and
consistent accounting procedure to convey an under-standing of some financial
aspects of a business firm. It may show position at a moment in time, as in the case of
balance sheet or may reveal a series of activities over a given period of time, as in the
case of an income statement. Thus, the term financial statements generally refers to
the two statements
(1) The position statement or Balance sheet.
(2) The income statement or the profit and loss Account.

OBJECTIVES OF FINANCIAL STATEMENTS:

According to accounting Principal Board of America (APB) states
The following objectives of financial statements: 1. To provide reliable financial information about economic resources and obligation
of a business firm.
2. To provide other needed information about charges in such economic resources and
obligation.

3. To provide reliable information about change in net resources (recourses less

obligations) missing out of business activities.
4. To provide financial information that assets in estimating the learning potential of
the business.

LIMITATIONS OF FINANCIAL STATEMENTS:

Though financial statements are relevant and useful for a concern, still they do not
present a final picture a final picture of a concern. The utility of these statements is
dependent upon a number of factors. The analysis and interpretation of these
statements must be done carefully otherwise misleading conclusion may be drawn.
Financial statements suffer from the following limitations: 1. Financial statements do not given a final picture of the concern. The data given in
these statements is only approximate. The actual value can only be determined when
the business is sold or liquidated.
2. Financial statements have been prepared for different accounting periods, generally
one year, during the life of a concern. The costs and incomes are apportioned to
different periods with a view to determine profits etc. The allocation of expenses and
income depends upon the personal judgment of the accountant. The existence of
contingent assets and liabilities also make the statements imprecise. So financial
statement are at the most interim reports rather than the final picture of the firm.
3. The financial statements are expressed in monetary value, so they appear to give
final and accurate position. The value of fixed assets in the balance sheet neither
represent the value for which fixed assets can be sold nor the amount which will be
required to replace these assets. The balance sheet is prepared on the presumption of a
going concern. The concern is expected to continue in future. So fixed assets are
shown at cost less accumulated depreciation. Moreover, there are certain assets in the
balance sheet which will realize nothing at the time of liquidation but they are shown
in the balance sheets.
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4. The financial statements are prepared on the basis of historical costs or original
costs. The value of assets decreases with the passage of time current price changes are
not taken into account. The statement are not prepared with the keeping in view the
economic conditions. The balance sheet loses the significance of being an index of
current economic realities. Similarly, the profitability shown by the income statements
may be representing the earning capacity of the concern.
5. There are certain factors which have a bearing on the financial position and
operating result of the business but they do not become a part of these statements
because they cannot be measured in monetary terms. The basic limitation of the
traditional financial statements comprising the balance sheet, profit & loss A/c is that
they do not give all the information regarding the financial operation of the firm.
Nevertheless, they provide some extremely useful information to the extent the
balance sheet mirrors the financial position on a particular data in lines of the structure
of assets, liabilities etc. and the profit & loss A/c shows the result of operation during
a certain period in terms revenue obtained and cost incurred during the year. Thus, the
financial position and operation of the firm.

FINANCIAL STATEMENT ANALYSIS

It is the process of identifying the financial strength and weakness of a firm
from the available accounting data and financial statements. The analysis is done
CALCULATIONS OF RATIOS
Ratios are relationship expressed in mathematical terms between figures, which are
connected with each other in some manner.
CLASSIFICATION OF RATIOS
Ratios can be classified in to different categories depending upon the basis of
classification
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The traditional classification has been on the basis of the financial statement to which
the determination of ratios belongs.

These are:

Profit & Loss account ratios

Balance Sheet ratios

Composite ratios

1.6 FINDINGS

By perusing the primary data of the company, I could get an insight about the
various components of the Working Capital Management i.e. Sundry Debtors and
related Debts collection period, Cash Flow of the Company and the richness of the
company enjoys due to its status in the Industry (i.e. Monopoly).
The details of Stock Accounting of the Company and the implications of the
same on the Working Capital Management also could be analyzed.
I could also know about how Creditors of the Company are being discharged so
also the various provisions are made by the Company in its Books of Accounts at the
end of the Financial Year and its implications on the Working Capital Management.
The good management of working capital is part of good financial
management. Effective use of working capital will add to the operational efficiency of
a department; optimal use will help to generate maximum returns so also the STATUS
of 'GOOD PAY MASTER" in the Industry.
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Ratio analysis can be used to identify working capital areas, which require
closer management. Various techniques and strategies, discussed above are available
for managing specific working capital items.
Debtors, creditors, cash and in some cases inventories are the areas most likely
to be relevant to a firm.

1.7 LIMITATION OF THE STUDY

The study conducted and done is analytical, subject to the following
limitations:
1. The study is mainly carried out based on the secondary data provided in the
financial statements.
2. This study is based on the historical data and information provided in the
annual reports therefore it may not be a future indicator.
3. There may be some fractional differences in calculated ratios.
4. Have to rely upon the data supplied.

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CHAPTER 2
ADEQUACY OF WORKING CAPITAL
Working capital or investment in current asset is a must for meeting the day-today expenditure on salaries, wages rent, advertising etc and for maintaining the fixed
asset. Large-scale capital in fixed asset is often determined by relatively small amount
of current asset. The heart of industry, working capital, if weak the business cannot
prosper and survive, although there may be a large investment of fixed assets.
Inadequate as well as superfluous working capital is dangerous for the health of the
industry.Inedequate working capital is disastrous, whereas superfluous working
capital is a criminal waste. Both situations are unwarranted in a sound business
organization. Adequacy of working capital is the lifeblood and controlling nerve
center of a business.
Some of the uses of adequate working capital are:
1) CASH DISCOUNT: By adequate working capital the business can avail the
advantage of cash discount by paying cash for the purpose of raw material and
merchandise. If proper cash balance is maintained, this will reduce the cost of
production.
2) SENSE OF SECURITY AND CONFIDENCE: Adequate working capital create
a sense of security, confidence and loyalty throughout the business and also
among its consumers, creditors and business associates .The proprietor, official
or manager of a concern are carefree, if they have proper capital arrangements
because they need not worry for the payment of business expenditure or
creditors.

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3) SOLVENCY AND CONTINUOUS PRODUCTION: In order to maintain the

solvency of business, it is essential that sufficient amount of funds are available
to make all the payments in time as and when they are due. In the absence of
working capital, production will suffer in the era of cutthroat competition and
business can never flourish in the absence of adequate working capital.
4) SOUND GOODWILL AND INCREASED DEBT CAPACITY: Promptness of
payment in business creates goodwill and increases the debt capacity of the
firm. If the investors and borrowers are confident that they will get their due
interest and payment of principle in time, a firm can raise funds from market,
purchase goods on credit and borrow short term loans from bank etc.
5) EASY LOANS FROM THE BANK: An adequate working capital helps the
company to borrow unsecured loans from the bank, because the excess provides
a good security to the unsecured loans. If the business has a good credit
standing and trade reputation, bank favors in granting seasonal loans.
6) DISTRIBUTION OF DIVIDEND: Short of working capital, a company cannot
distribute dividend to its shareholders in spite of sufficient profits. To make up
for the deficiency of working capital, profits are to be retained in business. On
the other hand ample dividend can be declared and distributed to the market
value of share and increase by sufficient working capital.
7) EXPLOITATION OF GOOD OPPORTUNITIES: Good opportunity can be
exploited through adequacy of capital in a concern. For example A company
may make off seasons purchase, resulting in substantial saving or it can fetch
big supply orders resulting in good profits.
8) MEETING UNSEEN CONTINGENCY: As stock piling of finished goods
becomes necessary, depression shoots up the working demand of capital. If a
14

company maintain adequate working capital, unseen contingencies such as

financial crisis due to heavy loses, business oscillation etc can easily be
overcome.
9) INCREASE IN EFFICIENCY OF FIXED ASSETS: Proper maintainces and

adequate working capital increase the efficiency of fixed asset of business. It

has been rightly said, the fate of large scale investment in fixed capital is often
determined by a relatively small amount of current asset.
10)

HIGH MORALE: The provision of adequate working capital improves

the morale of the executive as they get an environment of security, certainty and
confidence, which is a great psychological factor in improving the overall
efficiency of business and of the person who is at the helm of affair in the
company.
11) INCREASE PRODUCTION EFFICIENCY: A continuous supply of raw

material, research programs, innovation and technical development and

expansion programs are successfully carried out if adequate capital is
maintained in the business. It increases production capacity, which increases the
efficiency and morale of the employees.

15

CHAPTER 3
EVILS OF INADEQUATE WORKING CAPITAL
Some of the evils of not having adequate working capital in a business firm or a
company are as fallows:
1) LOSS OF CREDIT WORTHINESS AND GOODWILL: A firm losses its credit
worthiness and goodwill if it fails to honors its current liability. It finds it
difficult to procure the required funds for its business operation on easy terms.
This leads to reduced profitability and production interruption.
2) NO BENEFIT FROM FAVORABLE OPPORTUNITY: With inadequate
working capital a firm fails to undertake profitable projects. It prevents the firm
from availing the benefit of available opportunity and stagnate its growth.
3) FAILURE TO AVAIL CREDIT OPPORTUNITY: Due to inadequate working
capital a firm fail to avail attractive credit opportunities.
4) OPERATING INEFFICIENCIES: Inadequate working capital leads to
operating inefficiencies, as day-to-day commitment cannot be met.
5) LOW RATE OF RETURN ON FIXED ASSET: Inadequate working capital
leads to a lowering down of rate of returns of fixed asset, as it cannot be
efficiently utilized or maintained due to inadequacy of working capital.
6) INCREASE IN BUSINESS RISKS: Inadequate working capital increases the
business risk of the firm. Unable to discharge its current liability it is liable to
be declared as insolvent. Thus inadequate working capital posses a serious
threat to the working and survival of the firm.
16

7) CANNOT ACHIEVE PROFIT TARGET: Due to inadequate working capital

the firm cannot achieve its profit target, as it cannot put into operation, its
operating plans due to shortage of working capital.
8) LOW MORALE OF BUSINESS EXECUTIVES: Inadequate working capital
adversely lowers the morale of the firms executive, as they do not have an
environment of certainty safety and confidence, which is necessary
psychological factor in improving the overall efficiency of a business firm.
9) WEAKENING OF FINANCIAL CAPACITY: Inadequate working capital
weakens the shock absorbing capacity of the firm, as it cannot meet the
contingencies arising from business fluctuation, financial loses etc.

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CHAPTER 4
EVILS OF EXCESSIVE WORKING CAPITAL
Now let us look at some of the evils of having excessive or redundant working
capital:
1. IDLE FUNDS: Excessive and redundant working capital implies the presence
of idle funds, which earn no profits for the firm. A firm with excessive working
capital cannot earn proper rate of return on its total investments, as profits are
distributed on the whole of its capital. This brings down the rate of return to the
shareholders. Lower dividend reduce the market value of shares and causes
capital losses to the shareholders.
2. DECLINE IN OPERATING EFFICIENCY: Companies often adopt some
objectionable devices to inflate profits to maintain or increase the rate of
dividend. Sometimes unearned dividends are paid out of companys capital to
keep the show of prosperity by window dressing of accounts. In order to make
up the deficiency of reduced earnings, certain provision, such as the provision
for depreciation, repairs and renewals are not made. This leads to decline in
operating efficiency and fall in profits.
3. LOSS OF CONFIDENCE AND GOODWILL: Excessive working capital leads
to lower rate of returns on companys total investments. Lower dividend leads
to reduction of market value of companies share much less than the book value.
The shareholders losses confidence in the company and the goodwill or the
credit of the company suffers a serious setback. Thus the financial stability of
the company is jeopoderzied.
4. MISAPPLICATION OF FUNDS: Companies with excessive working capital
do not utilize the resources prudently. The company purchases excessive
18

inventories and fixed assets, which do not add to the profitability and increase
its maintaince cost and losses due to theft, waste and mishandling.
5. EVILS OF OVERCAPITALIZATION: Excessive working capital leads to over
capitalization, which is disastrous to the smooth working and survival of the
company and effect the interest of those associated with the company.
6. INEFFICIENT MANAGEMENT: Excessive working capital indicates that the
management is not interested in expanding the business; otherwise the
excessive capital might have been utilized for this purpose.
7. DESTRUCTION IN TURNOVER RATIO: Superfluous working capital
destroys the control of turnover ratio, which is commonly used in conduct of an
efficient business. It eradicates all other guide and signpost commonly used and
employed in conducting and operating a business.
Thus a company must have working capital adequate to its requirements. It
must neither be excessive or inadequate. While inadequate working capital adversely
affects the business operation and profitability, excessive working capital keeps it idle
and earns no profits.

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CHAPTER 5
WORKING CAPITAL MANAGEMENT

Working capital is the money used to make goods and attract sales. The less
working capital is used to attract sale, the higher is it likely to be the return of
investment. Working capital management is about the commercial and financial aspect
of inventory, credit, marketing, royalty and investment policy. The higher the profit
margin, lower is it likely to be the level of working capital tied up in creating and
selling titles. The faster that we create and sell the books the higher is it likely to be
the return on investment.
Now let us look at some of the definitions of working capital management:
PROF K V SMITH: Working capital management is concerned with
problems that arise in attempting to manage the current asset, the current
liability and the interrelation that exist between them.
WESTON AND BRIGHAM: Working capital management refer to all
aspect of administration of both current asset and current liability.
JAMES C VAN HORNE: Current asset, by definition are asset normally
converted into cash within one year. Working capital management is concerned
with the administration of these asset-namely cash and marketable securities.
Now let us look at some of the main and important objective of working capital
management:
1. To decide upon the optimum level of investment in various current asset i.e.
determining the size of working capital.
20

2. By optimizing the investment in current asset and by reducing the level of

current liability, the company can reduce the locking up of funds in working
capital and thereby it can improve the return on capital employed in the
business.

3. To decide upon the optimum mix of short-term funds in relation to long-term

capital.

4. The company should always be in a position to meet its current obligation,

which should be properly supported by current assets available with the firm.
Maintaining excess fund in working capital means locking of funds without any
returns.

5. To locate appropriate source of short term financing.

6. Maintaining working capital at appropriate levels.

7. Availability of sufficient funds at time of need.

8. The Firm should manage its current asset in such a way that marginal returns on
investment in current asset is not less than the cost of capital employed to
finance the current assets.
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CHAPTER 6
IMPORTANCE OF WORKING CAPITAL MANAGEMENT
According to Husband and Hockery,the prime object of management is to
make a profit, either or not this is accomplished, depend on the manner in which
working capital is accomplished. The primary object of working capital is
management is to manage the firms current asset and current liability in such a
manner that a satisfactory level of working capital is maintained. The firm may
become insolvent if it cannot maintain a satisfactory level of working capital. Working
capital assists in increasing the profitability of the concern. The working capital
position decide the various policies in the business with receipt to general operation
viz importance of working capital.
Positive correlation between sale and current assets: There is a positive
correlation between the sale of the product of the firm and its current assets. Increase
in the sale of the product requires a corresponding increase in current assets.
Therefore, the current asset must be managed properly.
Investment in current asset: Generally more than half of the total capacity of
the firm is invested in current assets. Thus less than half of the capital is blocked in
fixed asset. Therefore management of working capital attracts the attention of the
management.
No alternative for current asset: while fixed capital can be acquired on lease
in emergency, there is a alternative for current asset. Investment in current asset
cannot be avoided without substantial losses.
Important for small unit: The management of working capital is more
important for small unit because they do not relay on long term capital market and
22

have easy access to short term finance source such as trade credit, short term bank
loans etc.

23

CHAPTER 7
FACTORS DETERMINING WORKING CAPITAL REQUIREMENTS

Now let us look at the various factors determining the working capital
requirement in a business firm:
(A) Nature of businesses: The amount of working capital is related to the nature of
business. It concerns, where the cost of raw material used in manufacture of a product
is very large in production to its total cost of manufacture, the requirement of working
capital will be very large. For instance a cotton or sugar mills require a large amount
of working capital. On the other hand firms requiring large amount of investment in
fixed asset require less working capital. Public utility concern like Indian Railways,
require a lesser amount of working capital as compared to trading or manufacturing
concern, partly because of cash nature of their business and partly because, they are
selling service instead of a commodity and there is no need of maintaining
inventories.
(B) Size of business unit: The general principle in this regard is that the bigger the
size of business, the larger will be the amount of working capital required, because the
larger business unit is required to maintain big inventories for the flow of the business
and to spend more in carrying out the business operation smoothly.
(C) Seasonal variation: Strong seasonal variation create special problem of working
capital in controlling the internal financial swings in many companies such as sugar
mills, oil mills, woolen mills etc. These require larger amount of working capital in
the season to purchase the raw material in large quantity and utilize them throughout
the year. They adjust their production schedule and maintain a steady rate of
production in off seasons. Thus they require larger amount of working capital during
season.
24

(D) Time consumed in manufacture: The average time taken in the process of
manufacture is also an important factor in determining the amount of working capital.
The larger the period of manufacture the larger will be the working capital required.
Capital goods industries managed to minimize their investment in working capital by
asking advances from consumers as work proceeds in their orders.
(E) Turnover of circulating capital: Turnover means ratio of annual gross sales to
average working asset. It means the speed with which circulating capital complete its
round, or number of times the amount invested in working asset has been converted
into cash by sale of finished goods and reinvested in working asset during the year.
The faster the sales the larger the turnover. Conversely greater the turnover, larger the
volume of business to be done with given working capital. It requires lesser amount of
working capital in spite of larger sale because of great turnover.
(F) Labor intensive versus capital intensive industries: In labor intensive
industries, larger working capital is required because of regular payment of heavy
wage bills and more time taken in completing the manufacturing process. On the other
hand the capital intensive industry requires require lesser amount of working capital
because of heavy investment in fixed asset and shorter period in many acquiring
processes.
(G) Need to stockpile raw material and finished goods: The industry, where it is
necessary to stockpile the raw material and finished goods increase the amount of
working capital, which is tied up in stock and stores. In some line of business where
the materials are bulky and best purchased in large quantity such as cements,
stockpiling of raw material is very usual and used. In companies where labor strike is
very frequent like public utility concern, stockpiling of raw material is advisable. In
certain industries which are seasonal in nature, finished goods stock has to be in large
quantity which requires large working capital.
25

(H) Terms of purchase and sale: Cash or credit terms of purchase and sale also
affect the amount of working capital .If a company purchase all goods in cash and
sells its finished product on credit, it will require a large amount of working capital
.On the other hand a concern having credit facility and allows no credit to its
customers will require less amount of working capital. Terms and conditions of
purchase and sale are generally governed by prevailing trade practice and by changing
economic conditions.
(I) Conversion of current asset into cash: The need of having cash in hand to meet
the day to day requirement like payment of wage and salary, rent etc has an important
bearing in deciding the adequate amount of working capital. The greater the cash
requirement, higher will be the need of working capital. A company has ample stock
of liquid current asset will require lesser amount of working capital because it can
encash its assets immediately in open market.
(J) Growth and extension of business: Growing concern requires more working
capital than that which is static. It is logical to except larger amount of working capital
in a going concern to meet its growing need of funds and for its expansion programs
through it varies with economic condition and corporate practice.
(K) Business cycle fluctuation: Business cycle affect the requirement of working
capital At times, when the prices are going up and boom condition prevail, the
management seek to pile up big stock of raw material to have an advantage of lower
price and maintain a big stock of finished goods with an expectation to earn more
profit by selling it at higher price in future. The expansion of business unit caused by
the inflationary condition creates demand for more and more working capital.
Depression involves the locking up of big amount in working capital as the
inventories remain unsolved and book debts uncollected. The reduction in the volume
of business may result in increasing the cash position because of reduction in
26

inventories and receivable that usually accompanies decline in sale and shortening in
capital expenditure. In such case shortage of working capital develops.
(L) Profit margin and profit appropriation: Some firms enjoy a leading position in
the market due to quality product and good marketing management or monopoly
power in the market and thereby earn huge profits. It contributes towards working
capital, provided it is earned in cash. Cash profit can be found by adjusting the noncash item like depreciation, outstanding expense, accumulated losses and expense
written off in net profit. But in practice the whole cash inflows are not considered as
cash available for use as cash is used up to increase the other asset like, book debts
and fixed asset stock etc. In a growing concern working capital requirement will be
estimated on how the cash available is rightfully used. Even if the net profit is earned
in cash, whole of it is not available for working capital purpose. The contribution
towards working capital is effected by the way in which profit are appropriated and
affected by tax action, dividend, depreciation and reserve policy.
(M) Price level changes: The financial manager should predict the effect of price
level changes on working capital requirement of the firm. Rising price level will
require a higher level of working capital to maintain the same level of current asset, as
it will require higher investments. However if companies reverse their product prices,
they will not face a severe working capital problem. Thus the effect of rising price will
be different for different firm depending upon their price policy and its nature.
(N) Dividend policies: There is a well-established relationship between dividend and
working capital in companies where successive dividend policy is followed. The
changes in working capital position bring about an adjustment in dividend policy. In
order to maintain an established dividend policy, the management gives due
consideration to its effect on cash requirements. Storage of cash may induce the
management to reduce cash dividend. Strong cash position may justify the cash
dividend, even if earnings are not sufficient to cover the payments. Shortage of cash is
27

one of the reasons for issue of stock dividend. On the other hand if the company
follow the policy of retention of profit in business, the working capital position will be
quite adequate, alternatively, if the whole of the profit are distributed among the
shareholders, companys working capital position will suffer.
(O) Close coordination between production and distribution policy: This will
reduce the demand of working capital.

(P) An absence of specialization in the distribution of products: This will require

more working capital as such concerns will have to maintain its own marketing
organization.

(Q) If the means of transporting and communication are less developed: More
working capital is required in such areas to store the material and finished goods.

(R) Hazards in a particular business also decide the magnitude of working

capital required.

28

CHAPTER 8
WORKING CAPITAL FINANCING

The main source of working capital financing, namely, trade credit, bank credit,
RBI framework/regulation of bank credit/finance/advances, factoring and commercial
papers will be discussed in this chapter.
1. TRADE CREDIT: Trade credit refers to the credit extended by the suppliers of
goods and service in normal course of transaction/business/sale of the firm.
According to trade practice, cash is not paid immediately for purchase but after
an agreed period of time. There is however, no formal/specific negotiation of
trade credit it is an informal arrangement between buyer and seller. There is no
legal instrument of acknowledgement of debt, which is granted on an open
account basis.
(a) ADVANTAGES: - Trade credit as a source of short-term working capital
finance has certain advantages. It is easily available. Moreover it is
flexible and spontaneous source of finance. The availability and
magnitude of trade credits is related to the size of operation of a firm in
relation to sales/purchase. If the credit purchase of goods decline,
availability of credit will also decline. Trade credit is also an informal,
spoteganous source of finance. Not requiring negotiation and formal
agreement, trade credit is free from the restriction associated with
formal/negotiated source of finance/credit.
(b) COST: Trade credit does not involve any explicit interest charged.
However there is an implicit cost of trade credit. It depends on trade
credit offered by suppliers of goods. The smaller the difference between
29

the payment day and the end of the discount period, the larger is the
annual interest/cost of trade credit.
2. BANK CREDITS: It is the primary institutional source of working capital
finance in India. In fact it represents the most important source of financing of
credit asset. It can be provided by banks in five ways
(a) Cash/credit overdrafts: Under cash credits, the bank specifies a
predetermined borrowing/credit limit. The borrowers can draw/borrow
up to the stipulated credit/overdraft limit. Similarly repayment can be
made wherever desired during the period. The interest is determined on
the basis of the running balance/amount actually utilized by borrower
and not on the sanctioned amount.
(b) Loans: Under the arrangement the entire amount of borrowing is
credited to the current account of the borrower .The borrower has to pay
interest on the total amount.

(c) Bills purchased/discounted: -The amount made available under this

arrangement is covered by the cash credit and the overdraft limit. Before
discounting the bill the bank satisfies itself with the credit worthiness of
the drawer and the genuineness of the bill. To popularize the scheme, the
discounting banker asks the drawer of the bill (i.e. the seller of the
goods) to have his bills accepted by the drawee bank.

(d) Term loans for working capital: Under this arrangement, banks
advance loans for three to seven years repayable in yearly and half
yearly installments.
30

(e) Letter of credit: While the other forms of bank credit are direct forms
of financing in which banks provide funds as well as bears risk, letter of
credit is an indirect form of working capital financing and bank assume
only the risk, the credit being provided by the supplier.
MODES OF SECURITY
Banks provide credit on the fallowing modes of security:
1. Hypothecation: Under this mode of security the bank provide credit to
borrowers against the security of movable property, usually inventory of
goods.
2. Pledge: Pledge, as a mode of security is different from hypocatation in
that in the former unlike the later goods, which are offered as security is
transferred to the physical possession of the lender.
3. Lien: The term lien refers to the right of the party to retain goods
belonging to other party until a debt due to him is paid.
4. Mortgage: It is the transfer of legal stock equitable interest in specific
immovable property for securing the payment of debt.

31

CHAPTER 9
RESERVE BANK OF INDIA FRAMEWORK FOR REGULATION OF BANK
CREDIT

Till the mid sixties, the notable feature of bank financing of working capital of
corporate industrial borrowers were (a) easy access/over-reliance, i.e. in excess of
legimate requirement and (b) pre ponderance of cash credit arrangement/device
through which his finance was provided. In order to secure arrangement of a bank
credit with planning priorities and ensures equitable distribution to various sectors of
Indian economy, the RBI initiated several policy measures measure to direct bank
credit to priority sectors and enforce a measure of financial discipline among
industrial borrowers. However the basic character of bank financing and industry
namely, over borrowing and domination of cash credit system did not materially alter.
To reorient bank lending to industry to the two emerging reality of the Indian
economy in terms of the crucial factors of regulating controlling it, the RBI constitute
from time to time a number of expert groups to examine the various aspect of banking
policy relating to industrial financing, the notable being Dehejia committee of
1969,Marathe committee of 1974,Chore committee of 1980 and Marathe committee of
1984.The recommendation of these groups ( refer to annexure) shaped the
framework/regulation of industrial finance by banks after mid 1970s.After mid 1990
the framework have been relaxed permitting banks greater flexibility in tune with the
emergence of new banking in the country, focusing on viability and profitability in
contrast with earlier trust on social/development banking .The main element of the
framework and the subsequent relaxation are discuss

32

CHAPTER 10
FIXATION OF NORMS

A notable feature of the framework /regulation to the fixation of norms for bank
lending to industry fall under two categories:
1. Inventory and receivable norms: The norms refer to the maximum level
for holding inventory and receivable in each industry. Initially, the
inventory and receivable norms were applied in respect to 15 major
industries accounting for about one half of the industrial advance of the
bank. The norms pertained to (a) raw material including stores and other
item used in the process of manufacture: (b) stocks in process (c) finished
goods and receivables and bills purchased and discounted. The norms
were based on time elements

2. Lending norms: The lending norms are the basic element of the

framework of bank lending to have far-reaching implications. According

to lending norms a part of the current asset should be financed by trade
credit and other current liabilities. The remaining part of the current asset,
termed, as working capital gap should be partly financed by owners
funds and long-term borrowing and partly by short-term credit. There are
three alternative methods for working out the maximum permissible level
of bank borrowing/finance, each successive method reducing the
involvement of short-term bank credit to support current assets.

CHAPTER 11
33

HOW PUBLISHERS CAN MAKING MORE EFFICIENT USE OF

WORKING CAPITAL
The table below lists items, which influence working capital levels favorably
and adversely for Publishers
Items

that

reduce

capital levels

working Items that increase working

capital levels

-- Customers who pay promptly

-- Advance payment by customers

-- Long print runs expect where

all the books are required on
publication e.g. schools and
university textbooks.

-- Increased profit margins

-- Lower profit margins

-- Inventory which is sold and -- Slow authors whom deliver

paid for quickly by customers and late and whose manuscript
publication

require substantial editing.

-- Lower inventory level by -- Holding paper stock unless

reducing

print

quantities

and market condition demand and

working with printers who will the saving are large

delivery quickly and produce low -- Slow schedules for
development of new titles
print runs economically
-- Successful promotion that speed -- Making advance payment to
printers
up the rate of sale.
-- Seasonal sales except where
-- Licensing
the publishers print only for the
season
-- Paying suppliers on com
pletion with credit

Fig no.11.1

CHAPTER 12
34

ASSESSMENT OF WORKING CAPITAL REQUIREMENT IN SEASONAL

INDUSTRY

In the seasonal industries the level of working capital requirement will not be
similar all the year. In times of off-season, the working capital requirements and
therefore, the level of investment in current asset and liability are very low. But during
seasons, the firm requirement of working capital is at peak level. Now let us look at
the sugar industry. The crushing season in the year will remain for five to six months
time. During the season the plant is expected to work at full capacity, with triple shift
working and the requirement of stock is very high resulting in increased sugar stock.
The requirement for payment of labor, expense and maintenance is also very high.
There will not be immediate sale of sugar and finished stock inventory will be much
higher.
After the completion of crushing season the plants will stop and only upkeep
and maintenance of plant will be incurred and the level of current asset and the current
liabilities will come down and the working capital requirement will be very low. For
efficient management of working capital the finance manager should be able to
properly estimate the season and off season requirement of working capital. For this
the fallowing precaution are taken:
1. Preparation of projected cash flow statement showing the cash flow for peak
season, normal season and off-season requirement.
2. Make proper arrangement with the banks and other source of finance to meet
the short-term need of season
3. Make proper arrangement for meeting contingencies of higher-level
requirements than the projected level of requirement.
4. Proper and careful assessment of working capital requirement for the season
and off-season requirement.
35

5. Care to be taken to reduce the level of investment in current asset after the
season is completed.

36

CHAPTER 13
METHODS OF ESTIMATING WORKING CAPITAL REQUIREMENT

Now let us look at some of the ways used by a business firm in estimating the
working capital requirement:
Operating cycle method: Operating cycle is a period that a business enterprise takes
in converting cash back into cash. It has the fallowing four stages.
(a)

The raw material and stores inventory stage.

(b)

The semi finished goods or work in progress stage

(c) The finished goods inventory stage.

(d) The accounts receivable and book debt stage.
Each of he above stage is expressed in terms of days of relevant activity. Each
requires a level of investment to support it. The sum of these stage wise investments
will be total amount of working capital of the firm. The fallowing formulae can be
used to express the framework of the operating cycle.
T = (S * C) + W + F + B
Where
T

Stands for the total period of operating cycle in number of days

Stands for the number of days of raw material and stores

Consumption requirement held in raw material and store
Inventory

The number of days of purchase in trade creditors

The number of days of cost of production held in W.I.P

The number of days of cost of sales held in finished goods

The number of days of sale in book debt

37

The consumption may be made as under:

Average inventory of raw material and stores
R = Average per day of consumption of raw materials and stores
Average trade creditors
C = Average credit purchase per day
Average work in progress
W = Average cost of production per day
Average inventory of finished goods
F = Average cost of sale per day
Average book debts
B = Average sales per day
The average inventory, trade creditors, working progress, finished goods and
book debts can be computed by adding the opening and closing balance at the end of
the year in the respective accounts and dividing the concerned annual figures by 365
or the number of days in a given period.
The operational cycle method of determining working capital requirements
gives only an average figure. In this method the fluctuations in the intervening period
due to seasonal and other factors and their impact on working capital cannot be
judged. Continuous short run detailed forecasting and budgeting exercise are
necessary to identify these impacts.
The new concept that is gaining more and more importance in recent years is
this style of working capital method. The operating cycle refer to the average time
elapsed between the acquisition of raw material and the final cash realization.
Cash is used to buy the raw materials and other stores, so cash is converted into
raw materials and stores inventories. Then the raw materials and stores are issued to
38

the production department. Wages are paid and other expense are incurred in the
process and work in progress comes into existence. Work in progress becomes
finished goods. Finished goods are sold to costumers on credit. In the course of time
these costumers pay cash for the goods purchased by them. Cash is retrieved and cycle
is completed.
The operating cycle of working capital is shown below:
CASH
ACCOUNTS RECEIVABLE
PURCHASE OF RAW MATERIAL
INVENTORY

FINISHED GOODS

W.I.P
FIG 13.1 OPERATING CYCLE OF WORKING CAPITAL

Percent of sales method: It assumes that certain balance sheet items vary directly
with sales. Thus the ratio of the given balance sheet item to sales remains constant.
The firms need in terms of percentage of annual sales envisaged in each individual
balance sheet items are expressed in the following three ways:
As number of days of sale
As turnover
As percent of sales
Regression analysis method: This is a very useful statically technique of working
capital forecasting which helps in making projection after establishing the relationship
in the past years between sales and working capital and its various components. This
analysis may be carried out through the graphic portrayals or through mathematical
formulae. The relationship between the sales and working capital of various
39

components may be simple and direct indicating linearly between the two. It may be
complex involving simpler linear regression or simple curvilinear regression and
multiple regression situations. This method is particularly suitable for long term
forecasting.

40

CHAPTER 14
WORKING CAPITAL REPORT
A sensible finance manager is always vigilant for avoiding the financial
embarrassment likely to be caused to the firm due to inadequacy of working capital.
He always takes utmost care so as to keep himself well informed of the working
capital position, its present aspect and its future prospects. Working capital report
varies according to the requirement of individual firms and circumstances.
Some of the types of working capital report are:
Inventory report: It gives in detail a comparative analysis of composition of closing
stock of raw material and finished products. It may be prepared weekly, monthly or
quarterly. It brings into light the fact whether working capital is unnecessarily blocked
up in the inventory. Fallowing is an example of monthly inventory report.
Sr no

Item

Code

Max

Min

Order

Op

Received

Issued

no

Stock

Stock

size

Bal

During

during

Limit

Limit

The

the

Balance

001

***

***

***

***

***

Month
***

Month
***

***

002

***

***

***

***

***

***

***

***

003

***

***

***

***

***

***

***

***

004

***

***

***

***

***

***

***

***

005

***

***

***

***

***

***

***

***

006

***

***

***

***

***

***

***

***

007

***

***

***

***

***

***

***

***

Fig no. 14.1

41

Cash report: It reflects the net liquidity position of the concern. It is prepared on
daily basis. It shows the summary of daily cash receipt, cash disbursements and the
cash balance. Fallowing is the Performa of a cash report.
Particulars

Current

Letter

of Fixed

a/c

credit a/c

deposit

Cash

in Total

chest

Previous
week

a/c
A
REVENUE
X
Y
Z
B

***
***
***

***
***
***

***
***
***

***
***
***

***
***
***

***
***
***

CAPITAL
X

***

***

***

***

***

***

Y
Z

***
***

***
***

***
***

***
***

***
***

***
***

TOTAL

******

******

******

******

******

******

Fig no. 14.2

Receivables report:

These help in studying up the efficiency of the collection

policies and the desirability of credit policies. Detailed report may be made to depict
42

the reserve for bad and doubtful debts position. Some companies prepare aging report
in respect of debtors and receivables. A Performa of receivable report is given below

SUPPLIES
MADE DURING
THE MONTH

REALIZATION MADE
DURING THE MONTH

BALANCE AT THE BEGINNING

SR NO

PART

MORE

THAN

MO

NT

YEAR

HS

LESS
THAN 6
MONTHS

BILLS

BILLS

MORE

MOR

BEL

REALI

NOT

THAN

OW

ZED

REALI

THA

ZED

YEAR

MTH

MON
THS

Fig no. 14.3

CHAPTER - 15

RECEIVABLES MANAGEMENT
43

BACK

BAL

RECO

ANC

VERY

The receivables represent an important component of current asset of a firm.

The purpose of this chapter is to analyze the importance of efficient management of
receivables, within the framework of a firms objective of value maximizing. The first
section of this chapter discusses the objective of receivables management. This is
followed by an indebt analysis of three crucial aspect of management of receivables.
Before understanding the objectives of receivables management let us first
understand the two concepts, which forms an important part in receivables
management, namely debtors and creditors.
Debtors: Debtors (Accounts Receivable) are customers who have not yet made
payment for goods or services, which the firm has provided. The objective of
debtor management is to minimize the time-lapse between completion of sales
and receipt of payment. The costs of having debtors are:
1. Opportunity costs (cash is not available for other purposes);
2. Bad debts.
Debtor management includes both pre-sale and debt collection strategies.
Pre-sale strategies include:
1. Offering cash discounts for early payment and/or imposing penalties for late
payment;
2. Agreeing payment terms in advance;
3. Requiring cash before delivery;
4. Setting credit limits;
5. Setting criteria for obtaining credit;
6. Billing as early as possible;
7. Requiring deposits and/or progress payments.
Post-sale strategies include:
44

1. Placing the responsibility for collecting the debt upon the center that made
the sale;
2. Identifying long overdue balances and doubtful debts by regular analytical
reviews;
3. Having an established procedure for late collections, such as
- A reminder;
- a letter;
- cancellation of further credit;
- telephone calls;
- use of a collection agency;
- legal action.
Creditors; Creditors (Accounts Payable) are suppliers whose invoices for goods or
services have been processed but who have not yet been paid. Organizations
often regard the amount owing to creditors as a source of free credit. However,
creditor administration systems are expensive and time-consuming to run. The
over-riding concern in this area should be to minimize costs with simple
procedures.
While it is unnecessary to pay accounts before they fall due, it is usually not
worthwhile to delay all payments until the latest possible date. Regular weekly or
fortnightly payment of all due accounts is the simplest technique for creditor
management.
Electronic payments (direct credits) are cheaper than cheque payments,
considering that transaction fees and overheads more than balance the advantage of
delayed presentation. Some suppliers are unenthusiastic to receive payments by this
method, but in view of the significant cost advantage (and the advantages to the
suppliers themselves) departments may wish to encourage suppliers to accept this

45

option. However, electronic payments are likely to be used in combination with, rather
than as a replacement for, cheque payments.
Objectives of receivables management:
The term receivables are defined as debts owed to the firm by customers arising
from sale of goods or service in the ordinary course of business. When a firm makes
an ordinary sale of goods or service and does not receive payment the firm grant credit
and credits account receivable. Receivables management is also known as trade credit
management and thus, account receivables represent an extension of credits to
customers, allowing them a reasonable period of time in which to pay the goods
received.
The sale of goods on credit is an essential part of modern competitive economic
systems. Infact, credit sales and therefore receivables are treated as marketing tools to
aid the sale of goods. The objective of receivable management is to promote the sale
and profits until that point is reached where the return on investment in further
funding receivable is less than the cost of funds raised to finance that additional credit
(i.e.) cost of capital.
Now let us see some costs in receivable management:
1. Collection cost: Collection costs are administrative costs incurred in collecting
the receivables from the customers to who credit sale have been made.
2. Capital cost: The increased level of account receivable is an investment in asset.
They have to be financed thereby incurring a cost. The cost on the use of
additional capital, to support the credit sale, which alternatively, profitably
employed is therefore a part of the cost of receivables.

46

3. Delinquency cost: These costs arise out of the failure of customers to meet their
obligation when payment on credit sale becomes dew after the expiry of credit
period. Such cost is called delinquency cost.
4. Default cost: Finally the firm may not be able to recover the overdue because
the inability of the customers to pay. Such that are treated as bad debts and have
to be written off, as they cannot be realized is called default cost.
Benefits:
The benefits are increased sales and anticipated profits because of a more
liberal policy. When firms extend trade credits, that is, invest in receivables; they
intend to increase the sales. The impact of liberal trade credit policy is likely two
take two forms. First it is oriented to sales expansion. In other words a firm may
grant trade credit to increase sale to existing customers. Secondly the firm gives
trade credit to protect its current sales against competitions.
Credit policies:
The credit policy of the firm provides a framework to determine (a) whether or
not to extend credit to a costumer (b) how much credit to extend. The credit policy
decision of a firm has two broad dimensions
1. Credit standards
2. Credit analysis

CHAPTER 16
WORKING CAPITAL RATIO
47

Working capital ratios indicate the ability of a business concern in meeting its
current obligation as well as its efficiency in managing the current asset in the
generation of sales. These ratios are applied to evaluate the efficiency with which the
firm manages and make use of its current assets. The fallowing three categories of
ratio are used for efficient management of working capital (a) efficiency ratios (b)
Liquidity ratios (c) Structural health ratios.
Efficiency ratio: This ratio is computed by dividing the working capital by
sale. This ratio helps to measure the efficiency of utilization of networking capital. It
signifies for an amount of sale a relative amount of working capital is needed. If any
increase in sale is contemplated, working capital should be adequate and thus this
ratio is useful for maintaining adequate level of working capital.
Inventory turnover ratio: This ratio indicate the effectiveness and efficiency
of the inventory management .The formulae is as fallows
INVENTORY TURNOVER RATIO = SALES / CURRENT ASSET
This ratio shows how speedily the inventory is turned into accounts receivable
through sales. The lower the inventory of sales ratio, the more efficiently the
inventory is said to manage and vice versa.
Current assets turnover ratio: This ratio formula is:
CURRENT ASSET TURNOVER RATIO = SALES / CURRENT ASSETS
This ratio indicates the efficiency with which the current asset turn into sales.
The lower the current asset to sales ratio, it implies a more efficient use of funds.
Thus, a high turnover rate indicates reduced lock up of funds in current assets. An
analysis of this ratio over a period of time reflects working capital management of a
firm.
Liquidity ratio: This ratio indicate the extend of soundness of the current
financial position of an undertaking and the degree of safety provided to the creditors.
48

The higher the current ratio, the larger amount of rupee available, per rupee for current
liability, the more the firms ability to meet current obligation and the greater safety of
funds of short term creditors. The liquidity ratio formulae is
LIQUIDITY RATIO = CURRENT ASSET, LOANS, ADVANCES/ CURRENT
LIABILITY
Current assets are those assets, which can be converted into cash within an accounting
year. Current liability and provisions are those liability that are payable within a year.
A current ratio of 2: 1 indicates a highly solvent position. Banks consider a current
ratio of 1: 3: 1 as minimum acceptable level for providing working capital finance.
The constituents of the current asset are as important as current asset themselves for
evaluation of companies solvency position.
Quick ratio: This ratio is a more refined tool to measure the liquidity of an
organization. It is a better test of financial strength than the current ratio, because it
excludes very slow moving inventories and the item of current asset, which cannot be
converted into cash easily. This ratio shows the extend of cushion of protection
provided from the quick assets to the current creditors. A quick ratio of 1: 1 is usually
considered satisfactorily through it is again a rule of the thumb only.
Structural health ratio: This ratio explains the relationship between current
asset and total investment in current asset. A business enterprise should use its current
asset effectively and economically because it is out of the management of these assets
that profits accrue. A business will end up in losses if there is any lacuna in managing
assets to the advantage of business. Investment in fixed assets being inelastic in nature
there is no elbowroom to make an amendment in this sphere and its impact on
profitability remains minimal. This structural ratio can be indicated as
S.H.R = NET ASSETS / CURRENT ASSET
An analysis of current assets composition enable one to examine in which
components the working capital funds are locked up. Large tie up of funds in
inventories effect profitability of the business adversely owing to carry over cost .in
49

addition losses are likely to occur by the way of depreciation, decay, obsolesce,
evaporation and so on. Receivable constitute another component of current assets If
the major portion of current assets are made of cash alone the profitability will be
decreased because cash is a non earning asset. If the portion of cash balance is
excessive then it can be said that management is not efficient to employ surplus cash.
Debtor turnover ratio: This ratio shows the extend of trade credit granted and
the efficiency in the collection of debts and thus it is an indicative of trade credit
management. The lower the debtor to sale ratio the better the trade credit management
and better the quality of debtors. The lower debtor means prompt payment by
customers. An excessive long collection period on the other hand indicates a very
liberal ineffective inefficient credit and collection policy.
DEBTOR TURNOVER RATIO = SALES / DEBTORS
Average collection period measures how long it takes to collect amounts from
debtors. The actual collection period can be compared with the stated credit terms of
the company. If it is longer than those terms, this indicate some insufficiency in the
procedure of collecting debts
Bad debts to sale ratio: This ratio indicates the efficiency of the controlled
procedure of the company. The actual ratio is compared with the target of norms to
decide whether or not it is acceptable.
Creditor turnover period: The measurement of creditor turnover period shows
the average time taken to pay for goods and service by the company. In general the
longer the credit period achieved the better, because delay in payments means that the
operation of the company is financed interest free by suppliers funds. But there will
be point beyond which if they are operating in a sellers market, may harm the
company. If too long a period is taken to pay creditors, the credit rating of the
company may suffer, thereby making it more difficult to obtain supplier in future.
CREDIT TURNOVER PERIOD = CREDITORS * 365 / PURCHASES
50

CHAPTER 17
WORKING CAPITAL LEVERAGES
51

One of the important objectives of working capital management is by

maintaining the optimum level of investment in current asset and by reducing the
current liability .The company can minimize the investment in working capital and
thereby improve the return of capital employed. The term working capital leverages
refer to the impact of level of working capital on companys profitability. The working
capital management should improve the productivity of investment and current asset
and ultimately it will increase the return on capital employed. Higher level of
investment in current asset than is required means increase in the cost of interest
charged on short term loans and working capital finance raised from banks and will
resulting the lover return on capital employed and vice versa. Working capital
leverages measures the responsiveness of ROCE for changes in current asset. It is
measured by applying the fallowing formulae
Working capital leverages = C.A / T.A - C.A
Where:
C.A

= CURRENT ASSET

T.A

= TOTAL ASSETS (net fixed asset = current asset )

C.A

= CHANGE IN CURRENT ASSET

IMPACT OF INFLATION ON WORKING CAPITAL REQUIREMENT

When the inflation rate is high, it will have a direct impact on the requirement
of working capital as explained below
1. Inflation will cause the slow turnover figure at higher level even if there is no
increase in the quantity of sale. The higher the sale means the higher level of
balance in receivables.
52

2. Inflation will result in the increase of raw material price and hike in the
payment for expenses and as a result increase in balance of trade creditors and
creditors for expense.
3. Increase in the valuation of closing stock will result in showing higher profits
but without its realization into cash cause the firm to pay higher tax dividend
and bonus. This will lead the firm in serious problem in fund shortage and the
firm may enable to meet its short term and long-term obligation.
4. Increase in investment in current asset means the increase in the requirement of
working capital without corresponding increase in sale or profitability of a firm.
Keeping in view of the above stated points the finance manager should be very
careful about the impact of inflation in assessment of working capital requirement and
its management.
IMPACT OF DOUBLE SHIFT WORKING ON WORKING CAPITAL
REQUIREMENT
If the firm, which is presently running in single shift, plans to go for working in
double shift, the fallowing factors should be considered in assessing the working
capital requirement of the firm.
1. Working in double shift means requirement of raw materials will be doubled
and another variable expense will also increase drastically.
2. With the increase in the raw material requirement and expenses, the raw
material inventory and work in progress will increase simutanunsly. The
creditors for goods and creditors for expense balance will also increase.

53

3. Increase in production to meet the increased demand, which will also increase
the stock of finished goods. The increase in sales means increase in debtor
balance.
4. Increased in production will result in increased requirement of working capital
5. The fixed expense will increase with the working on double shift basis.
The finance manager should reassess the working capital requirement if the
change is contemplated from single shift operation to double shift operation.

CHAPTER 18
ZERO WORKING CAPITAL

54

This is one of the newest trends in working capital management. The idea is to
have zero working capital .For e.g. at all times the current asset shall be equal to
current liability. Excess investment in current asset is avoided and firms meet its
current liability out of the matching current asset.
As current ratio is 1 and quick ratio below 1, there may be appreansation about
the liquidity, but if all current assets are performing and are accounted at their
realizable values, these fears are misplaced. The firm saves opportunity cost on excess
investments in current assets and as bank cash credit limit are limits are linked to
inventory levels, interest cost is also sold. There would be a self-imposed financial
disciple on the firm to manage their activity within their current liability and current
asset and there may not be attendance to over borrow or divert funds.
Zero working capital also ensures a smooth and uninterrupted working capital
cycle, and it will pressurize the financial manager to improve the quality of current
asset at all times, to keep them 100 percent realizable. There will also be a constant
displacement in current liability and the possibility of having overdue may diminish.
The tendency to postpone current liability payment has to be curbed and working
capital always maintained at zero. Zero working capital will also call for a fine
balancing act in financial management, and the success in this endeavor would get
reflected in healthier bottom lines.

CHAPTER 19
OVERTRADING

55

Overtrading arises when a business expands beyond the level of funds

available. Overtrading an attempt to finance a certain volume of production and sales
with inadequate working capital .If the company does not have enough funds of its
own to finance stock and debtors it is forced, if it wish to expand, to borrow from
creditors and from banks on overdraft sooner or later and such expansion financed
completely by funds of others, will lead to a chronic imbalance in the working capital
ratio.
Expansion is advantageous so long as the business has funds available to
finance stock and debtors involved. Overtrading begins at a point where the business
relies on extra trade credit and increased turnover are financed by taking longer period
of credit from suppliers and/or negotiating an extension of overdraft limits with the
banks.
Over dependence on outside finance is a sign of weakness, unless the expansion
is curtailed, suppliers may refuse credit beyond certain limit, and the banks may call
for the reduction in overdrafts. If this happens the business may be insolvent in that it
does not have sufficient liquid resource to pay for current operation or to repay current
liability until customers pay for sale made on credit terms, or unless the stock is sold
for a loss for immediate cash payments.
Using the fallowing ratios it will be possible to analyze the situation properly
1. Working capital

= current asset: current liability

2. Acid test

= quick asset: current liability

3. Stock turnover

= stock: cost of sale

4. Debtors turnover = debtors: credit purchases

The object of using these ratios is to detect a disorientation of liquidity position
of a firm and increase reliance upon trade creditors and overdraft facilities.

56

CHAPTER 20
OVERCAPITALIZATION AND UNDER CAPITALIZATION OF
WORKING CAPITAL
57

If there are excessive stock, debtors and cash and very few creditors, there will
be an over investment in current asset. The inefficiency of managing working capital
will cause this excessive working capital resulting in lower returns in working capital
employed. And long-term funds will be unnecessarily tied up when they could be
invested to earn profit. This situation is known as overcapitalization of working
capital.
Under capitalization is a situation where a company does not have funds
sufficient to run the normal operation smoothly. This may happen, due to inefficient
working capital or diversion of working capital funds to finance capital items. If the
company faces the situation of undrecapitalization, then it will face difficulty in
meeting current obligation, procurement of raw material, meeting day-to-day running
expense etc. The result will ultimately be reduced profitability, and reduced turnover.
The finance manager must take immediate and proper step to overcome the situation
by making arrangements for sufficient working capital. For this purpose he should
prepare the realistic cash flow and fund flow statement of the company.
Some of the symptoms of poor working capital management are:
1. Excessive carriage of inventory over the normal levels required for
business will result in more balance in trade creditors account. More
creditors balance will cause strain on the management in management of
cash.
2. Working capital problem will arise when there is a show down in
collection of debtors.
3. Sometimes capital goods will be purchased from the funds available for
working capital. This will result in the working capital and its impact on
the operation of the company.
58

4. Unplanned production schedule will cause excessive stock of finished

goods or failure in meeting dispatch shedadule. More funds kept in the
form of cash will not generate any profit for the business.
5. Inefficiency in using potential trade credit requires more funds for
financing working capital.
6. Overtrading will cause shortage of working capital and its ultimate effect
is on the operation of the company.
7. Dependence in short term source of finance for financing permanent
working capital causes less profitability and will increase strain on
management in managing working capital.
8. Inefficiency in cash management will cause embezzlement of cash.

CHAPTER 21
INVENTORY MANAGEMENT

59

Inventories symbolize the second largest asset categories for manufacturing

companies, next only to plant and equipments. The proportion of inventories to total
asset varies between fifteen to thirty percent. Inventories are stocks of the product a
company is manufacturing for sale and component that make up the product. There
are three types of inventories: raw materials, work in progress and finished goods.
Raw materials are materials and components that are inputs in making the final
product. The work in progress, also called stock in progress, refer to goods in
intermediate stage of production. Finished goods consist of the final products that are
ready for sale. While manufacturing firms generally hold all three types of inventories,
distribution firms hold mostly finished goods. As inventory management has
important financial implication, the financial manager has the responsibility to ensure
that the inventory properly monitored and controlled.
The three general motives for holding the inventories are:
1. The transaction motives that emphasis the need to maintain inventories to
facilitate smooth production and sales operation.
2. The precautionary motive that necessitates holding of inventories to
guard against the risk of unpredictable change in demand and supply
force and other factors.
3. The speculative motive which influence the decision to increase and
reduce the inventory level to take advantage of price fluctuations.
The objectives of holding inventory are:
1. To maintain a large size of inventory for efficient and smooth production
and sales operation.
2. To maintain a minimum investment in inventories to maximize
profitability.
The objective of inventory management should be to determine and maintain
optimum level of inventory investment. The firm should always avoid a situation of
60

over investment or under investment in inventories. If there is over investment in

investment then it would result in unnecessary tie up of firms funds, loss of profit,
excessive carrying cost and risk of liquidity. Maintaining an inadequate level of
inventories is also dangerous. The consequence of under investment in inventories
will lead to production hold up and failure to meet delivery commitments. The aim of
inventory management thus should be to avoid excessive and inadequate level of
inventories and to maintain sufficient inventories for smooth production and sales
operation. Efforts should be made to place an order at the right time and with the right
source to acquire the right quantity at he right place and quality. An effective
inventory management should:
1. Ensure a continuous supply of materials to facilitate uninterrupted production.
2. Maintain sufficient stock of raw material in periods of short supply and
anticipate price change.
3. Maintain sufficient finished goods inventory for smooth sales operation, and
efficient customer service.
4. Minimize the carrying cost and time.
5. Control investment in inventories and keep it at an optimal level.
ECONOMIC ORDER QUANTITY:
There are two basic questions that should be considered in inventory
management namely (a) what should be the size of order? (b) At what level should the
order be placed?
This includes three types of cost:
1. Ordering cost: It relates to purchased items that include expense on
fallowing: requisitioning, preparation of purchase order, expediting,
transport and receiving and placing in storage.
2. Carrying cost: It includes expenses on interest on capital locked up in
inventory, storage, and insurance, obsolesces and taxes. Carrying cost
generally are 25% of the value of inventory held.
61

3. Storage cost: It arises when inventories are short of requirement for

meeting the need of production or demand of customers. Inventory
shortage may result in high cost, less efficient and uneconomic
production schedules, customer dissatisfaction and loss of sale.

Thus when a firm order in large quantities, in a bid to reduce the total
ordering cost, the average inventory, other things being equal, tends to be high
thereby increasing the carrying costs. In view of such relationship, minimization of
overall inventory management would require a consideration of trade off among
these costs.
For determining Economic Order Quantity formula the fallowing symbols
are used:
U

Annual usage/demand

Quantity ordered

Cost per order

Percent carrying cost

Price per unit

TC

Total cost of ordering and carrying

T.C = U * F * Q * P * C

The total cost of ordering and carrying cost is minimized when

Q = 2 FU / PC

CHAPTER 22
MONITORING AND CONTROLLING OF INVENTORIES
This includes the tools of ABC (Always Better Control) analysis, the various
measures for judging the effectiveness of inventories, the concept of just in time
62

inventory control and the steps that may be taken to maintain control over
inventories.
ABC analysis: In most inventories a small proportion of items account for a
very substantial usage (in terms of monetary value of annual consumption) and a
very large proportion of items account for a very small usage (in terms of monetary
value of annual usage). ABC analysis, based on this empirical reality, advocates in
essence, a selective approach to inventory control, which calls for greater
concentration of efforts on inventory items accounting for the bulk usage value.
This approaches calls for classifying inventories into three broad categories namely
A, B and C categories. Category A represent the most important items, which
generally consist of 15 to 25 % of inventory items and constitute for 60 70 % of
annual usage value. Category B, represent items of moderate importance, generally
consist of 20 to 30 % of inventory items and account for 20 to 30 % of annual
usage value. Category C represents items of least importance, generally consisting
of forty to sixty percent of inventory items and accounts for 10 to 15 % of annual
usage value.
To illustrate the use of ABC analysis, let the information on usage and price
of 20 items used by Control System Limited be
CLASS

NUMBER OF

% OF ITEMS

ITEMS

% OF
USAGE
VALUES

25

68.3

25

21.4

63

10

50

10.2

Fig no. 22.1

The procedure for numerical calculation of ABC analysis will be (1) Rank
the items of inventory on the basis of usage value (2) Record the cumulative usage
in value (3) Show the cumulative percent of the usage item. Now a days many
large manufacturers operate on just in time basis whereby all the components to be
assembled on a particular day arrive at the factory early that morning, no earlier-no
later. This helps to minimize manufacturing costs as JIT stock take up a little space,
minimize stock holding and virtually eliminate the risk of obsolete and damaged
stock. Because JIT manufacturers hold stock for a short time, they are able to
conserve substantial cash. IT is a good model to strive for, as it embraces all the
principle of sensible stock management.
The key issue for a business is to identify the fast and slow stock movers
with the objective of establishing optimum stock level for each category and
thereby minimize the cash tied up in stock. Factors to be considered when
determining optimum stock level include (a) what are the projected sales of each
product? (b) How widely available are the raw materials, components etc? (c) How
long does it take for delivery by suppliers? (d) Can you remove slow movers from
your product range without compromising best sellers?
Remember that stock sitting on shelves for long period of time ties up
money that is not working for you. For better stock control a firm should try the
fallowing (a) Review the effectiveness of existing purchases and inventory system?
(b) Know the stock turn for all major item of inventory (c) apply tight control to
significant few items and simplify controls for trivial many. (d) Sell off outdated or
64

slow moving merchandiseIt gets more difficult to sell the longer you keep it. (e)
Consider having part of your product outsourced to another manufacturer rather
than making it yourself (f) Review your security procedure to ensure that no stock
is going out the back door! Higher than necessary stock levels tie up cash and
cost more in insurance, accommodation costs and interest charges.

CHAPTER 23
ANALYSES 1
GUJARAT AMBUJA CEMENTS L.T.D
Gujarat Ambuja cements were set up in 1986.In the last decade the company
has grown tenfold. With the commencement of commercial production of its 2 mn
tones plant in Chandrapur, Maharashtra, and Ambuja will become Indias third largest
65

cement company with a capacity of 12.5 mn tones and revenue in excess of 2500
crores. Its plants are one of the most efficient in the world with environment
protection measures that are on par with the finest in the developed world.
Ambuja fallows a unique home grown philosophy of giving people the
authority to set their own targets, and the freedom to achieve their goals. This simple
vision has created an environment where there are no limits to excellence, no limits to
efficiency and has proved to be a powerful engine of growth for the company.
Ambuja, believes that an asset is worth only as much as the people who use it. The
peoples efforts to constantly raise efficiency have not only raised the bar at Ambuja,
but across the industry as well. Thus their people continue to achieve ever-high
efficiency and productivity at all their plants.
Over 40 % of the production cost of cement is power. Ambuja realized that to
run a profitable company, they need to keep power cost to minimum. So they set up a
captive power plant at a substantially lower cost than the national grid. They sourced a
cheaper and a higher quality coal from South Africa. They also brought better furnace
oil from the Middle East. The result is that today hey are in a position to sell their
excess power to the local government.
Their sea borne bulk cement transportation facility has brought many costal
markets within easy reach. It also made Ambuja Indias largest exporter of cement
consistently for the last five years. As a result Ambuja is the most profitable cement
company in India, and the lowest cost producer of cement in the world. Ambuja has
received the highest quality award The national quality award and the only current
company to do so. It was also the first to receive ISO 9002 quality certification.
Performance highlights of Gujarat Ambuja cements Ltd for the years 2001
2002 and 2002 2003

PARTICULARS

2002 2003
66

2001 -2002

(Rs in cores)

(Rs in cores)

Sales

1592

1474

(-) Expenditure

1126

1010

PBDIT

466

464

(-) Depreciation & Amortization

138

129

PBIT/Operating profit

328

335

(-) Interest/Financial charges

97

134

PBT

231

201

(-) Provision for tax

45

14

PAT

186

187

Fig no. 23.1

STATEMENT SHOWING WORKING CAPITAL OF GUJAART

AMBUJA CEMENT LTD

Particulars

2002 2003
67

2001 2002

Rs in lacks

Rs in lacks

Inventories

20837

16143

Sundry debtors

3901

3344

Cash and Bank balance

5072

2861

Other current asset

2371

2435

Loans and advances

15055

15278

47236

40061

Current liability

18821

22060

Provisions

3430

8313

TOTAL CURRENT LIABILITY

22251

30373

24985

9668

CURRENT ASSETS:

TOTAL CURRENT ASSET (A)

CURRENT LIABILITY

(B)

NET WORKING CAPITAL (AB)

Statement indicating short-term ratio:

68

1. Liquid ratios:

RATIO

FORMULAE

2002 - 2003

A) Current ratio

Current

47236

asset/current

=2.12

2001 - 2002
22251 40061 / 30373 =
1.32

liability
B) Quick ratio

(Current

asset

inventories)

26399 / 22251 = 23918 / 30373 =

/ 1.86

0.79

current liability
C) Cash ratio

Cash + marketable 5072 / 22251 = 0.23 2861 / 30373 = 0.09

securities / current
liability

2. Turnover ratios:

RATIO

FORMULAE

A) Debtor turnover

Net credit sales /

ratio

Closing debtors

Debtor collection

365 days / DTR

2002 - 2003

2001 - 2002

1592 / 39.01 =

1474 / 33 =

365 / 40.81 = 9

365 / 44 =14

period

B) Stock in trade

Cost of goods sold / 964.5 / 64.30 = 15

ratio

Closing stock in

898 / 63 =8

trade
Stock holding

365 days STR

365 / 15 = 24
69

365 / 14 =26

period
C)

Stores

and Cost of goods sold 433.99 / 143.98 = 406.90 / 97.93 =

consumables

turnover ratio

consumables

Stores

Closing 3.01 days

and 365 / SCTR

4.16 days

365 / 3.01 = 121 365 / 4.16 = 87

consumables

days

days

holding period

D)

Creditor Net

turnover ratio

credit 464.34 / 112.27 = 461.40 / 167.32 =

purchases

/ 4.14 days

2.76 days

Closing Creditors
Creditors payment 365 / CTR

365 / 4.1 = 88 days

period

365 / 2.76 = 132

days

3. Effect of turnover ratio on working capital:

RATIO

2002 2003 2001 2002

(IN DAYS)

(IN DAYS)

Stock holding period

24

26

(ADD)

Stores and consumables holding period

121

87

(ADD)

Debtors collection period

(LESS)

Creditors payment period

88

132

Total

66

(11)

70

4. Profitability ratio:

RATIO

FORMULAE

2002 - 2003

2001 - 2002

Gross profit margin Gross profit / net 328 / 1592 = 0.21 335 / 1474 = 0.23 =
ratio

sales

=21%

23%

Fig no.23.2
ANALYSIS:
WORKING CAPITAL OUTLAY:
In the cement business where the production and marketing cycle can be long,
working capital funds a number of activities: the purchase of raw materials, making
advances, availing cash discount on the total billing, maintaining an inventory on
production spares, sustaining the production cycle without interruption and sustaining
all the usual function within the organization.
Working capital accounted for 7.8 percent of the companies total capital
employed in 2002 2003.The total quantum of working capital was rs 24985 lac in
2002-2003 compared to 9688 lacks in 2001-2002,a 157.9% increase. The companys
turnover to working capital ratio increased from 6.6 times in 2001-2002 to 15.7 times
in 2002-2003.
LIQUIDITY RATIOS:
It implies the firms ability to pay its debts in a short run. It involves the
relationship between the current asset and current liability. In case of Gujarat Ambuja
Cements, the net working capital was Rs 9688 lacks in 2001-2002 has increased to Rs
24985 lacks in the year 2002-2003.It means that the liquidity position of the firm has
increased. This is mainly due to increase in inventory holding and cash balances.

71

The current ratio implies the firms ability to meet its current obligation. In
2001-2002 the current ratio was 1.32, which is now increased to 2.12 in 2002-2003,
which means that the company has current asset, which are 2.12 times the current
liability. This shows that the overall liquidity position of the company has seen an
improvement over the previous year. The increase in current ratio in over the earlier
period can be attributed towards an increase in inventory holdings and also a
noticeable rise in cash holdings over the earlier period. This if further affraimed by
quick ratio, which has shown a significant, raise from 0.79 in 2001-2002 to 1.86 in
2002-2003.In fact the quick ratio has more than doubled over the previous year. Thus,
the company has managed to generate adequate cash surplus to meet its growing
business needs. Besides they have also built up good stock levels of coal and other
packing materials, probably to take advantage of low price prevailing in the market.
SUNDRY DEBTORS:
Sundry debtors stood at 3901 lacks in 2002-2003, compared with Rs 3344 lacks
in 2001-2002, a 16.66 percent increase. Sales have increased by 9.34 percent in 20022003,and average collection period has more or less remained steady from 8 days in
2002 to nine days in 2003.This indicates that the company has succeeded in achieving
growth in sales and at the same time, efficiently collected its receivables from the
marketplace, as in the previous year. Credit worthiness was appraised on a periodic
basis.
INVENTORIES:
Inventories increased from Rs 16143 lacks in 2001-2002 to Rs 20837 lacks in
2002-2003,a 29% increase over the previous year primarily due to the increase in
stock of coal and packing material. Goods and consumables holding period increased
from 87 days to 121 days As a result the total inventory-holding period also increased
from days in 2001 2002 to 145 days in 2002-2003.
SUNDRY CREDITORS:
72

The sundry creditors decreased from 16732 lacks in 2001-2002 to Rs 11226

lacks in 2002-2003,a 32.9% decreases a result creditors payment period decreased
from 132 days in 2001-2002 to 88 days in 2002-2003.It seemed that the company has
pushed hard its cost cutting drive, and effectively negotiated with its major suppliers
to reduce the price of the supplies and compensated the suppliers to a certain extend
by accepting a lower credit period. Also, the company seems to have generated
enough cash from its operation to pay off the suppliers on a timely basis. The
company has strived hard to reduce its liabilities by paying off the creditors, which
shows that they have efficiently planned their finance.
To summarize one can say that, Gujarat Ambuja Cement has utilized its
working capital efficiently. It has been able to process at lower prices by
compromising on credit period from its creditors up to 88 days and has efficiently
collected from debtors in nine days. But the inventory seem to be slightly on the
higher side as compared to the previous year, which may me due to the company
availing the benefits of low price of material in the market.

PROFITABILITY RATIO:
This is the ratio that measures the firms activity and the ability to generate profits.
The gross profit margin ratio of Gujarat Ambuja Cement has decreased from 23% in
01-02 to 21% in 02-03.On an average it shows that company has made good profit as
compared to the earlier year.

73

CHAPTER 24
ANALYSES 2
SHREE CEMENTS LTD
SHREE cements are one of the major energy efficient and productive cement
manufacturing in the world. SHREE cements are engaged in manufacture of cement
through the dry process route in north India. The company process two plants in
Bewar and Rajastan.Shree cements manufacture cements of two varieties Gray
74

cement and Clinker cement. Its competitive advantage lays in its ability to
constituently generate a production in excess of its installed capacity.
In 2002 2003, Shree Company recorded a turnover of Rs 399.27 crore as
against Rs 554.60 crore in 2001 - 2002.This was because 2002 - 2003 comprised 9
working months as compared to 12 working months the previous year. In 2002 - 2003
SHREE cements posted a 28% increase in its cash profits i.e. 49.84 crore as compared
to the previous year.
The vision of SHREE cement is to register a strong consumer surplus through a
superior cement quality at affordable prices. And their mission is to strengthen
realization through intelligent brand building and to increase he awareness of superior
products through a realistic and convincing communication process with consumers.
The company is looking forward to make financial accounting module available
online for the authorized users. It also plans to get input from Weigh Bridge online to
exercise better control on inbound and out bound logistics. In coming days IT is
expected to play an even more important role in terms of integrating various activities
of business, maintaining Data and providing information.

PERFORMANCE HIGHLIGHTS OF SHREE CEMENTS LTD FOR THE

YEAR 2001-2002 & 2002-2003

PARTICULARS

2002-2003

2001-2002

(NINE

(TWELVE MONTHS)

MONTHS)
Rs in crores
75

Rs in crores

Sales

397.21

554.60

Other income

0.30

0.28

Increase/Decrease in stock

6.01

(13.31)

(-) Expenditure

326.75

445.80

PBDIT

76.77

95.77

(-) Interest and financial charges

26.93

44

Gross profit

49.84

51.77

(-) Depreciation and a moralization

43.12

25.64

PBT

6.72

26.13

(-) Provision for tax

3.10

(-) Provision for deferred tax

2.14

PAT

1.48

26.13

Fig no. 24.1

Statement showing working capital of shree cements ltd
2002-2003

2001-2002

All rs in crores

All rs in crores

Inventories

4103

3472

Sundry debtors

3003

4082

Cash and bank balance

553

1891

Loan and advance

6423

6584

Total current assets (A)

14082

16029

PARTICULARS

Current assets:

76

Current liabilities
Current liability

5840

5488

Provisions

446

599

Total current liability (B)

6286

6087

Net working capital (A-B)

7796

9942

Statement indicating Short term ratios

Liquidity ratio:

RATIO

FORMULAE

A) CURRENT RATIO

CURRENT

ASSETS

CURRENT LIABILITY
B) QUICK RATIO

2002-2003

2001-2002

14082/6286

16029/6087

= 2.24

= 2.63

CURRENT ASSETS 9979/6286 = 12557/607 =

INVENTORY

1.59

2.06

CASH + MARKETABLE

553/6286 =

1891/6087 =

SECURITIES/CURRENT

0.08

0.31

2002-2003

2001-2002

39722/4103

55460/3472

stock

= 9.68

= 16

holding 365 days/ITR

274/9.68 =

365/16 = 23

/CURRENT LIABILITY
C) CASH RATIO

LIABILITY
Turnover ratio:

RATIO

FORMULAE

A) Inventory turnover Goods

ratio
Inventory

sold/closing

77

period

B)

Debtor

turnover Net credit sales/Closing

ratio

28 days

days

39722/3003

55460/4082

= 13

= 14

274/13 = 21

365/14 = 27

days

days

debtors

Debtor

collection 365 days/DTR

period
C) Creditor turnover

Net credit

14829/3754

20823/3405

period

purchases/Closing

=3.95

= 6.11

274/3.96 =

365/6.11 =

69 days

60 days

creditors
Creditor payment

365/CTR

period

EFFECT OF THE TURNOVER RATIO ON WORKING CAPITAL

RATIO

2002-2003

2001-2002

Inventory holding period

28 DAYS

23 DAYS

ADD

Debtor collection period

21 DAYS

27 DAYS

LESS

Creditor payment period

69 DAYS

60 DAYS

(20)

(10)

TOTAL

PROFITABILITY RATIO
RATIO

FORMULAE

2002-2003

2001-2002

Gross profit

Gross profit/Net

4984/39722 =

5176/55461 = .09

margin ratio

sales

0.13 = 13%

= 9%

g no.24.2

78

Fi

ANALYSIS:
WORKING CAPITAL OUTLAY:
In the cement business where the production and marketing cycle can be long,
working capital funds a number of activity: the purchase of raw materials, making
advances, availing cash discount on the total billing, maintaining an inventory on
production spares, sustaining the production cycle without interruption and sustaining
all the usual function within the organization.
Working capital accounted for 12 percent of the companies total capital
employed in 2002 2003.The total quantum of working capital was rs 77crore in
2002-2003 compared to 99.42 crore in 2001-2002,a 21.58% decrease.
LIQUIDITY RATIOS: It implies the firms ability to pay its debtors I the short run. It
involves the relationship between the current asset and the current liability. In the case
of SHREE cements, the net working capital was rs 99.42 crores in 2001-2002 and
reduced to RS 77.96 cr in 2002-2003.It means that the liquidity position of the
company has decreased.
The current ratio implies the firms ability to meet its current obligation. In 0102 the current ratio was 2.63, which has now come down to 2.24, which means that
the company has current asset, which are 2.24 times the current liability. Thus the
liquidity position of the company has reduced. The quick ratio implies the firms
ability to pay off its liabilities without relaying on the sale of the inventory or its
recovery. The quick ratio is reduced from 2.06 in 01-02 to 1.59 in 02-03.,which means

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the inventories are reduced over a period of time and that liquidity position is good
although the current ratio gives a different picture.
SUNDRY DEBTORS: Retail sale increased by ten percent in 2002-2003 and sundry
debtors decreased by Rs 10.79 crore. This indicates that the companies collets its
outstanding faster from the marketplace. Sundry debtors stood at 30.03 crore in 20022003 compared with 40.82 crore in 2001-2002, a 26.43% decrease. Debtors day
decreased from 27 days in 2001-2002 to 21 days in 2002-2003, reflecting prudent
debtor management. Credit worthiness was appraised on a periodic basis. Attractive
financial incentive scheme were instituted to ensure a quick settlement of outstanding.
INVENTORY :Inventories increased from 34.05 crore in 2001-2002 to 37.54 crore in
2002-2003 which is a 10.24% increase. Creditor payment period increased from sixty
days in 2001-2002 to sixty nine days in 2002-2003, which shows a prudent credit
management. The company has strived hard to push their creditors, which shows they
have efficiently planed things.
PROFITABILITY RATIO: This is the ratio that measures the firms activity and its
ability to generate profit. The gross profit margin of SHREE CEMENTS has
decreased from thirteen percent to nine percent but on average it shows that the
companies has made good profit as compared to the earlier year.

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CHAPTER 25
CONCLUSIONS COMPARISONS OF THE TWO CEMENT
INDUSTRIES
In the cement industry, where the production cycle and the marketing cycle may
be long, working capital is required for various reason like purchase of raw material,
making advances, availing cash discounts on the total billings, maintaining an
inventory of production spares, sustaining the production cycle without interruption,
payment of wages and salaries and sustaining all the useful function within the
companies.
Gujarat Ambuja Cement working capital accounted for 7.8% of the total capital
employed for the year 2003,indicating 157.9% increase as compared to the previous
year where as that of SHREE cement accounted for 12% indicating 21.58% decrease
of the capital employed.
In general comparing the two cement industries, the inventory management of
SHREE cements ltd is very good as it holds inventory for only 28 days in comparison
Gujarat Ambuja who hold it for 121 days.
AS far as the debtor management is concerned, It is Gujarat Ambuja cements
that manage its debtors efficiently as it receives from the debtors on an average period
of nine days. SHREE CEMENTS, in 21 days.
Gujarat Ambujas payable period has reduced from 132 days in 2001 - 2002 to
88 days in 2002 2003. Thus Ambuja has supplemented its cost cutting effort by
accepting lower credit period from suppliers from lower price. On the other hand
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payable period of SHREE cements has increased from 60 days in 2001 - 2002 to 69
days in 2002 - 2003, indicating that they has negotiated a better credit period with its
suppliers at the same price.
On an average one can say that both the cement industries are managing their
working capital in such a way as to increase their profitability in the market.

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