minal jain08.01.13.doc
TRANSCRIPT
-
7/30/2019 Minal Jain08.01.13.doc
1/105
A
Project Study Report
On
Training Undertaken at
RSSML
Titled
WORKING CAPITAL MANAGEMENT
Submitted in partial fulfillment for theAward of degree of
Master of Business Administration
Submitted By: - Submitted To: -
-
7/30/2019 Minal Jain08.01.13.doc
2/105
PREFACE
The work and experience gained during training period has increased my
knowledge many folds. In this limited space and restricted standard a brief
and comprehensive account has been produced in the light of recent- work
and latest information available from various-sources. Business organization
is a dynamic entity. it has relations with vast variety of people, i.e. owners,
creditors, customers & govt., who are interested in its financial performance.
Business organization communications information through its financial
statement balance sheet & income statement.
Users of financial statements can have better insight into the financial strength
&weaknesses of the firm if they properly analyze, establish proper
relationship, in these statements.
Business organization has many departments &activities to perform such as
financial department, personnel department, marketing department and
reduction department. Financial department is the blood 4nerves of theorganization and working capital is the blood, circulating in the nerves of the
body of organization. It is in this context that, I have taken up the study -
entitled,- "Working Capital Management" at Rajasthan state mines and
minerals ltd. (RSMML). Ratio analysis technique has also been used for
analyzing the same. This project is submitted in the fulfillment of the degree
of "Masters of business administration".
-
7/30/2019 Minal Jain08.01.13.doc
3/105
ACKNOWLEDGEMENTS
Life is a journey of excellence. Every mile that one reaches during the eternal
journey is marked by the guidance of the near and dear ones and theendeavor of mine is no exception.
The immense pleasure and joy one derives on the completion of assigned job
is beyond description. It is the duty of the concerned person to pay this respect
& acknowledge the advice, guidance & assistance received from all the
persons to an accomplishment.
I owe a deep depth of gratitude to the college authorities Dr. Dipin Mathur
Associate Professor & Programme Coordinator, MBA for giving me the
opportunity to work on this project, his valuable help and keen interest,
constant encouragement, inspiration and critical supervision during the entire
course of this project, without his help and guidance, I wouldnt have got the
opportunity to successfully complete the project report.
I extend my deep sense of thankfulness to Mrs. Kalpana Agarwal (Chief
Personnel & Administration) who allowed me to do my project in RSMML,
Udaipur. It is with great pleasure & relief I am presenting this work today. The
present study is a teamwork reflecting the efforts of many.
I am extremely thankful to Mr. Rajendra Rao (Company Secretary, RSMML)
for providing me the necessary information & helped me to understand the
various aspects regarding my project report.
I shall ever remain indebted to Mr. B.L. Salvi (Deputy Manager HRD) for hisconstant support, guidance & encouragement.
I also extend my deep gratitude to Mr. Amit Sharma (Company Secretary,
RSMML) for providing me proper guidance in carrying out my project work.
I extend my deep sense of thankfulness to all my faculty members who gave
me continuous support in completing my project work.
-
7/30/2019 Minal Jain08.01.13.doc
4/105
CONTENTS
S.NO. TOPIC NAME PAGE NO.
01. INTRODUCTION OFINDUSTRY
02. INTRODUCTION OFCOMPANY
03. RESERCH METHODLOGY
04. FACTS AND FINDING
05. INTERPRETATION &ANALYSIS
06. SWOT ANALYSIS
07. CONCLUSION
08. SUGGESTION
BIBILOGRAPHY
EXECUTIVE SUMMARY
-
7/30/2019 Minal Jain08.01.13.doc
5/105
Practical knowledge has inestimable value for a student because theoretical
knowledge is incomplete if it is not correlated with the practical knowledge.
The work and experience gained during training period has increased my
knowledge many folds. In this limited space a brief and comprehensive
account has been produced in the light of recent work done on calculation of
Management of Working Capital at RSMML through latest information
available from various sources.
The most important task of a financial manager is toManagement of Working
Capital and interpret the financial results in such a manner, that it can be
clearly understood and also provides favorable and satisfactory information to
the shareholders.
-
7/30/2019 Minal Jain08.01.13.doc
6/105
Chapter-1
Introduction
of
Industry
INTRODUCTION
Rajasthan State Mines and Minerals limited (in short RSMML) is one of the
leading and progressive undertakings of the Government of Rajasthan. It
occupies a place of pride in production and marketing of non-metallic minerals
of India. RSMML is multi mineral and multi location enterprise engaged in
-
7/30/2019 Minal Jain08.01.13.doc
7/105
mining of Rock Phosphate, Lignite, SMS grade Limestone and Gypsum.
RSMML is not only the leader in Mining & Selling of Rock Phosphate, Gypsum
across the country, but also global pioneer in technology in open cast mining
and mineral beneficiation of Carbonate Rock Phosphate.
Besides minerals, RSMML has also forayed into Energy Sector and has setup
15 MW installed capacity Wind Power Project at Jaisalmer, Rajasthan.
CORPORATE PROFILE OF RSSML
Rajasthan State Mines & Minerals Limited (RSMML) is one of the
premier public sector enterprises of the Government of Rajasthan, primarily
engaged in mining and marketing of industrial minerals in the State. The very
objective of the company is to achieve cost effective technological innovations
in the mining of minerals and to diversify into mineral based downstream
projects. Apart from the above, the Company is also aiming at long-term fuel
supply to lignite based power projects, apart from setting up wind energy farms
at Jaisalmer. This company is professionally managed and remains focused
towards increasing productivity and growth.
AMALGAMATIONThe Department of Company Affairs, Government of India (Order No,
issued year 2003, witnessed completion of amalgamation of Rajasthan State
Mineral Development Corporation Limited (RSMDC), another Rajasthan State
Government PSU with Rajasthan State Mines & Minerals Limited (RSMML).
S.O.207 (E) dated 19th February 2003) under Section 396 of the Companies
Act, 1956 and the same has come into effect from 20th February, 2003, the
date of its publication in the Gazette of India (Extraordinary).
STRATEGIC BUSINESS UNITS & PROFIT CENTERS
After amalgamation, the following four mineral based Strategic Business Units
& Profit Centers (SBU & PC) namely Rock Phosphate, Lignite, Gypsum and
Limestone have been set up as a part of corporate restructuring: -
-
7/30/2019 Minal Jain08.01.13.doc
8/105
Strategic Business Unit and Profit Center Rock phosphate at
Udaipur.
Strategic Business Unit and Profit Centre Gypsum at Bikaner.
Strategic Business Unit and Profit Centre Limestone at Jodhpur.
Strategic Business Unit and Profit Centre Lignite at Jaipur.
The year 2004-05 will be remembered as a year of achievement as for the first
time profit before tax crossed 100 crores and settled at Rs. 118.5 crores in
comparison to profit before tax of Rs. 44.95 crores in 2003-04. The Company
started a number of R&D activities to further strengthen its R&D activities.
Generous contributions were made for creation of life saving medical
infrastructure in 8 project districts. The highest ever dividend of Rs.
15,51,03,000/- was declared on 22nd February 2005. Indeed it was a proud
moment for the company, which started as a small entity excavating gypsum in
1947.
RSMML today has broken away from its monopolistic moorings and welcomes
competition. From a small backwaters company, it is now rated as a
technologically advanced company and an innovator. It boasts of a highly
trained and competent workforce and strong financial base. It has established
itself as the most successful public sector company in Rajasthan.
HIGHLIGHTS
-
7/30/2019 Minal Jain08.01.13.doc
9/105
1. The company has achieved highest ever production and sales during in
the year 2004-05.
2. The revenue of the company has increased from Rs. 4301 millions to
Rs. 5108 millions.
3. RSMML declared the highest ever dividend to the Government of
Rajasthan for Rs. 15,50,82,956 being presented to Hon'ble Chief
Minister Smt. Vasundhara Raje.
4. Completion of the projects for doubling the capacity of the Industrial
Beneficiation Plant from 1500 TPD to 3000 TPD for beneficiation of low
grade rock phosphate ore to high-grade concentrate.
5. Successful commissioning of the third phase of 5 MW Wind power
project at Jaisalmer. Together with the two plants already in operation,
2005-06 2006-07 2007-08
-
7/30/2019 Minal Jain08.01.13.doc
10/105
the total capacity is now 15 MW and the power generated is of grid
quality.
6. Registration of Companys Wind Power Project with Executive Board of
Clean Development Mechanism under UNFCCC.
The revenue of the company has increased from Rs. 6364 millions to Rs.
9723 millions in the year 2008-09.
-
7/30/2019 Minal Jain08.01.13.doc
11/105
-
7/30/2019 Minal Jain08.01.13.doc
12/105
-
7/30/2019 Minal Jain08.01.13.doc
13/105
CHAPTER -2
Company Profile
PRODUCTS
We are producing following product: -
-
7/30/2019 Minal Jain08.01.13.doc
14/105
Lignite
It is suitable for power production, cement and agriculture uses.
Gypsum
We are producing following products :-
o Run of Mine (ROM) Gypsum
It is used for manufacture of cement and land reclamation.
o Gypsum Powder
It is used for manufacture of cement and land reclamation.
ROM Selenite
It is used for manufacture of Plaster of Paris and Ceramics.
Limestone
We are producing following products: -
o Low Silica Limestone
Low Silica Limestone is used in steel plants with BOF technology
as a flux.
o Chemical grade Limestone
Chemical grade limestone is used mainly in chemical industries
producing quick lime and hydrated lime. It is also used in White
Cement and Grey Cement plants for the same purpose.
Rock phosphate
We are producing following products:-
-
7/30/2019 Minal Jain08.01.13.doc
15/105
o Crushed " size High Grade Rock Phosphate
(SSP Manufacturing Units)
o Crushed " size High Grade Rock Phosphate
(DAP/ Nitro phosphate Manufacturing Units)
o Crushed " size High Grade Rock Phosphate
(DAP/ Nitro phosphate Manufacturing Units)
o Beneficiated Rock Phosphate Concentrate
(Fertilizer plants)
o Ground Low Grade Rock Phosphate (RAJPHOS)
(Fertilizer for direct application to acidic soils)
o Crushed " size Medium Grade Rock Phosphate
(SSP Manufacturing Units)
Mineral Deposits
-
7/30/2019 Minal Jain08.01.13.doc
16/105
RESEARCH AND DEVELOPMENT
-
7/30/2019 Minal Jain08.01.13.doc
17/105
The company has developed the organic fertilizer called Phosphate Rich
Organic Manure (PROM) by using high-grade rock phosphate with farmyard
waste and other organic matter. The field trials conducted through the different
agricultural universities in the country have shown that the agronomic efficacy
of this new P-fertilizer is higher than that of the complex phosphatic fertilizers
available in the market today. PROM is suitable to neutral and alkaline soils,
which will prove to be a boon to the Indian farmers. In the long run, this product
will be a winner as it has significant price advantage vis-a-vis the other
chemical fertilizers. Commercialization of the PROM technology will help
utilization of waste and also help in conservation of the mineral rock phosphate
as PROM shows good residual effect.
The company has put a major thrust on the R & D activities in the recent
past and several new R&D projects have been taken up.
Research project taken up for development of fused CaMg phosphate to
utilize the vast reserves of low-grade ore of rock phosphate.
Converting tailing rejects of IBP to Direct Application Fertilizer for
Magnesium deficient soils.
Research project taken up for possible commercial production of Bio-
Diesel from Jetropha plant.
Beneficiation of low-grade gypsum for producing high grade 80% +
material for cement industry.
R&D efforts on apatite mineral to be used in jewelry and decoration.
(Moving towards value added product)
Company has started a Training and Consultancy Center at Jaipur,
Rajasthan.
Research project taken up for development of fused Ca-Mg phosphate
to utilize the vast reserves of low-grade ore of rock phosphate.
Converting tailing rejects of IBP to Direct Application Fertilizer for
Magnesium deficient soils.
-
7/30/2019 Minal Jain08.01.13.doc
18/105
Research project taken up for possible commercial production of Bio-
Diesel from Jetropha plant.
Beneficiation of low grade gypsum for producing high grade 80% +
material for cement industry.
R&D efforts on apatite mineral to be used in jewelry and decoration.
(moving towards value added product)
Company has started a Training and Consultancy Center at Jaipur, Rajasthan
ENVIRONMENT AND SAFETY
As a responsible corporate citizen, RSMML accords equal importance
to ecological and social sectors. The company is concerned about not only the
economic bottom-line reflected by the impressive performance on all quarters
and higher profitability but also the benefits and impacts of our operations,
processes and products on the environment and the health and safety of ouremployees and the community.
RSMML has constructed a huge dam of 200 Mcft. Fresh water storage
capacity on Jhamari River, which has helped in recharging the regional water
table.
Extensive afforestation/planatation work is being done in and around all mines.
-
7/30/2019 Minal Jain08.01.13.doc
19/105
The Industrial Beneficiation Plant is "Zero discharge plant". The wastewater is
treated at acid water treatment plant, resulting in a saving of about 1.5 million
CuM of fresh water.
Regular monitoring and control of different environmental parameters
i.e. air, water, dust, noise and heat etc.
Installation of dust extraction system at crushing and screening plant
and at Central Gypsum Grinding Unit, Rawla, Bikaner.
The mined out area is being back filled simultaneously to reclaim the
land.
Sajjan Niwas Garden established in 1883 has been adopted by RSMML
and is being restored to its pristine glory.
-
7/30/2019 Minal Jain08.01.13.doc
20/105
Company has a safety and health policy. Company follows statutory
requirements as per Mines Act 1952. Every year Safety week celebrated at
different units under the aegis of Director General of Mines Safety (DGMS).
A well equipped vocational training center at Phosphate SBU caters toneed of various training regarding safety and occupational health for the
employees.
SOCIAL RESPONSIBILITY
As a responsible corporate entity committed to discharge its social
obligations, RSMML has been contributing generously towards the
development of the areas located near its mining sites and other areas of
operation.
These contributions have been in the areas of
Medical & Health Care
Drinking water
Education
Environment
Development of village infrastructure
-
7/30/2019 Minal Jain08.01.13.doc
21/105
The Company has been providing medical, educational and other
facilities to the villages situated around its mines.
To improve the medical infrastructure of Udaipur region, which is
predominantly a tribal district, RSMML has contributed Rs. 3.05 crores forestablishment of Cardio-Thoracic Surgery Centre and Neo-Natal Special Care
Unit at the M.B. Government Hospital, Udaipur.
A Contribution of Rs. 2.888 crores has been made to the Chief Minister
Fund for development of Medical and Health infrastructure facilities in project
districts.
The contribution has been made to Medical colleges / District Hospitals
at Udaipur, Bikaner, Jodhpur, Barmer, Sri Ganganagar, Jaisalmer,
Hanumangarh and Nagaur.
Memorandum of Understanding has also been entered with
Government of Rajasthan for utilization of these funds.
Medical Camps are being regularly organized in the villages around the
mine location and project areas of the company where free check-up and
medicines are provided.
RSMML has provided land for the project for setting up a 100-bedded multi
super specialty hospital at Udaipur under a JV arrangement with M/s American
International Health Management Limited, Udaipur. Total capital investment on
the hospital envisaged Rs. 200 millions.
Other works for development of village infrastructure include :
-
7/30/2019 Minal Jain08.01.13.doc
22/105
Contribution to Panchayats for schools.
Improvement in village Goshalas.
Medical Camps are being regularly organized in the villages around the
mine location and project areas of the company where free check-up
and medicines are provided.
RSMML has provided land for the project for setting up a 100 bedded
multi super specialty hospital at Udaipur under a JV arrangement with
M/s American International Health Management Limited, Udaipur.
Education & Mid-Day Meal
Company is providing full assistance in running a secondary school for
children of nearby villages at Jhamarkotra Rock Phosphate Mines,
Udaipur.
Company has contributed Rs. 1.10 crores for setting up centralised
kitchen for Mid-Day Meal scheme of government.
Company has contributed Rs. 34.20 lacs for "Shala Swasthya
Program" for children at Bikaner city.
According high priority to fulfill its social responsibilities, the company regularly
takes up works related to socio-economic development along with environment
-
7/30/2019 Minal Jain08.01.13.doc
23/105
restoration and management in the areas where the company has major
mining operations and other business activities.
SUPPLY OF PORTABLE WATER
Supplying 7 million liters per day of potable water from Jhamarkotra mines to
city of Udaipur since 1994-95.
Recently company has commenced supply of 6 million liters per day of potable
water from Kanpur mines in addition to the present supply of 7 million liters per
day. With this, RSMML caters to the potable water needs of more than 2 lacs
people of the water-starved Udaipur City.
Supply of potable water from Jhamarkotra mines to 7 nearby villages ona permanent basis since last 8 years.
Adequate potable water supply is ensured through a permanent pipeline
& 75000 liters capacity GLR in each village.
Medical & Health
Full Fledged dispensaries at Mine site and Corporate Office;
Managed by Qualified Doctors and paramedical staff
Regular annual Monitoring of Occupational Health
Health facilities extended to employees dependents at mine site
Company also extends medical facility to village population in & around
mine site
Recently, comprehensive health check up, covering all the 2200
employees, has been conducted with the help of National Institute of
Miners Health, Nagpur, India.
Other works for development of village infrastructure include:
Contribution to Panchayats for schools.
Improvement in village Goshalas.
According high priority to fulfill its social responsibilities, the company regularly
takes up works related to socio-economic development along with environment
-
7/30/2019 Minal Jain08.01.13.doc
24/105
restoration and management in the areas where the company has major
mining operations and other business activities.
Financial Performance
Rs. In millions
Indicator 2004-05 2005-06 2006-07 2007-08 2008-09
Total Revenue 5108.9 5411.6 5700.18 6364.12 9723.47
Profit Before Tax 1185.5 1418.9 1561.11 1867.51 1778.94
Profit After Tax 776.2 950.4 1024.04 1223.81 1206.76
Net Worth 2825.2 3553.4 4536.34 5576.95 6596.69
Capital Employed 3549.5 4111.8 5157.72 6349.33 7306.69
Contribution to State
Exchequer1163.5 1186.6 1123.66 1380.52 4071.55
Share Capital 775.5 775.5 775.5 775.5 775.5
Earning per Share 10.31 12.26 13.2 15.78 15.56
Output per Employee 2.37 2.53 2.68 3.14 5.09
-
7/30/2019 Minal Jain08.01.13.doc
25/105
-
7/30/2019 Minal Jain08.01.13.doc
26/105
-
7/30/2019 Minal Jain08.01.13.doc
27/105
-
7/30/2019 Minal Jain08.01.13.doc
28/105
CORPORATE OFFICE :
4, Meera Marg, Udaipur- 313 004- INDIA.
Phone : +91-294-2528681 to 85
Fax : +91-294-2523170
+91-294-2521727E-mail: [email protected]
mailto:[email protected]:[email protected] -
7/30/2019 Minal Jain08.01.13.doc
29/105
REGISTERED OFFICE :
C-89-90, Janpath, Lal Kothi Scheme,
Jaipur - 302 004, INDIA
Phone : +91-141-2743734
+91-141-2743934
Fax : +91-141-2743735
E-mail : [email protected]
Introduction of working capital management in RSSML
FINANCIAL MANAGEMENT
Finance - Finance is one of the basic functions of all economic activity
business needs money to make more money but it should be properly
managed. Finance refers to money or funds available to a firm.
mailto:[email protected]:[email protected] -
7/30/2019 Minal Jain08.01.13.doc
30/105
Financial management - Financial management may be defined as planning,
organizing, directing, and controlling of financial activity in business
enterprises.
According to solemn, Financial management is concerned with efficient useof an important economic resource namely capital fund.
Financial management is concern with procurement & utilization of funds.
It involves decision making in three areas
1- Investment of funds.
2- Financing of different activities.
3. Disposal of profit.
The finance manager is primarily concerned with arranging finances in desired
quantity, critical analysis of the available investment opportunities & controlling
the funds.Thus management of finance is crucial of success of business. The
financial manager must see that funds are procured in manner that risks cost
and control consideration are properly manage in firm and there is optimum
utilization of funds.
Objective - The objective provide a framework for optimum financial decision
making.
GENERAL OBJECTIVES-To provide general knowledge of company's
approach to resource management. To get familiar with the company's
management process and procedures to plan, estimate, implement, monitor
and evaluate; including internal control procedures. Student should acquire
knowledge and skills to be applied in leadership roles to financial and resourcemanagement activities.
SPECIFIC OBJECTIVES
Acquire general knowledge of the company, manages
organization structure and responsibilities for resource management.
Know how the company establishes goals and objectives at various
levels of the organization and how plans are developed to accomplishthese objectives.
-
7/30/2019 Minal Jain08.01.13.doc
31/105
Understand how the company establishes standards to measure
performance and identity deviations and other problems. How are
solutions implemented and monitored.
Understand management standard techniques and procedure; including
analytical techniques used to perform trend analysis and performance
measurement.
To become familiar with the application' of various management
information systems that supports the operations of the company and
the relationship of the various systems.
Knowledge of data management techniques and procedures, including
potential capabilities to interface with other organization.
Understand the human resource programs formulated by management;
to include lessons learned, incorporation of future training, program etc.
Financial affairs of R.S.M.M.L.
Financial affairs of R.S.M.M.L. are managed through drafting short term & long
term budgets, which are the company estimates of the requirement of funds in
the particular budget period short term budget are usually for period of one
month to six month while company consider budget for months & above to be
long term budget. Every department prepares its budget as per requirement.
The budgets are then presented to finance controller, one month before the
budget period or next financial controller, one month before the budget period
or next financial year for preparation of master budget this assists the financial
controller in decision making process.
One of the most important decision that finance manager has to take is
Investment decision.
Investment decision
The decision related to selection of asset in which, funds will be invested by a
firm.
Long term asset - Those assets which yield return over a period of in future.
-
7/30/2019 Minal Jain08.01.13.doc
32/105
Short term & current asset - Those assets which in normal course of
business are convertible into cash within a year
Financial decision making with reference to long term asset is known as
Capital budgeting.
Financial decision making with reference to current asset & short- term asset is
know as Working Capital decision.
Capital budgeting is probably the most crucial financial decision for a firm. It
relates to the selection of an asset or investment proposal or course of action
whose benefits are likely to be available in future over the lifetime of the
project. Whether the assets will be accepted or not will depends upon the
relative benefits and return, as well as the risk associated with it.
Working capital is concerned with the management of current assets. If a firm
does not have adequate working capital, it may become illequid and
consequently may not have ability to meet its current obligations and, thus,
invite the risk of bankruptcy. If the current assets are to large, profitability is
adversely affected.
The balance sheet of the year 2007-2008 shows that the working capital forthe year stood at Rs. 29958.061acs
WORKING CAPITAL MANAGEMENT
MEANING OF WORKING CAPITAL MANAGEMENT
Management of working capital means management of all aspects of current
assets and current liabilities.
-
7/30/2019 Minal Jain08.01.13.doc
33/105
According to Smith, K.V. Working Capital Management is concerned with
the problems that arise in attempting to manage the current assets, current
liabilities and the inter relationship that exist between them.
T
the term working capital refers to the amount of capital which is readily
available to an organization. That is, working capital is the difference between
resources in cash or readily convertible into cash (Current Assets) and
organizational commitments for which cash will soon be required (Current
Liabilities). Current Assets are resources which are in cash or will soon be
converted into cash in "the ordinary course of business. Current Liabilities are
commitments which will soon require cash settlement in "the ordinary course
of business. Thus :
WORKING CAPITAL = CURRENT ASSETS - CURRENT LIABILITIES
In a department's Statement of Financial Position, these components of
Working Capital are reported under the following headings:
Current Assets
Liquid Assets (cash and bank deposits)
Inventory
Debtors and Receivables
Short-term loans & advances
Raw materials
Work in progress
Finished product
Temporary investment
Prepaid expenses
-
7/30/2019 Minal Jain08.01.13.doc
34/105
Accrued incomes
Current Liabilities
Bank OverdraftCreditors and Payables
Outstanding expenses
Short-term loans
Dividend payable
Provision for taxation
Working capital management is management for the short-term assets
& its short- term liabilities. This is of critical importance to a firm. Managers
spend about 70% managing for the short-term. This makes sense. Every day
companies take in money, write receipts, balance checkbooks, record
receivable records, manage inventory and the like. Also short-term
management should not be discounted. As the old saying goes, "If you can
make it in the short-term long enough, you don't need to worry about the long-
term." Cash budget may be utilized in managing working capital.
Working capital has to do with the short-term accounts of a firm current
assets and current liabilities. Net working capital is defined as current assets
less current liabilities. The secret to good working capital management is
simple "use someone else's money every chance you get and don't let anyone
else use yours." Within reason, of course. To do that, the following strategies
might be employed; again within reason. A Company wouldn't want to stretch
out its payables for so long a period that it's forced out of business.
Stretch out accounts payable as long as possible. If a bill is due on
the 13th, don't pay it on the 10th. If a company has enough clout they
can negotiate longer terms with vendors.
Turn receivables as quickly as possible. Make it easy for customers
to pay prepaid envelopes, discounts, etc.
-
7/30/2019 Minal Jain08.01.13.doc
35/105
Turn inventories as quickly as possible. Inventories may be a big
investment for a firm and they earn no interest. Just-in-time inventory
methods and some other strategies are used to hold down a firm's
investment in inventories.
CLASSIFICATION OF WORKING CAPITAL
Working capital may be classified on the basis of :
Concepts, i.e Gross working capital &Net working capital
Time, i.e Permanent working capital & Temporary working capital
To ensure effective utilization of fixed facilities & for maintaining Circulation of
current assets
Gross working capital
It refers to the firm's investment in current asset current assets are the
assets which can be converted into cash within an accounting year and include
cash short term securities, debtors, bills receivables and stock.
Net working capital
It refers to the difference between current assets and current liabilities.
Current liabilities are those claims of outsiders, which are expected to mature
for payments within an accounting year and include creditors, bills payable,
and outstanding expenses net working capital can be positive and negative.
A positive net working capital will arise when current assets exceed
current liabilities. A negative working capital occurs when current liabilities are
in excess of current assets.
PERMANENT WORKING CAPITAL
This refers to that minimum amount of investment in all current assets which
is required at all times to carry out minimum level of business activities. It
represents the current assets required on a continuing basis over the entire
year.
-
7/30/2019 Minal Jain08.01.13.doc
36/105
Tandon committee has referred to this type of working capital as core current
assets.
The following are the characteristics of this type of working capital:-
1. Amount of permanent working capital remains in the business in one
form or another. This is particularly important from the point of view of
financing. The suppliers of such working capital should not expect its
return during the lifetime of the firm.
2. It also grows with the size of the business.
Permanent working capital is permanently needed for the business and
therefore it should be financed out of long-term funds.This is the reason why
the current ratio has to be substantially more than 1.
TEMPORARY OR VARIABLE WORKING CAPITAL
The amount of such working capital keeps on fluctuating from time to time on
the basis of business activities.
In other words, it represents additional current assets required at different
times during the operating year.
Temporary
Amount of working permanent
-
7/30/2019 Minal Jain08.01.13.doc
37/105
Capital (Rs.)
Time
Temporary
Amount of working permanentCapital (Rs.)
Time
Adequacy of working capital
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 position are dangerous from the firm, s point of
view.
Dangers of excessive working capital are as follows -
It results, in unnecessary accumulation of inventories. Thus, chances of
inventory mishandling, theft waste & losses increase.
It indicates defective credit policy and slack collection period.
Excessive working capital makes management complacent which
degenerates into managerial efficiency.
Excessive working capital means idle funds which means no profit for the
business & the business cannot run properly.
The redundant working capital gives rise to speculative transactions.
Inadequate working capital is also bad and has following
dangers
It stagnates growth. It become difficult for the firm to undertake profitable
projects for non- availability of working capital funds.
-
7/30/2019 Minal Jain08.01.13.doc
38/105
It becomes difficult to implement operating plans and achieve the firms
profit targets.
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.
Shortage of working capital funds renders the firms unable to avail
attractive credit opportunity etc.
The firm losses its reputation when it is not in position to honour its short-
term obligations.
It cannot buy its requirements in bulk.
Factors affecting working capital.
Factors requiring considerations while estimating working capital.
NEED FOR WORKING CAPITAL
For the effective operation of the business, working capital is required along
with the fixed capital. Working capital is needed for the purchase of raw
material and for the payment of various day to day expenses.
There will be hardly any business which does not require working capital. The
need for working capital is different in different businesses. Financial
management aims at maximizing the wealth of shareholders. To achieve this
objective, it is necessary to earn adequate profits. The profit depends largely
on sales but sales do not results cash immediately. To increase sales goods
are to be sold on credit, the collection of which takes place after time terms.
Thus, there exists a gap between the sales of goods and realization of cash.
During this period expenses are to be incurred to continue business
operations. For this purpose, working capital is required. The need of working
capital can be explained with the help of operating cycle or cash cycle.
-
7/30/2019 Minal Jain08.01.13.doc
39/105
WORKING CAPITAL REQUIREMENT FOR THE ANTICIPATED
NEEDS FOR FUTURE
These needs may be of Raw Material or Finished Goods. Sometimes
because of non-availability of Raw Material or due to seasonal availability of
Raw Material some advances stock of Raw material becomes necessary for
company. In the similar way due to sudden arise of demand of finished goods
in future more finished goods are kept in stock. For both reason more working
capital is required because funds will be involve in these safeties stocks.
FACTORS AFFECTING THE WORKING CAPITAL
The following are the factors that affect the working capital
The nature of the business
Size of the business
Production policy
Technology Manufacturing process
Seasonal variation
Credit policy
Market and demand conditions
Working capital cycle
Business cycle
Rate of growth of business
Earning capacity and dividend policy
Price level change
-
7/30/2019 Minal Jain08.01.13.doc
40/105
FACTORS REQUIRING CONSIDERATION WHILE ESTIMATING
WORKING CAPITAL
The cost incurred on material, wages and overheads.
The length of time for which raw materials are store in warehouse before
they are issued for production.
The length of production cycle of work.
Average credit period allowed to customer.
The amount of cash required for the day to day expenses of the business.
The average amount of cash required to make advance payment.
COMPONENT OF WORKING CAPITAL MANAGEMENT
Working Capital Management involves management of different components
of working capital such as cash, inventories, accounts receivables, creditors,
debtors etc.
Years 2006-07 2007-08 2008-09
Net Profit 1195816024 3148053854 5699574452
Change in % -45.27% 163.26% 81.05%
-
7/30/2019 Minal Jain08.01.13.doc
41/105
0
1000
2000
3000
4000
5000
6000
Net Profit (inlacs)
2006-07
Year 2007-08
Year 2008-09
SCOPE OF WORKING CAPITAL MANAGEMENT
The study is conducted at CADBURY INDIA LTD-BADDI, H.P. for 6 weeks
duration. The study of Working Capital Management is purely based on
secondary data and all the information is available within the company itself in
the form of records. To get proper understanding of this concept, I have done
the study of the annual report of the company. So scope of the study islimited up to the availability of official records and information provided by the
employees. The study is supposed to be related to the period of last five
years.
DETERMINATION OF FINANCIAL MIX
Hedging Approach - Hedging refer to the process of matching maturities of
debt with the maturities of financial needs. According to this approach maturity
of the source of funds should match the nature of the assets to be financed.
The Hedging approach suggests that long term funds should- be used to
finance the fixed portion of current assets requirement, in manner similar to the
financing of fixed assets .the permanent portion of funds required should be
financed with long term funds and the seasonal portion with short term funds.
Conservative approach- This approach suggest that the estimated
requirement of total funds should be met from long term sources, the short-
http://should.be/http://should.be/ -
7/30/2019 Minal Jain08.01.13.doc
42/105
term funds should be restricted to only emergency situation or when there is an
unexpected outflow of funds.
Trade-off approach - The third- approach of trade off between the hedging
and conservative approach strikes a balance and provides a financial plan thatlies between these two extremes. Trade-off is required because it has been
shown that hedging approach is associated with high profit & high risk while
conservative approach provides low profit and low risk. Neither approach by
itself would serve the purpose of efficient working capital management. The
exact trade-off between risk and profitability will differ from case to case
according to perception of the decision-makers.
MANAGING WORKING CAPITAL
Working capital refers to all aspects of the administration of both current
assets and current liabilities.
In other words, working capital management is concerned with the problems
that arise in attempting to manage the current assets, the current liabilities
and the interrelationships that exist between them.
Moreover, different components of working capital are to be properly balanced
in such a way that during one complete production or trade cycle the cash
should be available for purchase of fresh material and for running the
business including operating expenses, after realization of sale proceeds of
earlier cycle without any hurdles.
In the absence of such situation, the financial position in respect of the firms
liquidity may not be satisfactory in spite of satisfactory liquidity ratio.
Working capital management policy have a great effect on firms profitability,
liquidity and its structural health.
A finance manager should therefore, chalk out appropriate working capital
management policies in respect of each of the components of working capital
so as to ensure higher profitability, proper liquidity and sound structural healthof the organization.
-
7/30/2019 Minal Jain08.01.13.doc
43/105
In order to achieve this objective the finance manager has to perform basically
following two functions: -
1) Estimating the amount of working capital.
2) Sources from which these funds have to be raised.
ESTIMATING WORKING CAPITAL REQUIREMENTS: -
In order to determine the amount of working capital needed by a firm, a
number of factors viz. production policies, nature of business, length of
manufacturing process, rapidity of turnover, seasonal fluctuations, etc. are to
be considered by the finance manager.
TECHNIQUES FOR ASSESSMENT OF WORKING CAPITAL
REQUIREMENTS: -
1. ESTIMATION OF COMPONENTS OF WORKING CAPITAL METHOD: -
Since working capital is the excess of current assets over current liabilities, an
assessment of the working capital requirements can be made by estimating
the amounts of different constituents of working capital e.g., inventories,
accounts receivable, cash, accounts payable, etc.
2. PERCENT OF SALES APPROACH:-
This is a traditional and simple method of estimating working capital
requirements. According to this method, on the basis of past experience
between sales and working capital requirements, a ratio can be determined
for estimating the working capital requirements in future.
3.OPERATING CYCLE APPROACH: -
According to this approach, the requirements of working capital depend upon
the operating cycle of the business.The operating cycle begins with theacquisition of raw materials and ends with the collection of receivables
-
7/30/2019 Minal Jain08.01.13.doc
44/105
It may be broadly classified into the following four stages viz.
1. Raw materials and stores storage stage.
2. Work-in-progress stage.
3. Finished goods inventory stage.4. Receivables collection stage.
The duration of the operating cycle for the purpose of estimating working
capital requirements is equivalent to the sum of the durations of each of these
stages less the credit period allowed by the suppliers of the firm.
Symbolically the duration of the working capital cycle can be put as follows
O=R+W+F+D-C
Where,
O=Duration of operating cycle;
R=Raw materials and stores storage period;
W=Work-in-progress period;
F=Finished stock storage period;
D=Debtors collection period;
C=Creditors payment period.
Each of the components of the operating cycle can be calculated as
follows:-
R= Average stock of raw materials and stores
Average raw materials and stores consumptions per day
W=Average work-in-progress inventory
Average cost of production per day
D=Average book debts
Average credit sales per day
-
7/30/2019 Minal Jain08.01.13.doc
45/105
C=Average trade creditors
Average credit purchases per day
After computing the period of one operating cycle, the total number of
operating cycles that can be computed during a year can be computed by
dividing 365 days with number of operating days in a cycle. The total
expenditure in the year when year when divided by the number of operating
cycles in a year will give the average amount of the working capital
requirement.
Management of different components of working capitalWorking capital management involves management of different components
of working capital such as cash, inventories, accounts receivable, creditors,
etc.
(1) MANAGEMENT OF CASH
It is the duty of the finance manager to provide adequate cash to all segmentsof the organization. He also has to ensure that no funds are blocked in idle
cash since this will involve cost in terms of interest to the business. A sound
cash management scheme, therefore, maintains the balance between the
twin objectives of liquidity and cost.
Meaning of cash
The term cash with reference to cash management is used in two senses. In
a narrower sense it includes coins, currency notes, cheques, bank drafts held
by a firm with it and the demand deposits held by it in banks.In a broader
sense it also includes near-cash assets such as, marketable securities and
time deposits with banks. Such securities or deposits can immediately be
sold or converted into cash if the circumstances require. The term cash
management is generally used for management of both cash and near-cash
assets.
-
7/30/2019 Minal Jain08.01.13.doc
46/105
Motives for holding cash
A distinguishing feature of cash as an asset, irrespective of the firm in which it
is held, is that it does not earn any substantial return for the business. In spite
of this fact cash is held by the firm with following motives
1.Transaction motive
A firm enters into a variety of business transactions resulting in both inflows
and outflows. In order to meet the business obligation in such a situation, it is
necessary to maintain adequate cash balance. Thus, cash balance is kept by
the firms with the motive of meeting routine business payments.
2.Precautionary motive
A firm keeps cash balance to meet unexpected cash needs arising out of
unexpected contingencies such as floods, strikes, presentment of bills for
payment earlier than the expected date, unexpected slowing down of
collection of accounts receivable, sharp increase in prices of raw materials,
etc. The more is the possibility of such contingencies more is the cash kept by
the firm for meeting them.
3.Speculative motive
A firm also keeps cash balance to take advantage of unexpected
opportunities, typically outside the normal course of the business. Such
motive is, therefore, of purely a speculative nature.
For example-A firm may like to take advantage of an opportunity of
purchasing raw materials at the reduced price on payment of immediate cashor delay purchase of raw materials in anticipation of decline in prices.
4.Compensation motive
Banks provide certain services to their clients free of charge. They, therefore,
usually require clients to keep a minimum cash balance with them, which help
them to earn interest and thus compensate them for the free services so
provided.Business firms normally do not enter into speculative activities and,
-
7/30/2019 Minal Jain08.01.13.doc
47/105
therefore, out of the four motives of holding cash balances, the two most
important motives are the compensation motive.
Objectives of cash management
There are two basic objectives of cash management:
1. To meet the cash disbursement needs as per the payment schedule;
2. To minimize the amount locked up as cash balances.
1.Meeting cash disbursements
The first basic objective of cash management is to meet the payments
Schedule. In other words, the firm should have sufficient cash to meet the
various requirements of the firm at different periods of times. The business
has to make payment for purchase of raw materials, wages, taxes, purchases
of plant, etc. The business activity may come to a grinding halt if the payment
schedule is not maintained. Cash has, therefore, been aptly described as the
oil to lubricate the ever-turning wheels of the business, without it the process
grinds to a stop.
2.minimizing funds locked up as cash balances
The second basic objective of cash management is to minimize the amount
locked up as cash balances. In the process of minimizing the cash balances,
the finance manager is confronted with two conflicting aspects. A higher cash
balance ensures proper payment with all its advantages. But this will result in
a large balance of cash remaining idle. Low level of cash balance may result
in failure of the firm to meet the payment schedule. The finance manager
should, therefore, try to have an optimum amount of cash balance keeping the
above facts in view.
Cash management - - - - - basic problems
Cash management involves the following four basic problems:
-
7/30/2019 Minal Jain08.01.13.doc
48/105
1. Controlling levels of cash;
2. Controlling inflows of cash;
3. Controlling outflows of cash;
4. Optimum investment of surplus cash.
1. Controlling levels of cash
One of the basic objectives of cash management is to minimize the level of
cash balance with the firm.
This objective is sought to be achieved by means of the following: -
(i)Preparing cash budget:
Cash budget or cash forecasting is the most significant device for planning
and controlling the use of cash. It involves a projection of future cash receipts
and cash disbursements of the firm over various intervals of time. It reveals to
the finance manager the timings and amount of expected cash inflows and
outflows over a period studied. With this information, he is better able to
determine the future cash needs of the firm, plan for the financing of these
needs and exercise control over the cash and liquidity of the firm.
Thus in case a cash budget is properly prepared it correctly reveals the
timings and size of net cash flows as well as the periods during which the
excess cash may be available for temporary investment. In a small company,
the preparation of cash budget or a cash forecast does not involve much of
complications and, therefore, relatively a minor job. However, in case of big
companies, it is almost a full time job handled by a senior person, namely, the
budget controller or the treasurer.
(ii) Providing for unpredictable discrepancies:
Cash budget predicts discrepancies between cash inflows and outflows on the
basis of normal business activities. It does not take into account discrepancies
between cash inflows and cash outflows on account of unforeseen
circumstances such as strikes, short-term recession, floods, etc. a certain
-
7/30/2019 Minal Jain08.01.13.doc
49/105
minimum amount of cash balance has, therefore, to be kept for meeting such
unforeseen contingencies. Such amount is fixed on the basis of past
experience and some intuition regarding the future.
(iii) Consideration of short costs:
The term short cost refers to the cost incurred as a result of shortage of
cash. Such costs may take any of the following forms:
(a) The failure of the firm to meet its obligations in time may result in legal
action by the firms creditors against the firm. This cost is in terms of
fall in the firms reputation besides financial costs incurred in defending
the suit;
(b) Borrowing may have to be resorted to at high rate of interest. The firm
may also be required to pay penalties, etc., to banks for not meeting
the obligations in time.
(iv) Availability of other sources of funds:
A firm can avoid holding unnecessary large balance of cash for contingencies
in case it has adequate arrangements with its bankers for borrowing money intimes of emergencies. For such arrangements the firm has to pay a slightly
higher rate of interest than that on a long-term debt. But considerable saving
in interest costs will be effected because such interest will have to be paid
only for shorter period.
2. Controlling inflows of cash
Having prepared the cash budget, the finance manager should also ensure
that there is no significant deviation between the projected cash inflows and
the projected cash outflows. This requires controlling of both inflows as well
as outflows of cash.Speedier collection of cash can be made possible by
adoption of the following techniques, which have been found to be quite
useful and effective.
(i) Concentration Banking:
-
7/30/2019 Minal Jain08.01.13.doc
50/105
Concentration banking is a system of decentralizing collections of accounts
receivables in case of large firms having their business spread over a large
area. According to this system, a large number of collection centers are
established by the firm in different areas selected on geographical basis. The
firm opens its bank accounts in local banks of different areas where it has its
collection centers. The collection centers are required to collect cheques from
their customers and deposits them in the local bank account. Instructions are
given to the local collection centers to transfer funds over a certain limit daily
telegraphically to the bank at the head office. This facilitates fast movements
of funds. The companys treasurer on the basis of the daily report received
from the head office bank about the collected funds can use them for
disbursement according to needs.
This system of concentration banking results in the following advantages:
(a) The mailing time is reduced since the collection centers themselves
collect cheques from the customers and immediately deposit them in
local bank accounts. Moreover, when the local collection centres are
also used to prepare and send bills to the customers in their areas, the
mailing time in sending bills to the customer is also reduced;
(b) The time required to collect cheques is also reduced since the cheques
deposited in the local bank accounts are usually drawn on banks in that
area.
This helps in quicker collection of cash.
(ii) Lock-box system:
Lock-box system is a further step in speeding up collection of cash. In
case of concentration banking cheques are received by collection centres
who, after processing, deposit them in the local bank accounts. Thus, there is
time gap between actual receipt of cheques by a collection centre and its
actual depositing in the local bank account.Lock-box system has been
devised to eliminate delay on account of this time gap.According to thissystem, the firm hires a post-office box and instructs its customers to mail
-
7/30/2019 Minal Jain08.01.13.doc
51/105
their remittances to the box. The firms local bank is given the authority to pick
the remittances directly from the post-office box. The bank picks up the mail
several times a day and deposits the cheques in the firms account. Standing
instructions are given to the local bank to transfer funds to the head office
bank when they exceed a particular limit.
The Lock-Box system offers the following advantages:
(a) All remittances are handled by the banks even prior to their de3posits
with them at a very low cost;
(b) The cheques are deposited immediately upon receipt of remittances
and the collecting process starts much earlier than that under the
system of concentration banking.
3.control over cash flows
An effective control over cash outflows or disbursements also helps a firm in
conserving cash and reducing financial requirements. However, there is a
basic difference between the underlying objective of exercising control over
cash inflows and cash outflows. In case of the former, the objective is the
maximum acceleration of collections while in the case of latter, it is to slow
down the disbursements as much as possible. The combination of fast
collections and slow disbursements will result in maximum availability of
funds.
A firm can advantageously control outflows of cash if the following
considerations are kept in view:
(i) Centralized system of disbursement should be followed ascompared to decentralized system in case of collections. All
payments should be made from a single control account. This
will result in delay in presentment of cheques for payment by
parties who are away from the place of control account.
(ii) Payments should be made on the due dates, neither before
nor after. The firm should neither lose cash discount nor its
prestige on account of delay in payments. In other words, thefirm should pay within the terms offered by the suppliers.
-
7/30/2019 Minal Jain08.01.13.doc
52/105
(iii) The firm may use the technique of playing float for
maximizing the availability of funds. The term float refers to the
period taken from one stage to another in the cash collection
process.
4. Investing surplus cash
(i) Determination of the amount of surplus cash;
(ii) Determination of the channels of investments.
(i) Determining of surplus cash
Surplus cash is the cash in excess of the firms normal cash requirements.
While determining the amount of surplus cash, the finance manager has to
take into account the minimum cash balance that the firm must keep to avoid
risk or cost of running out of funds. Such minimum level may be termed a
safety level of cash.
(ii) Determining of channels of investments
The finance manager can determine the amount of surplus cash, by
comparing the actual mount of cash available with the safety or minimum level
of cash. Such surplus may be either of a temporary or a permanent nature.
Criteria for investment
In most of the companies there are usually no written instructions for investing
the surplus cash. It is left to the discretion and judgement; he usually takes
into consideration the following factors:
(i) Security:
-
7/30/2019 Minal Jain08.01.13.doc
53/105
This can be ensured by investing money in securities whose price remain
more or less stable.
(ii) Liquidity:
This can be ensured by investing money in short-term securities including
short-term fixed deposits with bank.
(iii) Yield:
Most corporate managers give less emphasis to yield as compared to security
and liquidity of investment. They, therefore, prefer short-term government
securities for investing surplus cash. However, some corporate managers
follow aggressive investment policies, which maximize the yield on their
investments.
(iv) Maturity:
Surplus cash is available not for an indefinite period. Hence, it will be
advisable to select securities according to their maturities keeping in view the
period for which surplus cash is available. If such selection is done carefully,
the finance manager can maximize the yield as well as maintain the liquidity
of investments.
Cash management models
Several types of cash management models have been recently designed to
help in determining optimum cash balance. These models are interesting and
are beginning to be used in practice.
Two of such models are given below:
1. Baumol model: -
This model was suggested by William J Baumol. It is similar to one used for
determination of economic order quantity. According to this model, optimum
-
7/30/2019 Minal Jain08.01.13.doc
54/105
cash level is that level of cash where the carrying costs and transactions costs
are the minimum.
Carrying costs
This refers to the cost of holding cash, namely, the interest foregone on
marketable securities. They may also be termed as opportunity cost of
keeping cash balance.
Transaction costs
This refers to the cost involved in getting the marketable securities converted
into cash. This happens when the firm falls short of cash and to sell the
securities resulting in clerical, brokerage, registration and other costs.
There is an inverse relationship between the two costs. When one increases,
the other decreases, the other decreases. Hence, optimum cash level will be
at that point where these two costs are equal.
The formula for determining optimum cash balance can be put as follows:
C= 2U x P
S
Where,
C = Optimum cash balance
U = Annual (or monthly) cash disbursements
P = Fixed costs per transaction
S = Opportunity cost of one rupee p.a. (p.m)
2. Miller-Orr Model
-
7/30/2019 Minal Jain08.01.13.doc
55/105
Baumol model is not suitable in those circumstances when the demand for
cash is not steady and cannot be known in advance. Miller-Orr model helps in
determining the optimum level of cash in such circumstances. It deals with
cash management problem under the assumption of stochastic or random
cash flows by laying down control limits for cash balances. These limits
consist of an upper limit (h), lower limit (o) and return point (z). When cash
balance reaches the upper limit, a transfer of cash equal to h-z is affected to
marketable securities. When it touches the lower limit, a transfer equal to z-o
from marketable securities to cash is made. No transaction between cash to
marketable securities and marketable securities to cash is made during the
period when the cash balance stays between the high and low limits.
The model is illustrated in the form of the following chart
Upper control limit
h
Cash balance
z Return point
O Lower control limit
Time
-
7/30/2019 Minal Jain08.01.13.doc
56/105
The above chart shows that when cash balances reaches the upper limit,
an account equal to h-z is invested in the marketable securities and cash
balance comes down to z level. When cash balance touches the lower
limit marketable securities of the value of z-o are sold and the cashbalance again goes up to z level. The upper limit and lower limit are set
on the basis of opportunity cost of holding cash; degree of likely fluctuation
in cash balances and the fixed costs associated with securities
transactions.
(2) MANAGEMENT OF INVENTORIES
Inventories are good held for eventual sale by a firm. Inventories are thus one
of the major elements, which help the firm in obtaining the desired level of
sales.
Kinds of inventories
Inventories can be classified into three categories.
(i) Raw materials:
These are goods, which have not yet been committed to production in a
manufacturing firm. They may consist of basic raw materials or finished
components.
ii) Work-in-progress:
This includes those materials, which have been committed to production
process but have not yet been completed.
(iii) Finished goods:
These are completed products awaiting sale. They are the final output of the
production process in a manufacturing firm. In case of wholesalers and
retailers, they are generally referred to as merchandise inventory.
The levels of the above three kinds of inventories differ depending upon the
nature of the business.
-
7/30/2019 Minal Jain08.01.13.doc
57/105
Benefits of holding inventories
Holding of inventories helps a firm in separating the process of purchasing,
producing and selling. In case a firm does not hold sufficient stock of raw
materials, finished goods, etc., the purchasing would take place only when the
firm receives the order from a customer. It may result in delay in executing the
order because of difficulties in obtaining/ procuring raw materials, finished
goods, etc. thus inventories provide cushion so that the purchasing,
production and sales functions can proceed at optimum speed.
The specific benefits of holding inventories can be put as follows:
(i) Avoiding losses of sales
If a firm maintains adequate inventories it can avoid losses on account of
losing the customers for non-supply of goods in time.
(ii) Reducing ordering cost
The variable cost associated with individual orders, e.g., typing, checking,
approving and mailing the order, etc., can be reduced if a firm places a few
large orders than numerous small orders.
(iii) Achieving efficient production runs
Maintenance of large inventories helps a firm in reducing the set-up cost
associated with each production run.
Risks and costs associated with inventories
Holding of inventories exposes the firm to a number of risks and costs. Risk of
holding inventories can be put as follows:
(i) Price decline
-
7/30/2019 Minal Jain08.01.13.doc
58/105
This may be due to increase in the market supply of the product, introduction
of a new competitive product, price cutting by the competitors, etc.
(ii) Product deterioration
this may due to holding a product for too long a period or improper storage
conditions.
(iii) Obsolescence
This may be due to change in customers taste, new production technique,
improvements in the product design, specifications, etc.
The costs of holding inventories are as follows:
(i) Materials cost
This includes the cost of purchasing the goods, transportation and handling
charges less any discount allowed by the supplier of the goods.
(ii) Ordering cost
This includes the variable cost associated with placing an order for the goods.
The fewer the orders, the lower will be the ordering costs for the firm.
(iii) Carrying cost
This includes the expenses for storing the goods. It comprises storage costs,
insurance costs, spoilage costs, cost of funds tied up in inventories, etc.
Management of inventory
Inventories often constitute a major element of the total working capital and
hence it has been correctly observed, good inventory management is good
financial management.Inventory management covers a large number of
issues including fixation of minimum and maximum levels; determining the
size of the inventory to be carried ; deciding about the issue price policy;
setting up receipt and inspection procedure; determining the economic order
quantity; providing proper storage facilities, keeping check on obsolescence
and setting up effective information system with regard to the inventories.
However, management inventories involves two basic problems:
-
7/30/2019 Minal Jain08.01.13.doc
59/105
(i) Maintaining a sufficiently large size of inventory for efficient
and smooth production and sales operations;
(ii) Maintaining a minimum investment in inventories to
minimize the direct-indirect costs associated with holding
inventories to maximize the profitability.
Inventories should neither be excessive nor inadequate. If inventories are kept
at a high level, higher interest and storage costs would be incurred. On the
other hand, a low level of inventories may result in frequent interruption in the
production schedule resulting in underutilization of capacity and lower sales.
objective of inventory management
(i) Ensuring a continuous supply of materials to production
department facilitating uninterrupted production.
(ii) Maintaining sufficient stock of raw material in periods of
short supply.
(iii) Maintaining sufficient stock of finished goods for smooth
sales operations.
(iv) Minimizing the carrying costs.
(v) Keeping investment in inventories at the optimum level.
Techniques of inventory management
Effective inventory requires an effective control over inventories.
Inventory control refers to a system which ensures supply of required quantity
and quality of inventories at the required time and the same time prevent
unnecessary investment in inventories.
The techniques of inventory control/ management are as follows:
1. Determination of Economic Order Quantity (EOQ)
Determination of the quantity for which the order should be placed is one of
the important problems concerned with efficient inventory management.
Economic Order Quantity refers to the size of the order, which gives
-
7/30/2019 Minal Jain08.01.13.doc
60/105
maximum economy in purchasing any item of raw material or finished product.
It is fixed mainly taking into account the following costs.
(i) Ordering costs:
It is the cost of placing an order and securing the supplies. It varies from time
to time depending upon the number of orders placed and the number of items
ordered. The more frequently the orders are placed, and fewer the quantities
purchased on each order, the greater will be the ordering costs and vice
versa.
(ii) Inventory carrying cost:
it is the cost of keeping items in stock. It includes interest on investment,
obsolescence losses, store-keeping cost, insurance premium, etc. The
larger the value of inventory, the higher will be the inventory carrying cost
and vice versa.
The former cost may be referred as the cost of acquiring while the latter as
the cost of holding inventory. The cost of acquiring decreases while the cost
of holding increases with every increase in the quantity of purchase lot. A
balance is, therefore, struck between the two opposing factors and theeconomic ordering quantity is determined at a level for which aggregate of two
costs is the minimum.
Formula:
Q = 2U x P
S
Where,
Q = Economic Ordering Quantity
U = Quantity (units) purchased in a year (month)
P = Cost of placing an order
-
7/30/2019 Minal Jain08.01.13.doc
61/105
S = Annual (monthly) cost of storage of one unit.
2. Determination of optimum production quantity
The EOQ model can be extended to production runs to determine the
optimum production quantity.
The two costs involved in this process are:
(i) Set up costs;
(ii) Inventory carrying cost.
The set up cost is of the nature of fixed cost and is to be incurred at the timeof commencement of each production run. Larger the size of the production
run, lower will be the set-up cost per unit.
However, the carrying cost will increase with increase in the size of the
production run. Thus, there is an inverse relationship between the set-up cost
and inventory carrying cost. The optimum production size is at that level
where the total of the set-up cost and the inventory carrying cost is the
minimum. In other words, at this level the two costs will be equal.
The formula for EOQ can also be used for determining the optimum
production quantity as given below:
E = 2U x P
S
Where
E = Optimum production quantity
U = Annual (monthly) output
P = Set-up cost for each production run
S = Cost of carrying inventory per annum (per month)
(3) MANAGEMENT OF ACCOUNTS RECEIVABLES
-
7/30/2019 Minal Jain08.01.13.doc
62/105
Accounts receivables (also properly termed as receivables) constitute a
significant portion of the total currents assets of the business next after
inventories. They are direct consequences of trade credit which has become
an essential marketing tool in modern business.
When a firm sells goods for cash, payments are received immediately and,
therefore, no receivables are credited. However, when a firm sells goods or
services on credit, the payments are postponed to future dates and
receivables are created. Usually, the credit sales are made on open account,
which means that, no, formal acknowledgements of debt obligations are taken
from the buyers. The only documents evidencing the same are a purchase
order, shipping invoice or even a billing statement.
Meaning of receivables
Receivables are assets accounts representing amounts owed to the firm as a
result of sale of goods / services in the ordinary course of business.
They, therefore, represent the claims of a firm against its customers and are
carried to the assets side of the balance sheet under titles such as accounts
receivables, customer receivables or book debts. They are, as stated earlier,
the result of extension of credit facility to then customers a reasonable period
of time in which they can pay for the goods purchased by them.
Purpose of receivables
Accounts receivables are created because of credited sales. Hence the
purpose of receivables is directly connected with the objectives of making
credited sales.
The objectives of credited sales are as follows:
(i) Achieving growth in sales:
If a firm sells goods on credit, it will generally be in a position to sell more
goods than if it insisted on immediate cash payments. This is because many
customers are either not prepared or not in a position to pay cash when they
purchase the goods. The firm can sell goods to such customers, in case itresorts to credit sales.
-
7/30/2019 Minal Jain08.01.13.doc
63/105
(ii) Increasing profits:
increase in sales results in higher profits for the firm not only because of
increase in the volume of sales but also because of the firm charging a higher
margin of profit on credit sales as compared to cash sales.
(iii) Meeting competition:
A firm may have to resort to granting of credit facilities to its customers
because of similar facilities being granted by the competing firms to avoid the
loss of sales from customers who would buy elsewhere if they did not receive
the expected output.
Costs of maintaining receivables
The costs with respect to maintenance of receivables can be identified as
follows:
1. Capital costs:
Maintenance of accounts receivables results in blocking of the firms financial
resources in them. This is because there is a time lag between the sale of
goods to customers and the payments by them. The firm has, therefore, to
arrange for additional funds top meet its own obligations, such as payment to
employees, suppliers of raw materials, etc., while awaiting for payments from
its customers. Additional funds may either be raised from outside or out ofprofits retained in the business. In both the cases, the firm incurs a cost. In the
former case, the firm has to pay interest to the outsider while in the latter
case, there is an opportunity cost to the firm, i.e., the money which the firm
could have earned otherwise by investing the funds elsewhere.
2. Administrative costs:
The firm has to incur additional administrative costs for maintaining accounts
receivable in the form of salaries to the staff kept for maintaining accounting
-
7/30/2019 Minal Jain08.01.13.doc
64/105
records relating to customers, cost of conducting investigation regarding
potential credit customers to determine their creditworthiness, etc.
3. Collection costs:
The firm has to incur costs for collecting the payments from its credit
customers. Sometimes, additional steps may have to be taken to recover
money from defaulting customers.
4. Defaulting costs:
Sometimes after making all serious efforts to collect money from defaulting
customers, the firm may not be able to recover the overdues because of the
of the inability of the customers. Such debts are treated as bad debts and
have to be written off since they cannot be realized.
Factors affecting the size of receivables
The size of the receivable is determined by a number of factors.
Some of the important factors are as follows:
(1) Level of sales:
This is the most important factor in determining the size of accountsreceivable. Generally in the same industry, a firm having a large volume of
sales will be having a larger level of receivables as compared to a firm with a
small volume of sales.
Sales level can also be used for forecasting change in accounts receivable.
(2) Credited policies:
The term credit policy refers to those decision variables that influence the
amount of trade credit, i.e., the investment in receivables. These variables
include the quantity of trade accounts to be accepted, the length of the credit
period to be extended, the cash discount to be given and any special terms to
be offered depending upon particular circumstances of the firm and the
customer. A firms credit policy, as a matter of fact, determines the amount of
risk the firm is willing to undertake in its sales activities. If a firm has a lenient
or a relatively liberal credit policy, it will experience a higher level of
receivables as compared to a firm with a more rigid or stringent credit policy.
-
7/30/2019 Minal Jain08.01.13.doc
65/105
This is because of two reasons:
(i) A lenient credit policy encourages even the financially
strong customers to make delays in payments
resulting in increasing the size of the accountsreceivables;
(ii) Lenient credit policy will result in greater defaults in
payments by financially weak customers thus resulting
in increasing the size of receivables.
(3) Terms of trade:The size of the receivables is also affected by terms of
trade (or credit terms) offered by the firm.
The two important components of the credit terms are:
(i) Credit period;
(ii) Cash discount.
(i) Credit period:
The term credit period refers to the time duration for which credit is extended
to the customers. It is generally expressed in terms of net days.
For example-If a firms credit terms are net 15, it means the customers are
expected to pay within 15 days from the date of credit sale.
(ii) Cash discount:
Most firms offer cash discount to their customers for encouraging them to pay
their dues before the expiry of the credit period. The terms of the cash
discounts indicate the rate of discount as well as the period for which the
discount has been offered.
(4) MANAGEMENT OF ACCOUNTS PAYABLE
Management of accounts payable is as much important as management of
accounts receivable. There is a basic difference between the approach to be
adopted by the finance manager in the two cases. Whereas the underlying
-
7/30/2019 Minal Jain08.01.13.doc
66/105
objective in case of accounts receivable is to maximize the acceleration of the
collection process, the objective in case of accounts payable is to slow down
the payments process as much as possible. But it should be noted that the
delay in payment of accounts payable may result in saving of some interest
costs but it can prove very costly to the firm in the form of loss credit in the
market. The finance manager has, therefore, to ensure that the payments
after obtaining the best credit terms possible.
Overtrading and undertrading
The concepts of overtrading and undertrading are intimately connected with
the net working capable position of the business. To be more precise they are
connected with the cash position of the business.
OVERTRADING:
Overtrading means an attempt to maintain or expand scale of operations of
the business with insufficient cash resources. Normally, concerns having
overtrading have a high turnover ratio and a low current ratio. In a situation
like this, the company is not in a position to maintain proper stocks of
materials, finished goods, etc., and has to depend on the mercy of the
suppliers to supply them goods at the right time. It may also not be able to
extend credit to its customers, besides making delay in payment to the
creditors. Overtrading has been amply described as overblowing the
balloon. This may, therefore, prove to be dangerous to the business since
disproportionate increase in the operations of the business without adequate
resources may bring its sudden collapse.
Causes of overtrading
The following may be the causes of over-trading:
(i) Depletion of working capital:
Depletion of working capital ultimately results in depletion of cash
resources. Cash resources of the company may get depleted by premature
repayment of long-term loans, excessive drawings, dividend payments,
purchase of fixed assets and excessive net trading losses, etc.
-
7/30/2019 Minal Jain08.01.13.doc
67/105
(ii) Faulty financial policy:
Faulty financial policy can result in shortage of cash and overtrading in
several ways:
(a) Using working capital for purchase of fixed assets.
(b) Attempting to expand the volume of the business without raising the
necessary resources, etc
(iii) Over-expansion:
In national emergencies like war, natural calamities, etc., a firm may berequired to produce goods on a larger scale. Government may pressurize the
manufacturers to increase the volume of production without providing for
adequate finances. Such pressure results in over-expansion of the business
ignoring the elementary rules of sound finance.
(iv) Inflation and rising prices:
Inflation and rising prices make renewals and replacements of assets costlier.
The wages and material costs also rise. The manufacturer, therefoe, needs
more money even to maintain the existing level of activity.
(v) Excessive taxation:
Heavy taxes result in depletion of cash resources at a scale higher than what
is justified.The cash position is further strained on account of efforts of the
company to maintain reasonable dividend rates for their shareholders
Consequences of overtrading
The consequences of over-trading can be summarized as follows:
-
7/30/2019 Minal Jain08.01.13.doc
68/105
(i) Difficulty in paying wages and taxes:
This is one of the most dangerous consequences of overtrading. Non-
payments of wages in time create a feeling of uncertainty, insecurity and
dissatisfaction in all ranks of the labour. Non-payments of taxes in time mayresult in bringing down the reputation of the company considerably in the
business and government circles.
(ii) Costly purchases:
The company has to pay more for its purchases on account of its inability to
have proper bargaining, bulk buying and selecting proper source of supplying
quality materials.
(iii) Reduction in sales:
The company may have to suffer in terms of sales because the pressure for
cash requirements may force it to offer liberal cash discounts to debtors for
prompt payments, as well as selling goods at throwaway prices.
(iv) Difficulties in making payments:
The shortage of cash will force the company to persuade its creditors to
extend credit facilities to it. Worry, anxiety and fear will be the managements
constant companions.
(v) Obsolete plant and machinery: Shortage of cash will force the company to delay
even the necessary repairs and renewals. Inefficient working, unavoidable
breakdowns will have an adverse effect both on volume of production and rate of
profit.
Symptoms and remedies for overtrading
The situation of overtrading should be remedied at the earliest possible
opportunity, i.e., as soon as its first symptoms are visible.
The symptoms can be put as follows:
(a) A higher increase in the amount of creditors as compared to debtors.
This is because of firms inability to pay its creditors in time and
exercising of undue pressure on debtors for payments;
(b) Increased bank borrowing with corresponding increase in inventories;
-
7/30/2019 Minal Jain08.01.13.doc
69/105
(c) Purchase of fixed assets out of short-term funds;
(d) A fall in the working capital turnover (working capital/sales) ratio.
(e) A low current ratio and high turnover ratio.
The cure for overtrading is easier to prescribe but difficult to follow. The cure
is simple-reduce the business or increase finance. Both are difficult. However,
arrangement of more finance is better. If this is not possible, the only
advisable course left will be to sell the business as a going concern.
UNDERTRADING:
It is the reverse of overtrading. It means improper and underutilization of
funds lying at the disposal of the undertaking. In such a situation the level of
trading is low as compared to the capital employed in the business. It results
in increase in the size of inventories, book debts and cash balances.
Undertrading is a matter of fact an aspect of overcapitalization. The basic
cause of undertrading is, therefore, underutilization of the firms resources.
Such underutilization may be due any one or more of the following causes: