completed project aji

A STUDY ON WORKING CAPITAL MANAGEMENT IN KERAFED LTD

INTRODUCTION

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

Fixed capital

Working capital

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

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

through purchase of fixed assets such as plant and machinery, land, building,

furniture, etc. Investments in these assets represent that part of firm’s capital which is

blocked on permanent or fixed basis and is called fixed capital. Funds are also needed

for short term purposes for the purposes of raw material, payment of wages and other

day to day expenses etc.

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

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

current assets such as cash, marketable securities, debtors & inventories. Funds, thus,

invested in current assets keep revolving fast and are being constantly converted in to

cash and this cash flow out again in exchange for other current assets. Hence, it is also

known as revolving or circulating capital or short term capital.

Concept of Working Capital

There are two concept of working capital:

Gross working capital

Net working capital

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

enterprise current assets are those assets which can convert in to cash within a

short period normally one accounting year.

CHMM College Chavarcode


Constituents of Current Assets

Cash in hand and cash at bank.

Bills receivable

Sundry debtors

Short term loans and advances

Inventories and stock as:

o Raw material

o Work in progress

o Stores and spares

o Finished goods

o Temporary investment of surplus fund

o Prepaid expenses

o Accrued incomes

o Marketable securities

In narrow sense, the term working capital refers to the net working

capital. Net working capital is the excess of current assets over liability, or, say:

NET WORKING CAPITAL = CURRENT ASSETS – CURRENT

LIABILITY

Net working capital can be positive or negative. When the current assets

exceeds the current liabilities are more than the current assets. Current

liabilities are those liabilities, which are intended to be paid in the ordinary



course of business within a short period of normally one accounting year out of

the current assets or the income business

Constituents of Current Liability

Accrued or outstanding expenses

Short term loans, advances and deposits

Dividend payable

Bank overdraft

Provision for taxation, if it does not amt. to app. Of profit

Bills payable

Sundry creditors

The gross working capital concept is financial or going concern concept

where as net working capital is accounting concepts have their own merits.

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

the following reasons:

It enables the enterprise to provide correct amount of working capital

at the correct time.

Every management is more interested in total current assets with

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

available.



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

enterprise would increase its working capital.

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

investments in working capital concepts, however, is also important

for following reasons:

1. It is qualitative concept, which indicates the firm’s ability

to meet its operating expenses.

2. It indicates the margin of production available to the short

term creditors.

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

4. It suggests the need of financing a part of working capital

requirement out of the permanent sources of funds.

Classification of Working Capital

Working capital may be classified in two ways:

On the basis of concept

On the basis of time

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

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

classified as:

Permanent or fixed working capital



Temporary or variable working capital



Permanent or Fixed Working Capital

Permanent or fixed working capital is minimum amount which is required to

ensure effective utilization of fixed facilities and for maintaining the circulation of

current assets. Every firm has to maintain a minimum level of raw material, work in

process, finished goods and cash balance. This minimum level of current assets is

called permanent or fixed working capital as this part of working is permanently

blocked in current assets. As the business grow the requirements of working capital

also increases due to increase in current assets.

Temporary or Variable Working Capital

Temporary or variable working capital is the amount of working capital which

is required to meet the seasonal demand and some special exigencies. Variable

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

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

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

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

for conducting research, etc.

Temporary working capital differs from permanent working capital in the sense

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

business.



RESEARCH METHODOLOGY

Research Design

A research work will be successful, only with a sound research design. The

research design for the purpose of the study is analytical in nature.

The major purpose of analytical research is to analyze the state affaires as it

exists at present. Analytical research includes survey and in depth plan calls for

gathering primary and secondary data.

Methods of Data Collection

In this research the collection of data is from various sources and they are two

types.

1. Primary data

2. Secondary data

Primary data:

Primary data collection was mainly done through direct interview and

telephone contacts.

Secondary data:

Secondary data was collected from company records, internet and books.

Nature of Data

Information for this work has been collected from previous records viz profit

and loss and balance sheet of the past five years. Both primary and secondary data

have been used for the study.

Tools of Data Analysis



Tools used for the purpose of the study are ratio analysis and statement of

changes in working capital. The tables and charts are used for the purpose of the

analysis and interpretation. To define any research problem and give a suitable

solution for the problem, a sound research plan is inevitable. Research methodology

underlines the various steps involved by the researcher in systematically solving the

problem with the objective of determining various facts.

Presentation of Data

Tables and charts are used to present the data.

Limitations



PROFILE

Industrial Profile

Coconut palm is one of the most valuable plant to man. In sanskrit the cocunut palm

is called ‘kalpa vriksha’ which regularly translatted means ‘free of life ’ in India. It provides

livelihood to about 10million people through various activities from its cultivation to

processing for product all the parts of cocunut tree can be put to useful purpose.The root, the

trunk,the wood,leaves the blossom and all the parts of the nut.

Two major classes of coconut palm are typically reorganised on the basis of stature

tall and dwarf. The ones most commonly planted for commercial are the tall varieties,which

are slow to meture and first flower six to ten years after planting. They produse medium to

ten years after planting. They produce medium to large size nuts and have life span of sixty to

seventy years. The dwarf variety may have orginated mutation of tall types. The dwarf

variety may grow to a height of 250to 35 and begin flowers after three years when they are

only about three feet tall. Their life span is only about 30years. India is the largest third

coconut producing country in the world.

Country Production

Indonesia 16300000

Philippians 14500000

India 9500000

Brazil 3303830

Srilanka 1950000

Thailand 1500000

Mexico 959000

Vietnam 940000

Malaysia 710000



Coconut Industry In India

Coconut palm are grown widely in the coastal tracks at the country. The coconut

economy at India is in a convenient status. India accounts for 22.34% of the world’s coconut

production and is one of the major players in the world’s coconut trade currently the crop is

grown in 1.91million hectors with an annual production of nearly 13000 million nuts. Copra

processing, coconut oil extraction and coir manufacturing are the traditional coconut based

industries in the country.

The price of coconut in the country is depend on the prevailing price at coconut oil

which is charaterised by recurring violent flactuactions,The behaviour of coconut oil price

relatively depend on overall supply of oils and facts in the country.the flactvation in the price

of coconut oil simotaniousily reflects on the price of coconut . The voletile price situation

ends in the negligence of coconut grands,leading to atttacts of pests and dieseases and low

prodativity of the of ways ,promating cost effecctive farming system. Product diversification

and valu addition play crucial role in the stabilisation of the coconut oil driven domest

market and it’s essential for re orinting and engineering the Indian coconut industry cost

effective and globally competative.

Coconut development has been playingvital role in promoting viable concerd

ccoconut based farming system, on farm processing and product devolopment.The production

and marketing of value added product have started attracting commecial interest and the

sitivation bought rejointation in the sector. The market promotional measures undertaken.

The market promotional measures undertaken in per suit of the popularization of health

benefit of coconut and tender coconut oil water have attributed a stimulating effect in less

dependency of coconut oil driven coconut economy. There has been a well defined network

in the country to undertake R&D of coconut. The state agriculture universities, CAR

institutes, agricultural horticultural department of state.Organisations likes NAFED,

KERAFED etc... And private institutions contribute to the pursuit of the research and

development process of coconut in the country



Strength of Indian Coconut Industry

One of the leading coconut producers of the world.( 13 billons nut per annum)

Coconut area distributed in it state and three union territories under different agro

climatic condition

3000 years tertian in coconut cultivation

Premier coir manufacturing country in the world

Producer of best grade milling copra in the world yielding high grade coconut oil non

for it’s aroma and flavors.

Large number of farmers’ co operative societies in primary processing and marketing.

Government agencies such as KERAFED, state trading corporation, Kerala state

marketing federation and Karnataka state marketing federation in manufacturing of

branded coconut oil in small packs.

Wide range of coconut products both edible and non edible available for export.

Technical known how and trained manpower for the manufacture of various coconut

based products.

Good number of cultivars having specific not characteristics.

Ava liability of research supports by reputed research organization such CSIR, ICAR,

DRDO.

Coconut Products of India

A large no: of coconut products are manufactured in I the country which have both

domestic and export market

Vinegar and soft drinks are manufactured in the country from coconut water is

another product which is manufactured and marketed successfully



Coconut Product

1. Tender coconut water

2. COPRA

3. Coconut oil

4. Coconut cake

5. Coconut toddy

6. Coconut shell based product

7. Coconut wood based product

Coconut Oil

Coconut oil makes up about 20% of all vegetable oil used in the world. Copra, the

dried kernel is the chief commercial product from coconut which is mainly used for oil

extraction. Coconut oil is made from fully dried copra having maximum moisture content at

6% for extraction of oil from copra The common method still prevailing in our country is

done through by using rotary chucks. But the efficient system of extraction of oil is by the use

of expellers.

Coconut oil is an important cooking medium in southern parts of the country

especially in Kerala state. Besides the oil has varied industrial application. It is used in

manufacture of toilet soaps, laundry soaps, surface active detergent, hair tonics, cosmetics

etc.It is used throughout the country as hair oil as it helps growth of hair. its massage oil it

has cooling effect on the body. Owing to these qualities coconut oil has potential market in

the country. Since the price of coconut oil in the international market is very much lower than

the domestic price. The quality and attractiveness of consumers packs are important factor to

complicate in the world market. While the demand for coconut oil for cooking purpose is

elastic. It as hair oil is inelastic.

Coconut oil is marketed in bulk as well as in packs ranging from sachets containing

5ml to 15kg tins. The branded coconut oil in small packs is mainly marketed as hair and body

oils. There Aare several brands known for their superior grade oil which has export market

throughout the world.india has unbeatable quality advantage in this sector. Refined coconut



oil is also manufactured in the country for industrial uses. Refined coconut oil is mainly used

in the manufacture of biscuits, chocolates and other confectionary items , ice creams,

pharmaceuticals products and vastly paints. Generally, filtred coconut oil is used for cooking

and toiletry purposes.

Virgin Coconut Oil

Virgin coconut oil is also made in the country from the milk extrcteded from raw

kernel this is done on a small scale by traditional method which is now partially mechanized

or on a large scale by adopting you processing technology. Coconut milk is terminated and

then by mechanical process, water is separated from oil with no heating or no application at

sunlight or drier is done for the process. The virgin coconut oil is free from trans fatty acid,

high in medium chain fats[MCFA] known as larvic acid, which is identical to special group at

fats found human breast milk and also rich in vitamin E. High quality of this oil makes its

idle, massage oil for babies and also for skin and hair application

Applications

cooking

Coconut oil is widely used in cooking, the refined oil is one of most commonly used.

Manufacturing:-

Coconut oil is used in volume quantities for making soap & cosmetics

Hydrogenated coconut oil is used in non-creamers and snack food

Fractionated coconut oil is used in manufacture of essences, massage oil &

Cosmetics

Coconut oil is an important component of many industrial lubricant for example in the

cold rolling of steel strip

Cosmetics and skin treatments:-

Coconut oil is an excellent moistures and softener. Coconut oil is used for styling

hair, cooling or smoothening the head, using as a fuel.

Traditional use:-

Coconut oil is used in oil lamps

In diesel engines:-



Coconut oil has been tested for use as a feed stock for biodiesel to be used as a diesel

engine fuel. In this manner it can be applied to power generators and transport using

diesel engines.

Raw coconut oil can be used as a fuel for generating electricity by remote

communities that have an abundant supply of coconut and milling capacity, provided

diesel engines are adopted

Coconut oil is currently used as a fuel for transport in Philippians

Health effects:-

Studies have founded that coconut oil can be help in weight loss and poison recovery

Antimicrobial effect

Coconut oil is used in the treatment of fungal infections

Coconut oil-unique Healthy:-

Coconut oil find extensive use in food, toiletary and industrial sector because of its

unique characteristics. The numerous qualities of coconut oil reported are:-

Oil of natural origin

Edible in raw form

Saturated and stable

Pleasing flavor

Light color

Pleasant aroma

Biodegradable

High resistance to oxidative rancidity

Sharp melting behavior

Narrow temperature range of melting

Skin friendly oil

Effective heat transfer agent in frying

Better shelf life of fried product

Ideal for deep frying

Idle confectionary fat

Provides moisture barrier and imparts high gloss

For bakery items in spray oil use

Low viscosity

Superior baby oil

Oldest and most widely used cosmetic raw material



Maximum guideline content

Easily saponifiable even in cold

Good emollient on on skin ,skull hair

Gives softness suppleness to skin in regular massaging

Spreads easily on the skin when used as massage oil

Excellent base for hair oil

Provides gloss to hair

Germicidal to antimicrobial property

Lower evaporative loss of water from skin

Protects skin from heat

Ready penetration in to the skin and appreciable water absorbing

property

Imparts headiness and lathering property to soap

Illuminant & lubricant

Does not leave asoky flame if used in open lamp

Blends well with other oil

Potential fatty raw material in chemical industry

Due to its biodegradable nature

Excellent fat source in preparation of filled milk and infant food

formula

Essential for the manufacture of toilet soaps, shaving cream etc

No harmful effect due to reheating

Can be converted into diesel fuel

Essential ingredient in ghee substitutes.

Nutritional/Medicinal

Easy digestibility and absorbability

Idle energy source in baby food

Contains vitamin E

Composed mainly for short &medium chain fatty acid which have

desirable qualities and functions.

Does not contain cholesterol

Reduce fat accumulation in body



Easily oxidized and therefore preferred energy source

Requires no transport system to absorbs, digest and metabolize

Very low content at omega 6 fatty acid

Studies undertaken by the biochemistry department, university of

Kerala showed that coconut oil:-

Does not evaluate blood cholesterol

Increases blood HDL cholesterol

Consumed along with coconut carnal lowers the blood cholesterol

Copra

Copra is the dried meat, or karnel, of the coconut. Copra making can be defined as

systematic process through which the fresh meat coconut 50 to 55% moisture is dried in sun

or other source to bring down the moisture content to 5 to 6% only.

Eleven to twelve month old nut reutilized for copra making to option the optimum

output of the better quality copra. The nuts are first husked to remove the fiber cotter layer of

the husk. The husked nuts are then split in to half and water is drained off. These splinted

nuts are then kept for half an hour with the open side turned down to ensure that the entire

water is drained off. If this is not done, some moisture will be retained which will in turn

leads to deterioration of copra. The half or cops ready for drying which should invariably

start with in 4 hours after breaking.

Two types of copra namely milling and edible are made in India. Milling copra is

used to extract oil while edible grade of copra is consumed as a dry fruit and used for

religious purpose. Milling copra is generally manufactured by adopting sun drying and

artificial means substantial Modern hot air drier resulting in the availability of superior

quality copra which is required for the manufacture of best grade coconut oil. A good number

of farmers co-operative societies are also involved in the manufacture and marketing a of

milling copra. Milling copra is available in different grades of edible copra are available in

the market according to the size and color etc. Quality of copra is determined based on

moisture content and extent of interior type of copra

Interior types of copra are generally:-

1. Mould effect



2. Immature or robbery copra made from immature nut

3. Insect attacked copra

4. Discolored copra

Good quality copra in which contain not more than 6% moisture.

Coconut oil is obtained by crushing copra; most efficient method of extraction is by expeller.

Table no :

Various methods Of oil

Chucks

Rotary mills

Expellers

50% - 60%

62% - 63%

63% - 65%

Coconut Cake

Coconut cake is the residue left after the extraction of oil from copra which is mainly

used as a cattle feed. Coconut cakes contain 4-5% oil which is extracted by solvent extraction

process. This oil is generally used for industrial purpose and de-oiled cake is used to make

mixed cattle feed. These few such units in the country especially in Kerala

NAFED

National Agricultural co-operative marketing federation, which was organized in

1958, represents the entire marketing structure at the national level. It was established with

the object of the members in agricultural and other commodities

There main Objective are

To make arrangements for the supply of agricultural requirement of its members.

To render advice and technical guidance to its members



The main aim of NAFED is to assisting the marketing of co-operatives in the state to

develop their marketing business. In order to achieve this NAFED adopt various

strategies with a view to ensure better return to farmers, it undertake price support

operation butter stocking, export and import of commodities etc to balance production

with consumption. When the government of India formulates policies for support price in

respect of certain commodities it appoints NAFED as its agency for procurement.

C0c0nut day (2nd September)

September 2nd of every year has been designated as coconut day as per the decision of

Asian &pacific coconut community headquarters’ of Jakarta Indonesia. Foundation day

of APCC also fall on 2nd September. Major coconut growing countries including India are

the members of the APCC

History

KERAFED was constituted by the Government of Kerala in 1987 with the confide

object of arranging to procure the produce of coconut farmers to regulate marketing operation

of the product to retrieve the segment of price crunch they were confronting at large. A

production unit relating to the sector was brought into operation in 1991 to crush and market

copra procured from the farmers at remuneration price to relive the section of price crunch

and also to cater the edible oil requirement of the society by maintain high quality standards.

Company Profile

Kerala kerakashaka sahakarana federation Ltd. (KERAFED) was registered under

the cooperative society’s act 1987, withassistance of European Economic Community.

National cooperative development cooperation and the government of Kerala. KERAFED is

apex cooperative federation of coconut farmers in Kerala and is the largest producer of

coconut oil in India. The federation started commercial production in 1993. The head office

of KERAFED is located in Thiruvananthapuram. KERAFED coconut oil complex at

karunagapally in kollam district is one of the biggest such unit in India, with a capacity of

200 tons per day.



The primary objective of KERAFED is to organize coconut growers by bringing them

under the co operative umbrella and to provide them with all supplies and services to

augment their income base by increasing productivity and value additions through the

integration system of production achievement, storage, processing, processing, diversification

and marketing of coconut oil and all any product of coconut palm at a price remunerative to

grosses and fair to consumers

As the farmers in Kerala were relying under the strange hold of powerful country

trade costels that consistently market conditions and dedicate price. Tend to their advantages

KERAFED aimed at 50% to 60% of the total coconut/copra product in the state which will be

processed on its own processing unit and marketed.

KERAFED is the single largest producers of coconut /copra produced in Kerala from 900

societies all over the state. KERAFED has a good distribution consisting of stockiest, dealers

and suppliers

For over 29 lakh coconut farmers in the state, KERAFED has been a beacon although,

affecting them attractive support prices fair coconut and copra during unfavorable market

conditions, processing copra under the price support scheme on behalf of NAFED,

government of India and rendering value added services to enhance their earning through

improved productivity and by assisting them in production and procurement. Apart from this,

the federation organizes periodic extension activities to help farmers, like demonstration

form, training camps, literature on coconut farming.

Also KERAFED reimburses the expenses for establishing copra drive s, through the

member of the federation namely primary agricultural co-operation credit society.



SL.N

O

Members of the federation Numbers

1. Government of Kerala 1

2. Kerala state co-operative agriculture 1

3. Kerala state co-operative agriculture development bank

Ltd.

1

4. District co-operative bank Ltd. 9

5. Primary co-operative bank agriculture 25

6. Primary agriculture co-operative bank credit society 898

Total

935 no.

The Objective of KERAFED

To reduce edible oil import

To provide an impulse effect ion internal production

To develop the agricultural potential of Kerala state

To strengthen the cooperative movement

To secure the marketing of coconut of coconut and its byproduct,

There by assuring income price to growers

To establish and manage infrastructure facility’s for production and supply at input

and process manufacturing and marketing of product and by product of coconut palm

To undertake research and development activities on product, processing and

marketing

Thus to increases the income of 29 lakh farmers’ families and create employment

opportunities on industrial sector



For effectively and efficiently carrying out the administrative and operational

practices on day to day basis, the state is dividing in to three regions southern region,nortern

of revenue district Trivandrum, kollam, kottayam,idukki,ernakulam,thrissur,palakkad district.

300 primary agricultural credit cooperative societies in such region are member of the

federation to undertake production, procurement and marketing actives at farmer’s level. For

processing and product diversification each region has one processing plant with a capital

200 tone of copra per day.

Copra Procurement Or Raw Material Collection Process Of KERAFED:

Coconut farmers or coconut growers

Primary agricultural cooperative societies

Mobile team of kerafed

Processing plant or god own

Coconut farmers deposit their product with respective primary agricultural co –

operative societies and collect the copra at the rate prevailing in the market on that particular

day. Primary agricultural co-operative society on their part checks the quality of copra and in

terms the kerafed about the procurement details. T he respective mobile team officer visit the



society and collect the same after checking the quality transaction details. This is transferred

to the plant for processing.

Objectives Of Kerafed:-

To reduce edible oil imports.

To provide an impulse effect on internal production of coconut.

To develop the agricultural potential of Kerala state

To strengthen the co-operative movement.

To secure the marketing of coconut and it’s by products, there by assuring economic

price to the growers.

To establish and manage infra structural for production and supply of input and

processing manufacturing and marketing of products and by products of coconut

palm

To undertake research and development activities on production ,[processing and

marketing,

Thus to increase the income of 29 lakh farmers families and create employments

opportunities is the industrial sector.

For effectively and efficiently carry may out the administrative and operational practices

on a day to day basis, the stage is divided into three region consist of the region ,the northern

region and centre region .the southern consist of the revenue districts.Thiruvanathapuram,

kollam, pathanamthitta and alappuzha, the northern region consist of malapuram, Kozhikode,

wayanad, kannur and kasargode district and the central region of kottayam,,

idukki,ernakulam, thrissur,palakkad districts. 300 primary agricultural credit co-operative

societies in each region are members of the federation to undertake production, procurement,

marketing activities at the farmers level .for processing and product diversification, each

region will have one processing plant with a capacity 200 tons per day.



REVIEW OF LITERATURE

Meaning of Working Capital



Working capital refers to the excess of current assets over current liabilities.

The manager of working capital is, therefore, concerned with the problems that arise

in administering of both current assets and current liabilities. In other words, working

capital management involves deciding up on the amount and composition of current

assets and how to finance these assets.

Forecasting/Determining/ Working Capital Requirements

The estimation of working capital requirements is not an easy task. Before

starting this exercise, a large number of factors are to be considered. The study of

operating cycle is one among them. It is the circular flow of cash to suppliers, to

accounts receivables and then to cash. The concept of operating cycle has the

following two important aspects:

a) The number of conversion of cash, and

b) The length of time required to complete each stage. Both these aspects

help in determining working capital requirements of a concern.

Operating cycle is a continuous process. However, the number of stages in an

operating cycle of a concern depends on the nature of its business. Thus the operating

cycle in a manufacturing concern involves the following stages

Operating cycle of a Manufacturing Concern.

CHMM College Chavarcode Debtors (5)

Sales (4)


1. Purchase of raw materials and warehousing.2. Work-in-process (manufacturing activities).3. Warehousing of finished goods before sale.4. Sales activities5. Debtors

The numbers of stages of operating cycle involved in a trading concern are as follows:

Sources of Working Capital

The working capital requirements of a concern are brought into two categories.

They are: (a) permanent or fixed capital requirements and (b) temporary or variable

working capital requirements.

The fixed proportion of working capital should be generally financed from the

long-term sources while the temporary or variable working capital requirements of a

concern may be met from the short-term sources.


Finished goods (3)

Finished Goods (1)

Sales (2)Cash

Debtors (3)


The various long-term sources for financing of working capital requirements

are as follows:

a. Equity capital

b. Debentures and preference shares

c. Long-term loans

The following are the various short-term sources for financing of working

capital requirements:

i) Trade credit (sundry creditors, bills payable)

ii) Bank overdraft

iii) Current provisions (such as provision for taxation)

iv) Short term loans from sources other than banks (such as loans from

directors, partners, employees, wages and salaries outstanding, income

received but not earned or advance payment from customers).

In India, the major portion of working capital finance is provided by

commercial banks and trade creditors. But in the case of public enterprise, in spite of

Government’s directives that they have to meet cent per cent of their working capital

needs by the cash credit arrangements with the banks (exclusively with SBI and

subsidiaries), a major portion of their working capital requirements is met by internal

sources (including depreciation reserves) and diversion of capital funds. Of late, there

has been emphasis on using long term sources to finance working capital requirements

(tendon Committee Report). Now-a-days, companies are issuing debentures (both

convertible and non-convertible) to meet their working capital needs. Moreover, in

order to make non-convertible debentures has been reduced from ‘12’ years to ‘7’

years and the ceiling rate of interest has been raised to 15%.

Financing of Working capital



The working capital financing policy of a firm is mainly concerned with the

determination of a suitable mix between the long-term sources and short-term sources

of finance. Usually this mix is guided by:

a. The tradeoff between risk and profitability and

b. The costs of alternative combinations of short term and long term

sources.

Moreover, on the basis of risk, profitability and cost, a firm should have

different working capital financing policies. But an ideal policy should be such which

is least costly, least risky and most profitable. However, as the ideal policy cannot be

practiced in real market situations, the task of management is to strike a happy balance

among these three variables, viz., risks, profitability and cost. For this purpose, the

following guidelines are available:

(a) The firm can use only long-term finance. It is the most costly in terms of

interest rates and most conservative policy in terms of certainty of

availability of funds.

(b) The firm can use only short-term finance. It is the least costly in the

short-run, the most profitable and most risky of available of funds.

A choice of suitable financing strategy between these two extremes is

influenced by the following factors:

i) The Approval of creditors and capital Market: This approval is

reflected in the actual ratios of the two sources in financial statement of

firms in industry, in general.

ii) The Condition of Money and Capital Markets: When the market in

long term sources of finance is in depressed condition, there is no

choice, but to raise funds from short term sources.

iii) The Composition of Current Assets: In case a firm has quickly

convertible non-cash current assets, it may rely more up on short-term



sources than upon long-term sources. Retailers of food articles, transport

undertakings, hotels, etc., are examples of such firms.

iv) Recent Use of Sources: In case a firm has incurred heavy capital

expenditure financed by long-term sources in the recent past, then such a

firm has no other choice than to finance increases in current assets by

short-term borrowings and vice-versa.

v) Management Attitude towards Risk Associated with a Source of

Finance: The attitude of management on raising funds long term and

short term sources are important while taking decisions on financing

working capital requirements. This attitude is formed by taking into

account, cash inflows and out flows (cash budget), funds from business

operation (profit and loss account), financial position (balance sheet),

conditions in the capital market, banking situations, fiscal and monetary

policies.

Advantages of Long-term Sources of Working capital

1. Less Risk: In the case of long-term sources of finance, the firm will

have sufficient time to plan for repayment. Thus the risk that the firm

may not have funds to repay loans on maturity date is less.

2. High Stability: In the case of long term sources of finance, a firm can

have enough funds for comparatively longer period to finance

accumulation of inventories or sale on credit (receivables) during off-

season. Thus the use of long-term sources of finance increases the

degree of stability in operations.

3. High Liquidity: The use of long-term sources of finance increases the

firm’s liquidity as the firm has less worry about the repayment of them

in the short-run.



Advantages of Short term Sources of Working Capital

1) Low Costs: In the case of short-term sources of finance, interest is paid

only for short periods for which funds are used. The overall impact of

this is reduction in costs.

2) Close Relations with Banks: In the case of short-term sources of

finance the financial manager of a firm has to frequently deal with bank

officials. Thus he can establish a close relation with bank officials which

can be used beneficially in larger dealing later on.

Analysis of Working Capital or Measuring Working Capital

Working capital is the lifeblood of a business. The success of a business,

therefore, depends on its adequacy. The outside parties such as trade creditors, banks

and financial institutions, debenture holders, share holders, etc., and the management

of the firm are highly interested in knowing the overall working capital position of a

concern through an analysis. Thus the basic aim of working capital analysis is to

evaluate solvency, liquidity and the cost of financing a concern.

The analysis of working capital can be conducted through the following methods:

1. Ratio Analysis

2. Funds Flow Analysis

Ratio Analysis:

Ratio analysis is the most popular technique of working capital analysis. It can

be used for measuring short-term liquidity or the working capital position of a

concern. Some commonly used ratios for this purpose are as follows:



a. Current ratio

b. Acid test ratio

c. Absolute liquid ratio

d. Inventory turnover ratio

e. Receivables turnover ratio

f. Payables turnover ratio

g. Working capital turnover ratio

h. Working capital turnover ratio

i. Working capital leverage

j. Ratio of current liabilities to tangible net worth

Funds Flow Analysis:

It is a technique designated to study the sources from which additional funds

derived and the uses to which these funds are being put. It is an effective management

tool to study changes in working capital between the two points of time, along with

events causing such changes.

The funds flow analysis consists of: (a) preparing schedule of changes in

working capital and (b) statement of sources and application of fund.


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