PROJECT ON WORKING CAPITAL

MANAGEMENT

SUBMITTED FOR FULFILLMENT OF FUNCTIONAL

MANAGMENET SUBJECT in M.M.S PROGRAMME
SUBMITTED BY
MOATASIM IMRAN PARKAR
UNDER THE GUIDANCE OF
PROF:-RENAPURE L.N.

SUBMITTED TO
RAJARAM SHINDE COLLEGE OF M.B.A
PEDHAMBE, CHIPLUN

FOR THE ACADEMIC YEAR

2018-2019

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 ACKNOWLEDGEMENT

Apart from the efforts by me, the success of any project depends largely on

the encouragement and guidelines of many others. I take this opportunity to

express my gratitude to the people who have been instrumental in the

successful completion of this project.

I would like to show my greatest appreciation to Mr. Laxman Renapure

(Professor, MES) .I can‘t say thank you enough for his tremendous support

and help. Without his encouragement and guidance this project would not

have materialized.

The guidance and support received from all the members who contributed

and who are contributing to this project, was vital for the success of the

project. I am grateful for their constant support and help.

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 TABLE OF CONTENTS

S.NO. PARTICULARS PAGE NO.

1 INTRODUCTION
2 FINANCIAL HIGHLIGHTS:
i DIFFERENT SECTIONS IN THE
DEPARTMENT
iii MATERIAL ACCOUNTS SECTION
iv BUDGET SECTION
v TIME OFFICE SECTION
vi PROVIDENT FUND SECTION
vii CATEGORIES OF OPERATION
3 RESEARCH METHODOLOGY
4 SWOT ANALYSIS
5 CONCLUSION
6 SUGGESTIONS
7 BIBLIOGRAPHY

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 INTRODUCTION OF TOPIC

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 refer 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, accounts receivable and inventory.

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

earnings of the concern. The basic current liabilities are accounts payable, bill payable,

bank overdraft, and outstanding expenses.

The goal of working capital management is to manage the firm’s current 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.

The interaction between current assets and current liabilities is, therefore, the

main theme of the theory of working management.

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 CONCEPTS OF WORKING CAPITAL

There are two concepts of working capital:

1. Gross working capital.

2. Net working capital.

 Gross working capital refers to the firm’s investment in current assets. Current

assets are the assets which can be converted into cash within an accounting

year and include cash, short-term securities, debtors, (accounts receivable or

book debts) bills receivable and stock (inventory).

Gross work capital = total current assets

 Net working capital refers to the difference between current assets and current

liabilities, Current liabilities are those claims of outsiders which are expected to

mature for payment within an accounting year and include creditors (accounts

payable), bills payable, and outstanding expenses. Net working capital can be

positive or negative. A positive net working capital will arise when current assets

exceed current liabilities are in excess of current assets.

Net working capital = current assets – current liabilities

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 NEED FOR WORKING CAPITAL

The need for working capital (gross) or current assets cannot be

overemphasized. Given the objective of financial decision making to maximize the

shareholders’ wealth, it is necessary to generate sufficient profits. The extent to which

profits can be earned will naturally depend, among other things, upon the magnitude of

the sales. A successful sales programmed is, in other words necessary for earning

profits by any business enterprise. However, sales do not convert into cash instantly;

there is invariably a time-lag between the sale of goods and the receipt of cash. There

is, therefore, a need for working capital in the form of current assets to deal with the

problem arising out of the lack of immediate realization of cash against goods sold.

Therefore, sufficient working capital is necessary to sustain sales activity.

Technically, this is referred to as the operating or cash cycle. The operating cycle

can be said to be at the heart of the need for work capital. The continuing flow from

cash to suppliers, to inventory, to accounts receivable and back into cash is what is

called the operating cycle. In others words, the term cash cycle refers to the length of

time necessary to complete the following cycle of events.

1. Conversion of cash into inventory;

2. Conversion of inventory into receivables;

3. Conversion of receivables into cash.

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 OPERATING CYCLE OR WORKING CAPITAL CYCLE

Operating cycle is the time duration required to covert sales after the conversion

of recourses into inventories, into cash.

The operating cycle consists of three phases;

PHASE:-1 Cash gets converted into inventory. This includes purchase of raw materials,

conversion of raw materials into work-in-progress, finished goods and finally the transfer

of goods to stock at the end of the manufacturing process. In the case of trading

organizations, this phase is shorter as there would be no manufacturing activity and

cash is directly converted to inventory. The phase is, of course, totally absent in the

case of service organizations.

PHASE:-2 in this phase the inventory is converted into receivables as credit sales are

made to customers. Firms which do not sell on credit obviously not have phase II of the

operating cycle.

PHASE:-3 the last phase represents the stage when receivables are collected. This

phase completes the operating cycle. Thus, the firm has moved from cash to inventory,

to receivables and to cash again.

The above operating cycle is repeated again and again over the period

depending upon the nature of the business and type of product etc. The duration of the

operating cycle of a manufacturing firm is the sum of:-

i. Inventory conversion period. (ICP)

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 ii. Debtors (receivable) conversion period. (DCP)

The inventory conversion period is the total time needed for producing and

selling the product. Typically, it includes:

a. Raw material conversion period (RMCP).

b. Work-in-process conversion period (WIPCP).

c. Finished goods conversion period (FGCP).

d. The debtors’ conversion period is the time required to collect the outstanding

amount from the customers. The total of inventory conversion period and

debtors’ conversion period is referred to as gross operating cycle (GOC).

e. In practice, a firm may acquire resources (such as raw materials) on credit

and temporarily postpone payment of certain expenses. Payables, which the firm

can defer, are spontaneous sources of capital to finance investment in current

assets. The creditors (payables) deferral period (CDP) is the length of time of the

firm is able to defer payments on various resource purchases. The difference

between (gross) operating cycle and payables deferral period is net operating

cycle (NOC).

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 TYPES OF WORKING CAPITAL

PERNAMENT WORKING CAPITAL: Permanent of fixed working capital is the

minimum amount which is required to ensure effective utilization of fixed facilities and

for maintaining the circulation of current assets. There is always a minimum level of

current assets, which is continuously required by the enterprise to carry cut its normal

business operations. For example, every firm has to maintain a minimum level of raw

materials, work-in-process, finished goods and cash balance. This minimum level of

current assets is called permanent or fixed working capital as this part of capital is

permanently blocked in current assets. As the business grows the requirements of

permanent working capital also increase due to the increase in current assets.

The permanent working capital can further be classified as regular working capital and

reserve working capital required ensuring circulation of current assets from cash to

inventories, from inventories to receivables and from receivables to cash and so on.

i. Regular working Capital: This is the amount of working capital required for

the continuous operations of an enterprise. It refers to the excess of current

assets over current liabilities. Any organization has to maintain a

minimum stock of materials, finished goods and case to ensure its smooth

work and to meet its immediate obligations.

ii. Reserve Working Capital: Reserve working capital is the excess amount

over the requirement for regular working capital which may be provided for

contingencies that may arise at unstated period such as strikes, rise in prices,

depression, etc.

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Temporary or Variable Working Capital: Temporary or variable working capital is

the amount of working capital which is required to meet the seasonal demands and

some special exigencies. Variable working capital can be further classified as seasonal

working capital and special working capital.

i. Seasonal Working Capital: Seasonal working capital is required to meet the

seasonal needs of the enterprise such as a textile dealer would require large

amount of funds a few months before Diwali.

ii. Special Working Capital: Special working capital is that part of working

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

extensive marketing campaigns for conducting research, etc.

Temporary working capital differs from permanent working capital in the sense

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

business.

The following diagrams would show the difference between permanent and temporary
working capital.

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 BALANCE WORKING CAPITAL POSITION

The firm should maintain a sound working capital position. It should have

adequate working capital to run its business operations. Both excessive as well as

inadequate working capital positions are dangerous from the firm’s point of view.

Excessive working capital means holdings costs and idle funds which earn no profits for

the firm. Paucity of working capital not only impairs the firm’s profitability but also results

in production interruptions and inefficiencies and sales disruptions.

The dangers of excessive working capital are as follows:

 It results in unnecessary accumulation of inventories. Thus, chances of inventory

mishandling, waste, theft and losses increase

 It is an indication of defective credit policy and slack collection period.

Consequently, higher incidence of bad debts results, which adversely affects

profits.

 Excessive working capitals make management complacent which degenerates

into managerial inefficiency.

 Tendencies of accumulating inventories tend to make speculative profits grow.

This may tend to make dividend policy liberal and difficult to cope with in future

when the firm is unable to make speculative profits.

 Inadequate working capital is also bad and has the following dangers:

 It stagnates growth. It becomes difficult for the firm to undertake profitable

projects for non-availability of working capital funds.

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  It becomes difficult to implement operating plans and achieve the firm’s profit

target.

 Operating inefficiencies creep in when it becomes difficult even to meet day-to-

day commitments.

 Fixed assets are not efficiently utilized for the lack of working capital funds. Thus

the firm’s profitability would deteriorate.

 Paucity of working capital funds render the firm unable to avail attractive credit

opportunities etc.

 The firm loses its reputation when it is not in a position to honour its short-term

obligations. As a result, the firm faces tight credit terms.

An enlightened management should therefore, maintain the right amount of

working capital on a continuous basis. Only then a proper functioning of business

operations will be ensured. Sound financial and statistical techniques, supported by

judgment, should be used to predict the quantum of working capital needed at different

time periods.

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 POLICIES FOR FINANCEING CURRENT ASSETS

A firm can adopt different policies vis-à-vis current assets. Three types of financing may

be distinguished:

 Long-term financing: The sources of long-term financing include ordinary

share capital, preference share capital, debenture, long-term borrowings from

financial institutions and reserves and surplus (retained earnings).

 Short-term financing: The short-term financing is obtained for a period less

than one year. It is arranged in advance from banks and other suppliers of short

term finance in the money market. Short-term finance includes working capital

funds from banks, public deposits, commercial paper, factoring of receivable etc.

Spontaneous financing: Spontaneous financing refers to the automatic sources of

short-term funds arising in the normal course of a business. Trade (suppliers’) credit
and outstanding expenses are examples of spontaneous financing. There is no explicit
cost of spontaneous financing. A firm is expected to utilize these sources of finances to
the fullest extent. The real choice of financing current assets, once the spontaneous
sources of financing have been fully utilized, is between the long-term and short-term
sources of finances.

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 DETERMINING FINANCING MIX

Financing mix is the choice of source of financing of current assets. There are

three basic approaches to determine an appropriate financing mix:

(a) Hedging approach

(b) Conservative approach

(c) Aggressive approach

(a) Hedging approach: the term ‘hedging’ is often used in sense of a risk-

reducing investment strategy involving transactions of a simultaneous but

opposing nature so that the effect of one is likely to counterbalance the effect

of the other. With reference to an appropriate financing-mix, the term hedging

can be said to refer to the process of matching maturities of debt with the

maturities of financial needs. This approach to the financing decision to

determine an appropriate financing-mix is, therefore, also called as matching

approach.

(b) Conservative approach: A firm in practice may adopt a conservative

approach in financing its current and fixed assets. The financing policy of the

firm is said to be the conservative when it depends more on long-term funds

for financing needs. Under a conservative plan, the firm finances its

permanent assets and also a part of temporary current assets with long term

financing. In the periods when the firm has no need for temporary current

assets, the idle long-term funds can be invested in the tradable securities to

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 conserve liquidity. The conservative plan relies heavily on long-term

financing and, therefore, the firm has less risk of facing the problem of

shortage of funds.

(c) Aggressive approach: A firm may be aggressive in financing its assets. An

aggressive policy is said to be followed by the firm when it uses more short-

term financing than warranted by the matching plan. Under an aggressive

policy, the firm finances a part of its permanent current assets with short-term

financing. Some extremely aggressive firms may even finance a part of there

fixed assets with short-term financing. The relatively more use of short-term

financing makes the firm more risky.

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 COMPUTATION OF WORKING CAPITAL

The two components of working capital (WC) are current assets (CA) and current

liabilities (CI). They have a bearing on the cash operating cycle. In order to calculate the

working capital needs, what is required is the holding period of various types of

inventories, the credit collection period and the credit payment period. Working capital

also depends on the budgeted level of activity in terms of production/sales. The

calculation of WC is based on the assumption that the production/sales is carried on

evenly throughout the year and all costs, accrue similarly.

The steps involved in estimating the different items of CA and CI are as follows.

Estimation of Current Assets

1. Raw Materials Inventory: The investment in raw materials inventory is

estimated on the basis of:-

Budgeted cost of raw Average inventory

Production x materials(s) x holding period

(In units) per unit (Months/days)

12 months/365 days

2. Work-in-Process(W/P) Inventory: The relevant costs to determine work-in-

process inventory are the proportionate share of cost of raw materials and

conversion costs (Labour and manufacturing overhead cost excluding

depreciation). In case, full unit of raw material is required in the beginning, the

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 unit cost of work-in-process would be higher, that is cost of full unit + 50 per cent

of conversion cost, compared to the raw material requirement throughout the

production cycle: S/P is normally equivalent to 50 per cent of total cost of

production. Symbolically:

Budgeted Estimated work Average time span

Production x -in-process cost x of work-in-progress

(In units) per unit (Months/days)

12 months/365 days

3. Finished Goods Inventory: Working capital required to finance the finished

goods inventory is given by factors summed up:-

Budgeted cost of goods produced finished goods

Production x per unit (excluding x holding period

(In units) depreciation) (Months/days)

12 months/365 days

4. Debtors: The WC tied up in debtors should be estimated in relation to total cost

price (excluding depreciation) Symbolically:-

Budgeted cost of sales per average debt

Credit sales x unit excluding x collection period

(in units) depreciation (months/days)

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 12 months/365 days

5. Cash and Bank Balances: Apart from WC needs for financing inventories and

debtors, firms also procedure of determining such and amount. This would

primarily be based on the motives for holding cash balances of the business firm,

attitude of management toward risk, the access to the borrowing sources in times

of need and past experience, and so on.

Estimation of Current Liabilities:

1. Trade Creditors:

Budgeted yearly Raw material Credit period

Production x cost x allowed by creditors

(in units) per unit (months/days)

12 months/365 days

2. Direct Wages:

Budgeted yearly Direct labour Average time-lag in

Production x cost x payment of wages

(in units) per unit (months/days)

12 months/365 days

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3. Overheads (Other Than Depreciation and Amortization).

Budgeted yearly Overhead Average time-lag in

Production x cost x payment of overheads

(in units) per unit (months/days)

12 months/365 days

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FORMATE: Determination of Working Capital.

(i) Estimation of Current Asset: Amount

(a) Minimum desired cash and bank balances. …………

(b) Inventories:

Raw material …………

Work-in-process …………

Finished goods …………

(c) Debtors …………

Total Current Assets …………

(ii) Estimation of Current Liabilities:

(a) Creditors. …………

(b) Wages. …………

(c) Overheads …………

Total Current Liabilities …………

(iii) Net Working Capital(i-ii) …………

Add: margin for contingency …………

(iv) Net Working Capital Required …………

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 CASH MANAGEMENT

Introduction

Cash is the important current assets for the operation of the business. Cash is

the basic input needed to keep the business running on a continuous basis; it is

also the ultimate output expected to de realized by selling the service or product

manufactured by the firm. The firm should keep sufficient cash, neither more nor

less. Cash shortage will disrupt the firm’s manufacturing operations while

excessive cash will simply remain idle, without contributing anything towards the

firm’s profitability. Thus, a major function of the financial manager is to maintain a

sound cash position.

Facets of Cash Management

Cash management is concerned with the managing :-

 Cash planning: cash inflows and outflows should be planned to project cash

surplus or deficit for each period of the planning period. Cash budget should be

prepared for this purpose.

 Managing the cash flows: the flow of cash should be properly managed. The

cash inflows should be accelerated while, as far as possible, the cash outflows

should be decelerated.

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 Optimum cash level: the firm should decide about the appropriate level of cash

balances. The cost of excess cash and danger of cash deficiency should be

matched to determine the optimum level of cash balances.

 Investing surplus cash: the surplus cash balances should be properly invested

to earn profits. The firm should decide about the division of such cash balance

between alternative short-term investment opportunity such as bank deposits,

marketable securities, or inter-corporate lending.

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 MOTIVES FOR HOLDING CASH

The firm’s need to hold cash may be attributed to the following three motives:

 The transactions motive

 The precautionary motive

 The speculative motive

 Compensative motive

Transaction motive: The transaction motive requires a firm to hold cash to

conduct its business in the ordinary course. The firm needs cash primarily to

make payments for purchases, wages and salaries, other operating expenses,

taxes, dividends etc. the need to hold cash would not arise if there were perfect

synchronization between cash receipts and cash payments, i.e., enough cash is

received when the payment has to be made. But cash receipts and payments are

not perfectly synchronized. For those periods, when cash payment exceed cash

receipts, the firm should maintain some cash balance to be able to make

required payments. For transactions purpose, a firm may invest its cash in the

marketable securities. Usually, the firm will purchase securities whose maturity

corresponds with some anticipated payments, such as dividends, or taxes in the

future. Notice that the transactions motive mainly refers to holding cash to meet

anticipated payments whose timing is not perfectly matched with cash receipts.

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Precautionary motive: The precautionary motive is the need to hold cash to

meet contingencies in the future. It provides a cushion or buffer to withstand

some unexpected emergency. The precautionary amount of the cash depends

upon the predictability of the cash flows. If cash flows can be predicted with

accuracy, less cash will be maintained for emergency. The amount of

precautionary cash is also influenced by the firm’s ability to borrow at short notice

when need arises. Stronger the ability of the firm to borrow at short notice, lesser

will be the need for precautionary balance. The precautionary balance may be

kept in cash marketable securities. Marketable securities play an important role

here. The amount of cash set aside for precautionary reasons is not expected to

earn anything; therefore, the firm should attempt to earn some profit in it. Such

funds should be invested high-liquid and low-risk marketable securities.

Precautionary balance should, thus, be hold more in marketable securities and

relatively less in cash.

Speculative motive: The speculative motive relates to the holding of cash

for investing in profit-making opportunities as and when they arise. The

opportunity t make profit may arise when the security prices change. The firm will

hold cash, when it is expected that interest rates will rise and security prices will

fall. Securities can be purchased when the interest rate is expected to fall; the

firm will benefit by the subsequent fall in interest rates and increase in security

prices. The firm may also speculate on materials’ prices. If it is expected that

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materials’ prices will fall, the firm can postpone materials’ purchasing and make

purchases in the future when price actually falls. Some firms may hold cash for

speculative purpose. By and large, business firms do not engage in speculations.

Thus, the primary motives to hold cash and marketable securities are: the

transactions and the precautionary motives.

Compensating motive: Yet another motive to hold cash balances is to

compensate banks for providing certain services and loans.

Banks provide a variety of services to business firms, such as clearance of

cheque, supply of credit information, transfer of funds, and so on. While for some

of these services banks charge a commission or fee, for others they seek indirect

compensation. Usually clients are required to maintain a minimum balance of

cash at the banks. Since the balance cannot be utilized by the firms for

transaction purposes, the banks themselves can use the amount to earn a return.

Such balances are compensating balances.

Compensating balances are also required by some loan agreements between a

bank and its customers. During periods when the supply of credit is restricted

and interest rates are rising, banks require a borrower to maintain a minimum

balance in his account as a condition precedent to the grant of loan. This is

presumably to ‘compensate’ the bank for a rise in the interest rate during the

period when the loan will be pending.

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 CASH MANAGEMENT MODEL

Two important cash management model which lead to determination of optimum

balance of cash are:-

(1) Optimum cash balance under certainty : Baumol’s Model

(2) Optimum cash balance under uncertainty : The Miller-Orr Model

Optimum cash balance under certainty : Baumol’s Model

The Baumol’s model of cash management provides a formal approach for determining a

firm’s optimum cash balance under certainty. It considers cash management similar to

an inventory management problem. As such, the firm attempts to minimize the sum of

the cost of holding cash and the cost of converting marketable securities to cash.

The Baumol’s model makes the following assumption:-

 The firm is able to forecast its cash needs with certainty.

 The firm’s cash payments occur uniformly over the period of time.

 The opportunity cost of holding cash is known and it does not change over time.

 The firm will incur the same transaction cost whenever it converts securities to

cash.

Let us assume that the firm sells securities and starts with a cash balance of C

rupees. As the firm sped cash, its cash balance decreases steadily and reaches

to zero. The firm replenishes its cash balance to C rupees by selling marketable

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securities. This pattern continues over the time. Since the cash balance

decreases steadily, the average cash balance will be: C/2.

The firm incurs a holding cost for keeping the cash balance. It is an opportunity

cost; that is, the return forgone on the marketable securities. If the opportunity

cost is k, then the firm’s holding cost for maintaining an average cash balance is

as follows:-

Holding cost = k(C/2)

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 The firm incurs a transaction cost whenever it converts its marketable

securities to cash. Total number of transactions during the year will be total funds

requirement, T, divided by the cash balance, C, i.e. T/C. the per transaction cost

is assumed to be constant. If per transaction cost is c, then the total transaction

cost will be:-

Transaction cost = c(T/C)

The total annual cost of the demand for cash will be:

Total cost = k(C/2) + c(T/C)

The holding cost increases as demand for cash, C, increases. However, the

transaction cost reduces because with increasing C the number of transaction will

decline. Thus there is a trade-off between the holding cost and the transaction

cost .

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The optimum cash balance, C*, is obtained when the total cost is minimum. The

formula for optimum cash balance is as follows:-

C* =  2cT/k

Where,

C*= optimum cash balance,

c = cost per transaction,

T = total cash needed during the year, and

k = opportunity cost of holding cash balance.

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The optimum cash balance will increase with increase in the per transaction cost

and total funds required and decrease with the opportunity cost.

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Optimum Cash Balance under Uncertainty: The Miller-Orr Model

Miller-Orr model is a model that provides for cost-efficient transactional balances

and assumes uncertain cash flows and determines an upper limit and return

point for cash balances.

It assumes that net cash flows are normally distributed with a zero value mean

and a standard deviation. As shown in following figure, the MO model provides

for two control limits—the upper control limit and the lower control as well as a

return point. If the firm’s cash flows fluctuate randomly and hit the upper limit,

then it buys sufficient marketable securities to come back to a normal level of

cash balance (the return point). Similarly, when the firm’s cash flows wander and

hit the lower limit, it sells sufficient marketable securities to bring the cash

balance back to the normal level (the return point).

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The firm sets the lower control limit as per its requirement of maintaining

minimum cash balance. The difference between the upper limit and the lower

limit depends on the following factors:

 The transaction cost (c)

 The interest rate, (i)

 The standard deviation (𝜎) of net cash flows.

The formula for determining the distance between upper and lower control limits

(called Z) is as follows:

(Upper limit – Lower limit) = ( 3/4 * Transaction Cost * Cash Flow

Variance/Interest per day)1/3

Z = (3/4*cσ2/ i )1/3

We can notice from above equation that the upper and lower limits will be far off

from each other (i.e. Z will be larger) if transaction cost is higher or cash flows

show greater fluctuations. The limits will come closer as the interest increases. Z

is inversely related to the interest rate. It is noticeable that the upper control limit

is three times above the lower control limit and the return point lies between the

upper and the lower limits. Thus,

Upper limit = lower limit + 3Z

Return point = lower limit + Z

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The net effect is that the firms hold the average cash balance equal to:

Average Cash Balance = Lower Limit + 4/3Z

The MO model is more realistic since it allows variation in cash balance within

lower and upper limits. The financial manager can set the lower limit according to

the firm’s liquidity requirement. The past data of the cash flow behavior can be

used to determine the standard deviation of net cash flows. Once the upper and

lower limits are set, managerial attention is needed only if the cash balance

deviation from the limits. The action under these situations are anticipated and

planned in the beginning.

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 MARKETABLE SECURITIES

Meaning and characteristics:

Once the optimum level of cash balance of a firm has been determined, the

residual of its liquid assets is invested in marketable securities. Such securities

are short-term investment instruments to obtain a return on temporarily idle

funds. In other words, they are securities which can be converted into cash in a

short period of time, typically a few days. The basic characteristics of marketable

securities affect the degree of their marketability/liquidity. To be liquid, a security

must have two basic characteristics: a ready market and safety of principal.

Ready marketability minimizes the amount of time required to convert a security

into cash. A ready market should have both breadth in the sense of a large

number of participants scattered over a wide geographical area as well as depth

as determined by its ability to absorb the purchase/sale of large amounts of

securities.

The second determinant of liquidity is that there should be little or no loss in the

value of a marketable security over time. Only those securities that can be easily

converted into cash without any reduction in the principal amount qualify for

short-term investments. A firm would be better off leaving the balances in cash if

the alternative were to risk a significant reduction in principal.

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 MARKETABLE SECURITY ALTERNATIVES

Marketable security alternatives are more prominent marketable/near-cash securities

available for investment. Our concern is with money market instruments.

 Treasury bills: Treasury bills (TBs) are short-term government securities.

The usual practice in India is to sell treasury bills at a discount and redeem them

at par on maturity. The difference between the issue price and the redemption

price, adjusted for the time value of money, is return on treasury bills. They have

liquidity. Also, they do not have the default risk.

 Commercial papers: Commercial papers (CPs) are short-term, unsecured

securities issued by the highly creditworthy large companies. They are issued

with e maturity of three months to one year. CPs are marketable securities, and

therefore, liquidity is not a problem.

 Certificates of deposits: Certificates of deposits (CDs) are papers issued

by banks acknowledging fixed deposits for a specified period of time. CPs are

negotiable instruments that make them marketable securities.

 Bank deposits: A firm can deposit its temporary cash in a bank for fixed

period of time. The interest rate depends on the maturity period.

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 For example, the current interest rate for a 30 to 45 days deposit is about 3 per

cent and for 180 days to one year is about 6-7 per cent. The default risk of the

bank deposits is quite low since the government owns most banks in India.

 Inter-corporate deposit: Inter-corporate lending/borrowing or deposits is a

popular short-term investment alternative for companies in India. Generally a

cash surplus company will deposit (lend) its funds in a sister or associate

companies or with outside companies with high credit standing. In practice,

companies can negotiate inter-corporate borrowing or lending for very short

periods. The risk of default is high, but returns are quite attractive.

 Money market mutual funds: Money market mutual funds (MMMFs)

focus on short-term marketable securities such as TBs, CPs, CDs or call money.

They have a minimum lock-in period of 30 days, and after this period, an

investor can withdraw his or her money time at a short notice or even across the

counter in some cases. They offer attractive yields; yields are usually 2 per cent

above than on bank deposits of same maturity. MMMFs are of recent origin in

India, and they have become quite popular with institutional investors and some

companies.

 Repurchase agreements: These are legal contracts that involve the actual

sale of securities by borrower to the lender with a commitment on the part of the

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 former to repurchase the securities at the current price plus a stated interest

charge. The securities involved are government securities and other money

market instruments. The borrower is either a financial institution or a security

dealer.

 Bills discounting: Surplus funds may be deployed to purchase/discount

bills. Bills of exchange are drawn by seller (drawer) on the buyer (drawee) for

the value of goods delivered to him. During the tendency of the bill, if the seller is

in need of funds, he may get it discounted. On maturity, the should be presented

to the drawee for payment.

 Call market: It deals with funds borrowed/lent over night/one day (call) money

and notice money for periods up to 14 days. It enables corporate to utilize their

float money gainfully. However, the returns (call rates) are highly volatile. The

stipulations pertaining to the maintenance of cash reserve ratio (CRR) by banks

in the major determinant of the demands in the funds and is responsible for

volatility in the call rates.

36
 RECEIVABLE MANAGEMENT

INTRODUCTION

The term receivable is defined as ‘debt owed to the firm by customers arising

form sale of goods or services in the ordinary course of business’. When a firm

makes an ordinary sale of goods or services and does not receive payment, the

firm grants trade credit and creates accounts receivable which could be collected

in the future. Receivables management is also called trade credit management.

Thus, accounts receivable represent an extension of credit to customers,

allowing them a reasonable period of time in which to pay for the goods received.

Cost associated with the extension of credit:

The major categories of cost associated with the extension of the credit and

account receivables are:

1. Collection cost

2. Capital cost

3. Delinquency cost, and

4. Default cost.

Collection cost: Collection costs are administrative costs incurred in collecting the

receivables from the customers to whom credit sales have been made. Included

in this category of costs are:

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 a) Additional expenses on the creation and maintenance of a credit

department with staff, accounting records, stationary, postage and other

related items;

b) Expenses involved in acquiring credit information either through outside

specialist agencies or by the staff of the firm itself.

These expenses would not be incurred if the firm does not sell on credit.

Capital cost: The increased level of accounts receivable is an investment in

assets. They have to be financed thereby involving a cost. There is a time lag

between the sale of goods to, and payment by, the customers. The firm should

arrange for additional funds to meet its own obligations while waiting for

payments from its customers. The cost on the use of additional capital to support

credit sales, which alternatively could be profitably employed elsewhere, is,

therefore, a part of the cost of extending credit or receivables.

Delinquency cost: this cost arises out of the failure of the customers to meet

their obligations when payments on credit sales become due after the expiry of

the credit period. Such costs are called delinquency cost. The important

components of this cost are:

i. Blocking up of funds for an extended period,

ii. Cost associated with steps that have to be initiated to collect the over

dues.

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Default cost: the firm may not be able to recover the over dues because of the

inability of the customers. Such debts are treated as bad debts and have to be

written off as they cannot be realized. Such costs are known as default cost

associated with credit sales and account receivables.

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 CREDIT POLICY

The credit policy of a firm provides the frame work to determine:

a) Whether or not to extend credit to a customer and

b) How much credit to extend.

The term credit policy is used to refer to the combination of three decision

variables:

1. Credit standards,

2. Credit terms, and

3. Collection efforts

Credit standards: Credit standards are criteria to decide the type of

customers to whom goods could be sold on credit. If a firm has more slow paying

customers, its investment in accounts receivable will increase. The firm will also

be exposed to higher risk of default.

Credit terms: Credit terms specify duration of credit and terms of payment by

customers. Investment in accounts receivable will be high if customers are

allowed extended time period for making payments.

Credit terms have three components:

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 i. Credit period, in terms of the duration of time for which trade credit is

extended. During this period the over due amount must be paid by the

customers.

ii. Cash discount, if any, which the customer can take advantage of, that is,

the over due amount will be reduced by this amount.

iii. Cash discount period, which refers to the duration during which the

discount can be availed of.

Collection efforts: Collection efforts determine the actual collection period.

The lower the collection period, the lower will be the investment in accounts

receivable and vice versa.

The effort should in the beginning be polite, but, with the passage of time it

should gradually become strict. The steps usually taken are:

i. Letters, including reminders, to expedite payments;

ii. Telephone calls, for personal contacts;

iii. Personal visit;

iv. Help of collection agencies; and finally,

v. Legal action.

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 INVENTORY MANAGEMENT

MEANING AND TYPE

Inventories are stock of the product a company is manufacturing for sale and

components that make up the product. The various forms in which inventories

exist in a manufacturing company are:-

 Raw materials: Raw materials are those basic inputs that are converted

into finished product through the manufacturing process. Raw material

inventories are those units which have been purchased and stored for

future productions.

 Work-in-progress: Work-in-progress inventories are semi manufactured

products. They represent products that need more work before they

become finished products for sale.

 Finished Goods: Finished goods inventories are those completely

manufactured products which are ready for sale. Stocks of raw material

and work-in-progress facilitate production while stock of finished goods is

required for smooth marketing operations.

The levels of three kinds of inventories for a firm depend on the nature of its

business.

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NEED TO HOLD INVENTORIES

Maintaining inventories involves tying up of the company’s funds and incurrence

of storage and holding costs. If it is expensive to maintain inventories, why do

companies hold inventories? There are three general motives for holding

inventories:-

 Transaction Motive: Transaction motive emphasizes the need to

maintain inventories to facilitate smooth production and sales operation.

 Precautionary Motive: Precautionary motive necessitates holding of

inventories to guard against the risk of unpredictable changes in demand

and supply forces and other factors.

 Speculative Motive: Speculative motive influences the decision to

increase or reduce inventory levels to take advantage of price

fluctuations.

COST OF HOLDING INVENTORIES

The cost associated with the inventory fall into two basic categories:-

i. Ordering or Acquisition or Set-up costs, and

ii. Carrying costs.

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Ordering costs: This category of costs is associated with the acquisition or

ordering of inventory. Firms have to place orders with suppliers to replenish

inventory of raw materials. The expenses involved are referred to as ordering

costs. They include costs incurred in the following activities: requisitioning,

purchase ordering, transporting, receiving, inspection and storing. Ordering costs

increases in proportion to the number of order placed.

Carrying costs: Cost incurred for maintaining a given level of inventory are

called carrying costs. They include storage, insurance, taxes, deterioration and

obsolescence. Carrying costs vary with inventory size. This behavior is contrary

to that of ordering costs which decline with increase in inventory size.

The economic size of inventory would thus depend on trade-off between carrying

costs and ordering costs.

OBJECTIVE OF INVENTORY MANAGEMENT

In the context of inventory management, the firm is faced with the problem of

meeting two conflicting needs:

 To maintain a large size of inventories of raw material and work-in-

progress for efficient and smooth production and of finished goods for

uninterrupted sales operations.

 To maintain a minimum investment in inventories to maximize profitability.

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Both excessive and inadequate inventories are not desirable. These are two

danger points within which the firm should avoid. The objective of inventory

management should be to determine and maintain optimum level of inventory

investment.

The major dangers of over investment in inventories are:

a. Unnecessary tie-up of the firm’s funds and loss of profit,

b. Excessive carrying costs, and

c. Risk of liquidity.

The excessive level of inventories consumes funds of the firm, which can not be

used for any other purpose, and thus, it involves an opportunity cost.

Maintaining an inadequate level of inventories is also dangerous. The

consequences of under investment in inventories are:

a. Production hold-ups and

b. Failure to meet delivery commitments.

The aim of inventory management, thus, should be to avoid excessive and

inadequate levels of inventories and to maintain sufficient inventory for the

smooth production and sales operation. An effective inventory management

should:

45
  Ensure a continuous supply of raw materials to facilitate uninterrupted

production.

 Maintain sufficient stocks of raw materials in periods of short supply and

anticipate price changes.

 Maintain sufficient finished goods inventory for smooth sales operation,

and efficient customer service.

 Minimize the carrying cost and time, and

 Control investment in inventories and keep it at an optimum level.

DETERMINATION OF STOCK LEVELS

Various stock levels are discussed as such:

1. Minimum level (safety stock): This represents the quantity of stock that

should be held at the time, stock level is normally not allowed facing below

this level. This level of stock is a buffer stock for use during emergencies.

Fall in stock level below minimum level will indicate potential danger to the

business.

2. Re-ordering level: When the quantity of materials reaches at a certain

figure then fresh order is sent to get material again. The order is sent

before the materials reach minimum stock level. The rate of ordering level

is fixed between minimum level and maximum level. Reordering level is

fixed with the following formula:

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Reordering level = Maximum consumption × maximum reorder period

3. Maximum level: It is the quantity of materials beyond which a firm should

not exceed its stock. If the quantity exceeds maximum level then it will be

over stocking. Over stocking will means blocking of more working capital,

more space of storing the materials, more wastage of material and more

chances of losses from obsolescence. The following formula may be used

for calculating maximum stock level:

Maximum stock level = re-ordering level + reordering quantity – (minimum

consumption × minimum reorder period )

4. Danger level: it is the level beyond which materials should not fall in any

case. If the danger level arises then immediate step should be taken to

replenish the stock even if more cost is incurred in arranging the materials.

If materials are not arranged immediately there is a possibility of stoppage

of work. Danger level is determined with the following formula:

Danger level = average consumption × maximum reordering period for

emergency purchase

5. Average Stock level: The average stock level is calculated as such:

Average stock level = minimum stock level + ½ of reordering quantity

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INVENTORY MANAGEMENT TECHNIQUES

1) A B C Inventory control system: A B C Inventory control system is an

inventory management technique that divides inventory into three

categories of descending importance based on the rupee investment in

each on the basis of the cost involved, the various inventory items are,

according to the system categorized into three classes - A, B and C.

The high value items are classified as ‘A item’ and would be under the

tightest control. ‘C items’ represents relatively least value and would be

under simple control. ‘B items’ fall in between these two categories and

require reasonable attention of management.

2) Just-in-time (JIT) Systems: Japanese firms popularized the Just-in-time

system in the word. In the JIT system material or the manufactured

components and parts arrive to the manufacturing sites or stores just few

hours before they are put to use. The delivery of material is synchronized

with the manufacturing cycle and speed; this eliminates the necessity of

carrying large inventories, thus, saves carrying and other manufacturing

costs.

3) Out-Sourcing: A few years ago there was a tendency to manufacture all

the parts of components in house, but now companies are adopting the

practice of out sourcing. It is a system of buying parts and components

from out side rather than manufacturing internally for example Tata Motors

48
 developed number of units around its manufacturing sites that supply

parts and components to its manufacturing units.

4) Computerized Inventory Control system: Now days this system is

adopted by every firm, large or small for controlling inventories. This

system enables a company to easily track large items of inventories. It is

an automatic system of counting inventories, recording withdrawals and

revising the balance. There is an inbuilt system of placing order as the

computer notices that the re-order point has been reached.

5) Economic order quantity (EOQ) analysis: EOQ is the inventory

management technique for determining optimum order quantity which is

the one that minimize the total of its order and carrying cost. It balances

fixed ordering cost against variable ordering cost.

EOQ can be calculated with the following formula-

EOQ = 2 × quantity required × ordering cost

Carrying costs

49
 OBJECTIVES OF THE STUDY

This training as per scheduled under syllabi has been emphasis on getting aware with

the practical environment of an organization and specifically with the concerned

department related to the specialization. There are certain objectives stated as under:

1 To integrate theoretical knowledge with practical orientation through assignments.

2 To get aware with the procedure of financial department.

3 To know how the functions passes through other departments in relation to

financial departments.

4 To become familiar with the formats of different documents and their meaning.

5 To know each departments decision effect on finance department and vice-versa.

6 To coincide each functioning with the accounting perspective.

7 Try to generate new ways of performing a task.

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8 To differentiate the practical task from theoretical knowledge.

9 To know organizational structure and specifically financial department.

10 To get habitual with the stressful working condition.

51
 Research Methodology

Research Problem: In every step of life resources are always scarce. In the same

way, Business organizations are also facing such type of problems. In this respect every

organization wishes to use available resources in an optimum manner. This study refers

to the all aspects of current assets, namely cash, marketable securities, debtors and

stock and current liabilities.

Research Objective: To study the process of Working Capital Management with

main emphasis on the technique which is used in I.T.I, Raibareilly.

Research Design: Descriptive Research

Type of Research: Analytical

Data Collection Methods: Secondary

52
 SWOT ANALYSIS

STRENGTH :

1) I.T.I. is headed by an excellent and extra ordinary chairman, who is most capable of

managing the organization by getting the work load from Indian Air Force, Navy,

Army and Coast Guard for its financial growth and management.

2) The technological know how are very confidential and have the best – suited for

making and overhauling the Defense Aircraft that is incomparable with any

technologies.

3) I.T.I. is a very good pay-master to its employees as it is very much financially healthy

due to its existence under Ministry of Defense.

4) The monitoring of the Finance and the manufacturing and delivery of Aircraft to the

customers timely for the best use of the same.

5) The reputation of I.T.I. being the Defense organization has its importance and

technically and financially renowned among PSUs (Public Sector undertakings) as

Navratna and carries ISO: 14001 company .Quality in the world/Internal Business

Organization.

53
WEAKNESSES:

1) IAF is fully satisfied with the performance of I.T.I. so far as the following of licenses

Technical know-how are concerned, but due to recent Air crashes of MIG Aircraft

and few other Aircrafts there are few problems which are minor.]

2) Sometimes the foreign vendors on whom I.T.I. depends for procuring raw materials

for projects are not in a position to deliver the same in time this causes financial

loses to I.T.I. by paying liquidated damages to IAF / Customers.

3) Sometimes I.T.I. use to make payment to suppliers as advance for procurement of

raw-material because there are some parties who cannot supply without advance

payment due to their financial problems.

4) Sometimes I.T.I. does not get the approval from IAF against the items appeared in

FPQ (Fixed Price Quotation) at the rate prevalent in the International market with

then approved suppliers. Escalation percentage in respect of the items where it is

much more than permissible limit can put to loss to the extent it is more.

5) Machineries required from Foreign vendor take abnormal time leading to-delay in the

normal manufacturing function, hence now I.T.I. wants get similar type of

machineries if approved by the customers.

54
OPPORTUNITIES:

1) I.T.I. is the only manufacturer of the Defense Aircrafts; hence the job opportunities

as well as profit earning opportunities are more to day and in the forthcoming years.

2) Promotion opportunities are in-vogue to all the professionals including technical and

non-technical areas Departments.

3) As I.T.I. has monopoly in the manufacturing and overhauling of aircraft, so it can

explore all the advantages related to this field.

4) As I.T.I. has developed its own R & D centers so now it would not have to depend on

Russia for Technical know-how.

THREATS:

1) I.T.I. has fear to terrorist as it is a defense organization producing fighter aircrafts.

2) Though I.T.I. is manufacturing fighter Aircrafts in confidence and getting the same

inspected by the authorized officials of Air force. There is a fear that during testing

there should not be any unwanted happening / rejections of Aircrafts which may

cause the losses.

3) During war, I.T.I. has its fear of attack by enemy – countries as I.T.I. is very famous

for a very good supporting organization with arms / fighter aircraft.

4) Threatening is given by many agencies / users that the materials modules / parts /

equipment are not be touched by any country’s ship or otherwise. In case any

project is given by false that the above, materials / modules / part have been

touched by any ship during importing then the user suspect on unnecessarily.

55
 CONCLUSION

The topic undertaken for study was too wide to be studied in detail & in all

aspects. Duration of the summer training was limited and the sample size was restricted

to accessories division Raibareli only. The data so collected to write this report is the

result of direct personal accounts department. This study not only makes me familiar

with big organization like I.T.I., but also provided me the practical view that how the

financial functions and theories are applicable in an organization.

I.T.I. is listed among top ten public sector units which are running in profit. Its

main customer is IAF; its other customers are ADA and other civil customers, Navy, Air

Force and Coast Guard etc.

All sections of Finance & Accounts department functioning separately but in a

coordinated manner. Their functioning depends on each other. One section provides

data as an input to other section, the section processes it and gets output in this manner

these sections are interdependent.

Budget and budgetary control system is a wide area to cover. The method of

budgeting is differs from industry to industry on the basis of requirements. In I.T.I.

budgeting system, the period considered for budgeting is the financial year from April to

March. It lays a comprehensive plan of action expressed plan of action expressed in

financial and physical terms. It acts as a tool in the hands of management to establish

goals, objects and target of the company. It ensures the overall control over the

expenditure as all the expenditures are sanctioned in the budget.

56
 It is ensured that working capital facility is made available in time to suit

production requirement. Estimates and expenditures are presented physical and

financial aspects. Approval of Board is required to break the budget into monthly budget

to ensure uniform production from month to month. In the context of I.T.I., budgeting

system that is prevailing can be said to be an effective one of the organization.

57
 BIBLIOGRAPHY

 I.M. Pandey: Financial Management, 4th edition Tata McGraw-Hill Publishing

Company Limited, New Delhi (2004).

 V.K. BI.T.I.l: “Working Capital Management”, 5th edition Anmol Publication New

Delhi (2003).

 Prasanna Chandra: Financial Management Theory and Practice, 6 th edition Tata

McGraw-Hill Publishing Company Limited, New Delhi (2004).

 Khan and Jain: Financial management, 4th edition Tata McGraw-Hill Publishing

Company Limited, New Delhi (2004).

 Annual Report of I.T.I. Raibareli.

 Financial websites :-

 www.I.T.I.-india.com

 www.hindubusiness.com

 www.mag-india.com

 www.domail-b.com

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