PROJECT ON WORKING CAPITAL

MANAGEMENT

Submitted By
Navdeep Singh Momi(2013164)
Navneet Singh (2013165)
Nikita Agarwal(2013171)
Poulami Sarkar(2013201)

Abstract
Efficient management of working Capital is one of the pre-conditions for the success of an enterprise.
To reach optimal working capital management firm manager should control the trade-off between
profitability and liquidity accurately. The purpose of this study is to investigate the relationship
between working capital management and firms profitability.
In this study, we have selected a sample of 5 top notch Electricals firms and taken their financial data
for a period of 6 years from 2008 2013 and studied the effect of different variables of working
capital management including the Cash conversion cycle and Current ratio on the profitability of the
firms.
The study shows that there is a negative significant relationship between cash conversion cycle &
firms profitability and positive relationship between Current Ratio & profitability of firms. This
reveals that reducing cash conversion period and increasing the current ratio results into profitability
increase. Thus, in purpose to create shareholder value, firm manager should concern on shorten of

cash conversion cycle till accomplish optimal level .

DATA AND METHODOLOGY USED

DATA: The study is based on secondary data collected from the audited Profit & Loss A/c
and Balance Sheet associated with schedules and annexure available in the published annual
reports of Electricals firm. For the purpose of the study, public enterprise survey reports,
government publications etc. have been used. Journals, conference proceedings and other
relevant documents have also been consulted to supplement the data.
METHODOLGY: The available data have been analyzed by using various financial ratios as
a managerial tool.
Maximizing Profitability
The term 'Profitability' means the ability to earn profits by an enterprise on its static resources
(i.e. invested capital). The profitability acts as a yardstick to measure the operating efficiency
of the enterprise. The profitable investment of excess cash, minimization of inventories,
speedy collection of receivables and avoidance of unnecessary and costly short-term
financing all contribute to the maximization of profitability. The profitability of the enterprise
is popularly measured with the help of financial ratios conveying quantitative relationship
between two variables considered for the purpose.
Adequate Liquidity
The term 'liquidity' refers to the capability of a firm to meet short term financial obligations
[i.e. Current Liabilities (CL)] by converting the short term assets [i.e. Current Assets (CA)]
into cash without suffering any loss. Here current assets refer to those which are readily
convertible into cash within one accounting period. Current liabilities, on the other hand, are
those, which are to be met within one accounting period. The liquidity of a firm actually
depends on the effective management of the composition of CAvis--vis CL The liquidity
position of a firm is generally analyzed with the help of some important ratios computed on
the basis of different constituents of working capital either in isolation or in aggregate or
both.
The important ratios reflecting the liquidity and profitability position of a firm are as follows:
1. Current Ratio Useful for Managers and working capital fund providers. Measures the
companys liquidity and also the margin of safety ,the company has in order to meet any
emergency arising out of uneven flows of funds through current assets and current liabilities
account. It expresses the extent to which the current liabilities of a business ( i.e liabilities due
to be settled in 12 months) are covered by its current assests (i.e assets expected to be realized
within 12 months) . A current ratio of 2 would mean that current assests are sufficient to
cover for the twice the amount of a companys short term liabilities. As per the calculation
above calculated for 5 years its clearly visible that its been decreased from 1 so decreasing
trend in the current ratio suggests a deteriorating liquidity position of the business .

Current Ratio = Current Assets / Current Liabilities

2. Working capital - Working capital is a measure of liquidity of a business. It equals

current assets minus current liabilities. If current assets of a business at the point in time are
more than its current liabilities the working capital is positive, and this tells that the company
is not expected to suffer from liquidity crunch in near future and from calculations we can see
that it has happened only in year 2008. However, if current assets are less than current
liabilities the working capital is negative, and this communicates that the business may not be
able to pay off its current liabilities when due.
Working Capital = Current Assets Current Liabilities
3. COGS - COGS is the costs that go into creating the products that a company sells;
therefore, the only costs included in the measure are those that are directly tied to the
production of the products. cost of goods sold is the primary component in calculating gross
profit, and it affects nearly every other profit measure. Calculating COGS is the primary
reason most companies take inventory every month. It is important to understand that
different inventory methods typically generate different costs of goods sold for identical
companies, and it is therefore necessary to study a company's inventory valuation disclosure
when evaluating cost of goods sold. When comparing companies, it is also important to note
that some industries tend to have higher COGS than others. This is why comparisons are
generally most meaningful among companies using the same inventory method within the
same industry, and the definition of "high" or "low" cost should be made within this context.
Cost of Goods Sold (COGS) = Net Sales Operating Profit

4. Day sales inventory - A financial measure of a company's performance that gives

investors an idea of how long it takes a company to turn its inventory (including goods that
are work in progress, if applicable) into sales. Generally, the lower the DSI the better, but it is
important to note that the average DSI varies from one industry to another. Since inventory
carrying costs take significant investment, a business must try to reduce the level of
inventory. Lower level of inventory will result in lower days' inventory on hand ratio.
Therefore lower values of this ratio are generally favorable and higher values are
unfavorable.
DSI = 365 * Average Inventory / COGS
5. Day Sales Outstanding - Days' sales outstanding ratio (also called average collection
period or days' sales in receivables) is used to measure the average number of days a
business takes to collect its trade receivables after they have been created. It is an activity
ratio and gives information about the efficiency of sales collection activities. Since it is
profitable to convert sales into cash quickly, which means that a lower value of Days Sales
Outstanding is favourable whereas a higher value is unfavourable. However it is more
meaningful to create monthly or weekly trend of DSO. As per the calculation it is clear that

there is significant increase in the trend is unfavourable and indicates inefficiency in credit
sales collection.
DSO = 365* Average Receivables / Net Sales
6. Days Sales Payable - Days Sales payables outstanding (DSP) is the average number of
days in which a company pays its suppliers. It is also called number of days of payables a low
DPO highlights good working capital management because the company is availing early
payment discounts. However, the DPO should be corroborated by other ratios, particularly
the liquidity ratios. When a company's liquidity position is good, a high days payables
outstanding most likely tells that the company is delaying payments to its creditors till the last
possible date to shorten its cash conversion cycle.
DSP = 365 * Average Trade Payables / COGS
7. Cash Conversion Cycle - Cash conversion cycle is the time it takes a company to convert
its resource inputs into cash. It measures how effectively a company is managing its working
capital. Shorter the cash conversion cycle the better the company is off because it has to lock
up cash for a relatively smaller period of time.
Cash Conversion Cycle (CCC) = DSI + DSO DSP

Relationship between Profitability and Liquidity of a Firm:

Liquidity-Profitability tangle: The relationship between liquidity and profitability can be
explained with the help of return on capital employed ratio expressing it in the following
form:
P = PBIT / (FA+NWC)
Where,
P= Profitability, EBIT=Earnings before interest and taxes, and NWC= Net working capital.
This ratio indicates that other things remaining unchanged, continuous reduction in
NWC (i.e. liquidity) improves the profitability (P) of a firm with the simple passage of time.
This suggests that there always exists a negative relation between liquidity and profitability.
But in reality it is seen that unless there is a minimum level of investment in CA, which could
provide a promising vehicle for increasing profitability, the required amount of output and
sales cannot be maintained. Therefore, upto a certain level liquidity and profitability are
complementary to each other. In this connection James E. Gentry hypothesized that upto a
certain level, increase in liquidity will lead to a corresponding increase in profitability.
Beyond that, profitability remains constant with an increase in liquidity within a specified
domain. Therefore, any further investment in CA will lead to decline in profitability. Thus,

the shape of the curve showing the relationship between liquidity and profitability seem to be
an inverted teacup. This is shown in the following exhibit:

Figure 1. Relationship between Profitability and Liquidity (Gentrys Curve)

Sector Chosen and Companies

The sector chosen is Electrical and the companies chosen are Bajaj Electricals Ltd,Bharat Heavy
Electricals Ltd, Brook Crompton Grooves Ltd , ECE Industries Ltd , Khaitan Electricals Ltd.

Ratios Analysis
When it comes to analysing financial statement information, ratio analysis is one of the fundamental analysing
processes. Following

are the calculated values for the selected companies:

Regression Analysis
Bajaj
Electricals
Ltd.

Brook
Ltd.
Profitability
(Y)
1609.4
2017.2
2531.4
2728.1
2638.3
1933.7

Year
2008
2009
2010
2011
2012
2013
Co-eff of Det.

CCC (X)
94.20291713
81.85619258
80.92934138
97.38862552
111.1487477
118.2723294
0.000495

Year
2008
2009
2010
2011
2012
2013
Co-eff of Det.

Bharat Heavy Electricals Ltd.

Profitability
CCC (X)
(Y)
133.7564006 61936.8
120.9434863 73220.4
128.7787721 88017.6
117.1438732 132923.9
153.5576608 134180
204.2398056 136704
0.267990966

Crompton

CCC (X)
94.20291713
210.6855708
203.4773616
81.34697963
25.81699812
67.46428643
0.094017326

Greaves

Profitability
(Y)
96.8
16.3
1.4
11
20.3
36.1

Khaitan Electricals Ltd.

Profitability
CCC (X)
(Y)
187.1129229 340.3
249.4516419 141.3
221.1609611 303.2
183.0625973 369.2
212.7687189 248.7
190.1403684 512
0.672930429

E C E Industries Ltd.
Profitability
CCC (X)
(Y)
72.4271254
423.1
86.10021026 220.2
99.5051503
145.4
85.57863085 81.5
72.98882102 141.6
45.27595395 173.8
0.03344226
Electrical
AVERAGE
CCC (X)
90.95545256
108.8919759
107.8605652
87.66012189
81.97916751
85.93694052
0.474520025

Industry
Profitability
(Y)
12881.28
15123.08
18199.8
27222.74
27445.78
27871.92

Initial Hypothesis-The profitability of the electrical companies are directly dependent on cash
conversion cycle.

Cash Conversion Cycle

The cash conversion cycle is a measure of working capital efficiency, often giving valuable clues
about the underlying health of a business. The cycle measures the average number of days that
working capital is invested in the operating cycle. It starts by adding days inventory outstanding
(DIO) to days sales outstanding (DSO). This is because a company "invests" its cash to acquire/build
inventory, but does not collect cash until the inventory is sold and the accounts receivable are finally
collected.
Receivables are essentially loans extended to customers that consume working capital; therefore,
greater levels of DIO and DSO consume more working capital. However, days payable outstanding
(DPO), which essentially represent loans from vendors to the company, are subtracted to help offset
working capital needs. In summary, the cash conversion cycle is measured in days and equals DIO +
DSO DPO:

Coefficient of Determination-We calculated coeff of determination as coeff of relation wont

be true statistically if CCC is negative. In the analysis part we have found out the coefficient of
determination which indicates how well data points fit a statistical model sometimes simply a line or
curve. It is a statistic used in the context of statistical models whose main purpose is either the
prediction of future outcomes or the testing of hypotheses, on the basis of other related information. It
provides a measure of how well observed outcomes are replicated by the model, as the proportion of
total variation of outcomes explained by the model. The below data is for the year 2008-13:
Electrical Industry AVERAGE
Year

CCC (X)

Profitability (Y)

2008

90.95545256

12881.28

2009

108.8919759

15123.08

2010

107.8605652

18199.8

2011

87.66012189

27222.74

2012

81.97916751

27445.78

2013

85.93694052

27871.92

Co-eff of Det.

0.474520025

Coeffi cient of determination

27871.92
3000027445.78 27222.74
25000
20000
Profitability

18199.8
15123.08

12881.28

15000
10000
5000
0
80

85

90

95

100

105

110

115

Cash Conversion Cycle

The coefficient of determination comes out to be greater than 0.45 so we can accept the hypothesis
and conclude that the efficient management of working capitals directly affects the profitability of the
sector.

Conclusion
Working Capital Management has its effect on liquidity as well on profitability of the firm. In this
paper a sample of the 5 Indian firms, listed on BSE including firms from different sectors of our
economy for a period which extends to five years starting from 2008 to 2013 has been taken. An
attempt has been made to examine the effect of different variables of working capital management
including the Debt ratio, Average collection period, Inventory turnover in days, Average payment
period, Cash conversion cycle and Current ratio on the Net operating profitability of sample firms.
The results show that there is a strong positive relationship between variables of the working capital
management and profitability of the firm.