introducation of working capital

7/30/2019 Introducation of Working Capital

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Introducation of working capital

Management of the working capital is nothing but the management of current assests. The

management of the current assets includes inventory, received, debtors,book debts, shortterm assets,cash and bank balance. The management of fixed and current assets, however differs in three inportant

ways

In managing fixed assets item is a very important factors, consequently discounting and compounding

techniques play a significant role in capital budgeting and minor one in the management of current

assets.

The large holding of current assets, like cash,strngthens,the firms liquidity position. But alsoreduces the

overall profitablility. Thus a risk return trade off is involved in holding current assets.

Level of fexed as well as current assets, which can be adjusted with sales flucutation in the short run.

Thus firm has greater degree of flexibility in managing current assets.

The working capital refers to the amount of capital which is readily available to an organization that is

working capital is the difference between resource in cash and readily convertible into cash and

organization commitments for which cash will soon be required.

Thus working capital involves activities such as arranging the short term finance, negotiation favorable

credit terms, controlling the movement also a great deal time.

Importance of working capital management:-

The working capital created, security and confidence in the minds of the persons in the management as

well as int the minds of creditors and workrs.

It creates a good credit standing for the firm because, credit standing depends upon the ability to paypromptly. A company with adequate working capital is always able to meet currewnt liabilities.

It ensures solvency and stability of the enterprises.

It also ensures continuity in production and sales.

It enable the company toprocure loans from bands on easy and competitive terms.


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Objectives of working capital management:-

It is the terms of profitability and risk he aggressive financing strategy and the conservative finacing

strategy for total permanent and seasonal und requirements.

The need for working capital as reated to operating/cash cycle,permanent and temporary working

capital.

In general terms the factors having a bearing on the total quantum of working catial required.

The computation of working capital,using both the cash approach and the operating cycle approach.

Components of working capital:-

There are two components of working capital.

Current Assest

Current Liabilities

Current Assets

Cash and bank balance

Stock of raw material at cost work in progress and finished goods.

Advance recoverable in cash.

Deposits under the company scheme.

Advance payment of income takes credit certificates.

Outstanding debts for a period exceeding six month.

Current Liabilities

Sundry creditors for the good and expenses.

Income tax deducted at sources from contractors.

Expenses payable.

Unclaimed dividend.

Security deposits.

Liabilities for bill discounted.

Bank overdraft acceptance.


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Ratios

Introduction

Meaning and definition

Limitation Types of ratios

Types of Ratios

Analyses and interpretation

Introduction of Ratios:-

When observed the financial statements comprising the balance sheet and profit and loss

account is that they do not give all the information related to financial operation of the firm

they can provide some extremely useful information to the extent that the balance sheet shows

as the financial position on a particular date I terms of structure of Assets, Liabilities and

Owners equity and profit or loss account shows the result of operation during the year. Thus

the financial statements will provide a summarized view of the firm.

The idea of ration analysis was introduced by Alexander wall for the first time in 1919. Ratios

are quantitative relationship between two or more variables taken form financial statements.

Meaning and definition:-

Ratios analysis is one of the powerful techniques which is widely used for interpreting financial

statement. This technique serves as a tool for assessing the financial soundness of the business.


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Ratio analysis is defined the systematic use of ratio to interpret the financial statement so the

strength and weakness of the firm as well as its historical performance and current financial

condition can be determined in the financial statements we can find many items are co-related

with each other. For ex:- current assets, current liabilities, capital and long term debt, gross

profit and net profit, purchase and sales etc.

To take decision the ration of such items reveals the soundness of financial position. Such

information will be useful for creditors, share holders, management.

Limitation of ratios:-

Ratios should be used with extreme care and consideration judgment.

Because, they suffer from certain serious drawback, some of limitations are listed below,

Ration can sometimes be misleading if an analyst does not know the reliability andsoundness of the figures from which they are computed and the financial position of the

business at other times of the year.

The mechanics of ratio construction are not as important as the proper Interpretation of the ratio. Ratio can never be substitute of raw figure. Price level changes makes ratios analysis difficult.

Types of ratios:-

Ratio as tool of financial management of crucial significance. Ratios are tool of measuring

liquidity, profitability, efficiency and financial position of the firm.

Ratio can classified in to 4 basic types.

1)Liquidity ratio:-

The Liquidity ratio provides test to measure the ability of the firm to cover its short termobligation out of its short term resource. Interpretation of liquidity ratios provides considerable

insight into the present cash solvent in item of adversity.


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It is mainly classified into 2types

Current ratio

Quick ratio

2)Leverage ratio:-

Leverage ratio generally designed to measure the contribution of the firms owner vis--vis the

funds provide by its creditors.

Its mainly classified in to 3 types.

Total debt ratio.

Debt equity ratio.

Interest coverage ratio.

3)Activity ratio:-

The activity ratios reflect how efficiently the firm is managing its resources. This ratio expresses

relation between the level of sale and the investment in various assets.

It mainly classified into 10 types

Inventory turnover ratio.

Inventory conversion ratio.

Debtor turnover ratio.

Debtor collection period.

Gross operating ratio.

Creditor turnover ratio.

Creditor collection ratio.

Net assets turnover ratio.

Working capital ratio.

4)Profitability ratio:-


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Profitability ratios are the best indicators of overall efficiency of a business concern. Because,

they return of valume put into business with sale or service carried on by the firm with the help

of assets employed.

It is mainly classified into 6types.

Gross profit margin ratio.

Net profit margin ratio.

Operating expense ratio.

Proprietary ratio.

Return on investment ratio.

Return on equity ratio.

Analysis and interpretation:-

1) Current ratio:-

The current ratio of a unit measure firms short term solvency, that is its liabilities to meet short

term obligation. It is the ratio of total current assets to the current liabilities.

The current ratio measure the liability of the firm its current liabilities, current assets get

converted in to cash in the operating cycle in the operating cycle of the firm and provides the

funds needed to pay current liabilities.

Current ratio= current assets/current liabilities


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Table:4.1

The table showing current ratio

Year Current assets Current liabilities Ratio

2010 98539092.23 75655623.45 1.302011 172644224.02 121367200.37 1.42

2012 156259842.11 116150143.82 1.35

Interpretation:-

The table4.1 revels that the liquidity position of Dharwad milk union is satisfactory the ratio of

all 3 years less than the conventional norm that is table2 because, the dharwad milk union is

public utility firm, so, as for the conventional rile concerned the public utility firms liquidity

position is satisfactory even though the current ratio is less than the conventional norm. so, forthe liquidity position of dharwad milk union is satisfactory.

2)Quick ratio:-


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This ratio is also termed as acid test ratio is concerned with the relationship between quick

assets and current liabilities. It is measure of liquidity calculated dividing current assets minus

inventory and prepaid expense by current liabilities.

Quick ratio= Quick current assets/current liabilities

Table:4.2

The table showing quick ratio

Year Quick assets Current liabilities Quick ratio

2010 77345340.36 75655623.45 1.02

2011 93373691.72 121367200.37 0.76

2012 93493738.22 116150143.82 0.80


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Interpretation

The liquidity ratio of dharwad milk union is good in the last 3year. 2009-2010 the liquidity ratio

is more the standard norm that is 1.05 it indicates that liquidity ratio of D.M.U is good. However

for 2010-11 the liquidity less than the standard norm. However 2011-12 the ratio become less

then the 2009-10 so it show the liquidity ratio of D.M.U is not constant or good. Therefore, it

indicated that the company is able to pay its current liabilities whit quick assets. The D.M.U is

able to utilize its current assets properly and the inventory movement is quicker and debt

payment of faster.

3)Inventory turnover ratio:-

Every firm has to maintain certain of inventory of finished goods,

So as be meeting the requirements of the business. Thus inventory turnover reflect the

efficiency of inventory management. The higher ratio reflects more efficient the managementof inventories and vice versa.

This ratio establishes relationship between cost of goods sold during a given period of time and

average amount of inventory held during that period.

Inventory turnover ratio=

Cost of goods sold/average inventory

Cost of goods sold=opening stock + closing stock/2


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Table:4.3

The table showing inventory turnover ratio

Year Cost of goods sold Average inventory Inventory turnover

ratio

2010 595737894.5 37881998.94 15.7

2011 795319325.8 60829018.01 13.07

2012 1052090540 110655089.02 9.50


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Table:4.4

The table showing inventory conversion period

Year No. of days in year Inventory t. ratio Inventry conversion

period

2010 365 15.07 24.22

2011 365 13.07 27.92

2012 365 9.50 38.42

Interpretation:-

The table shows that the Dharwad milk union is taking how many days to convert the raw

material into finished products. In last 3year the company is improved its conversion period


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yearly. In the year 2009-10 the D.M.U has taken less days to convert inventory. But, in the year

2010-11 and 2011-12 the D.M.U taken more days to convert inventory. Its indicates that the

Fastly conversion inventory and selling the goods. There the D.M.U is maintain same way in

inventory conversion period is more.

5) Debtors turnover ratio:-

Debtors turnover ratio is an important part of current asset. It is determining by dividing the

credit sales by average debtors outstanding during the year.

Debtors turnover ratio=total sales/debtors

Table:4.5

The table showing debtors turnover ratio

Year Total sales Debtors D.t.ratio

2010 7376999820 24179465 30.5

2011 968614982 15765438 61.43

2012 1230099874 25960548 47.38


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Interpretation:-

The table 5 shows that the in last 3years debtor turnover ratio in dharwad milk union. In year

2009-10 the debtor not collected rapidly. But in the year 2010-11 the debtors are collected

rapidly that is 60.01 and in the year 2011-12 again the debtors turnover ratio is decreases that

is 40.55. there for the D.M.U is maintaining better sales. But, managing its debts collection is

not feeiciency.

6) Debtors collection period:-

Debtors collection period is the required to collect the outstanding amount from the

customers. It means the quality of debtors, since it indicates the speed of their collection.

Debtor collection period= number of days in a year/debtors turnover ratio

Table:4.6

The tale showing debtors collection period

Year No. of days in year Debtors collection

ratio

Debtors collection

2010 365 30.5 11.96

2011 365 61.43 5.94

2012 365 47.38 7.70


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Interpretation:-

The table 6 revels that the debt collection period of Dharwad milk union. In year 2009-10 the

debt collection period in increasing trend. It indicates that the customers are not madepayment promptly. But in the year 2010-11 the debt collection period decreasing to 8days. It

indicated that the customer had made the payment in that year. But in year 2011-12 again the

collection period is increasing 8 to 14 days.

7)Working capital turnover ratio:-

This ratio indicates whether the working capital has been properly utilized in making sales or W

Working turnover ratio= cost of goods sold/net working capital

Cost of goods sold=sales-gross profit

Net working capital =current assets-current liabilities.

Year Cost of goods sold Net working Working

capital.t.ratio

2010 595737895 5127024 11.6

2011 795319326 22883469 34.7

2012 1052090540 40109699 26.2


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Interpretation:-

The table shows working capital turnover ratio is increasing and decreasing ternd. In the year

2009-10 ratio is 11.6. its shows the D.M.U is properly utilized the working capital for makingsales. It reflect the working capital management is efficient. It indicates the D.M.U is not

properly untilized of working capital. It is not good to company. But in the year 2010-11 the

working capital turnover ratio is high compared to the last years that is 2009-10. The D.M.U is

i.e 26.2 it indicates that D.M.U is properly not utilized the working capital.

8) Current assets turnover ratio:-

This ratio reveals the relation cost condition sold and current assets. The higher ratio the better

is the condition of the firm I utilizing its current assets.

Current assets turnover ratio=total sales/current assets

Table:4.8

The table showing current assets turnover ratio

Year Total sale Current assets Current assets t.ratio

2010 737699820 98539092 7.48

2011 968614982 172644224 5.61

2012 1230099874 156259843 7.8


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Interpretation:-

The table shows that how the Dharwad milk union is utilized its current saaets. In the year

2009-10 the ratio is increasing 7.48 it indicates that the D.M.U is utilizing its current assets

more efficiently. It reflects the good current assets management. But in the year 2010-11 the

ratio is decreasing from 5.61 it indicates the D.M.U is decreasing current assets. But, its

increasing from 7.8 in the year 2011-12. There for the D.M.U is efficiently manage its current

assets.

9)Gross operating cycle:-

The time lag between purchase of raw materials sale is gross operating cycle. It refers to the

sum of inventory period and debtors collection period.

Gross operating cycle= inventory conversion period + debtors collection period.

Table:4.9

Year Inventory conversion

period

Debtors conversion

period

Gross operating cycle

2010 24.22 11.96 36.18

2011 27.92 5.94 33.86

2012 38.42 7.40 45.82


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Interpretation:-

From above table 10 there is up and down in the ratio of credit turnover ratio. The ratio is low

in the year 2010-11 it indicates that the D.M.U credit payment is not good that is 54.06 it is not

good point to liquidity position. But in the year 2009-10 is increasing credit payment of D.M.U

that is year 2011-12 decreasing the credit payment of D.M.U that is 124. It indicates the D.M.U

has paying credit payment properly. But the year 2011-12 decreasing the credit payment of

D.M.U that is 70 because, that the D.M.U has not paying in the credit properly.

11) creditors payment period:

The creditor payment period ratio represents the average number of days taken by the firm to

pay the creditors.

Creditors payment period= number of days in a year / creditors turnover ratio


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Table.4.11

The table showing credit payment period

Year No of days in year Creditors turnover

ratio

Creditors payment

period2010 365 124.01 2.94

2011 365 54.06 6.75

2012 365 70.00 50.21

Interpretation:-

It fund for table no 1 that there is up and down in credit payment period of Dharwad milk

union. In the year 2010-11 is increasing trend. That is 6 days. It indicates company is

maintaining credit payment properly. But in the year 2009-10 the credit payment period is low


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that is 2 days. Because the D.M.U has not taken less credit facility and paying the credit in

current time. Again in the year 2011-12 increasing for 5 days it indicates company has not

maintaining the credit payment properly. It is better sign of the company utilizing the credit

facilities properly.

12) Net operating cycle:-

Net operating cycle is the time length between the payment for raw material purchase and the

collection of cash for sale. It is the difference between gross operating cycle and creditors

conversion period.

Net operating cycle= Gross operating cycle-Creditors payment period

Table:4.12

Year Gross operating cycle Creditors payment

cycle

Net operating cycle

2010 36.18 2.94 33.24

2011 33.86 6.75 27.11

2012 45.82 5.21 40.61


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Interpretation:-

From above table 4.12 the net operating cycle of the dharawd milk union. There ups and down

in the working capital period. In the year 2009-10 and 2011-12 the D.M.U gas taking mover

days to complete the working capita operating cycle 33.24 and 40.61 days comparing last 3

years. But in the remaining one years it take lesser days to complete the working capital.


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Findings,Suggestion,Conclusion

Findings:-

The current ratio is bellow the standard ratio and it is not good for companys points ofview. It shows it is not good position to meet the short term liabilities.

The liquidity ratio is according to standard ratio and it is good for companys point ofview. It shoes the company is able to meet its liabilities in short period.

The debt equity ratio is showing decreasing ternd in year. It indicates that the companyis depending on more on internal source, funds, its shoe there financially strong.

The inventory turnover ratio are not good. Less inventory ratio that is holding periodsAre increasing in conversion of work in progress to finished goods ratio is 34 days.

The debtors turnover ratio is good. It shows the collection of debtors is very properly. Working capital ratio is not good. Because, it is decreasing by year by year. The credit turnover ratio goes on increasing and credit payment period is decreasing. The return of total assets is also fluctuating in indicates that the assets had not been

utilized properly by the firm.

Suggestion:-

It is the suggested that the D.M.U has to inventory and increases investment in the fromquick , assets and the it can maintain good liquidity position.

In the recent years the debt turnover ratio of D.M.U is decreases so, it is suggested toincreases the debt turnover ratio it help to maintain the debt collection.

In the recent years, the debt collection period of D.M.U is increasing so, it is advised toD.M.U to reduce the collection period.

The study of inventory utilization ratio D.M.U not properly utilizes their inventory it isadvised up adopt scientific inventory management to improve working capital

It is suggested that D.M.U reduce its operating cycle so, that can maintain sufficientworking capital in the liquid from

It is suggested that D.M.U should reduce the time lengh of net operating cycle andproductivity of employees.

introducation of working capital

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