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T.Y.B.M.S. K.C. COLLEGE GROUP NO. - 6

Group Members:

HARSH BATHEJA VALEN FERNANDES NIPUL JAIN NIKITA PARYANI SAUMYA SARASWAT SAHEJ SETHI

03 11 18 32 39 42

ACKNOWLEDGEMENT

We, as students of K.C.College from third year BMS have a great pleasure in presenting our efforts of studying the WORKING CAPITAL MANAGEMENT project in a satisfactory and appreciable form. We would like to particularly like to thank our Professor MR. JUSTIN for granting us the opportunity to work on this project. We offer our heartfelt thanks to Ms. Manju Nichani (Principal Of K.C.College) and Mr. Kailash Chandak (HOD BMS Department) for their enthusiasm & contribution towards our project. Her sessions enhanced our knowledge about the mounting and the specifications helped us to establish a suitable framework of this project. Our efforts have been a success due to the immense help available on the internet and books.

INDEX:
Introduction5 Kinds of Working Capital..6 Working Capital Cycle...9 Consequences of Under Assessment of Working capital.10 Consequences of Over Assessment of Working capital...10 Factors influencing Working Capital11 Financing Working Capital....13 Format of Working Capital...14 Ratios relating to Working capital.16 Conclusion..18

INTRODUCTION:
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Every business needs investment to procure fixed assets, which remain in use for a longer period. Money invested in these assets is called Long term Funds or Fixed Capital. Business also needs funds for short-term purposes to finance current operations. Investment in short term assets like cash, inventories, debtors etc., is called Short-term Funds or Working Capital. The Working Capital can be categorised, as funds needed for carrying out day-to-day operations of the business smoothly. The management of the working capital is equally important as the management of long-term financial investment. Every running business needs working capital. Even a business which is fully equipped with all types of fixed assets required is bound to collapse without the following: (i) adequate supply of raw materials for processing; (ii) cash to pay for wages, power and other costs; (iii) creating a stock of finished goods to feed the market demand regularly; and, (iv) the ability to grant credit to its customers. All these require working capital. Working capital is thus like the lifeblood of a business. The business will not be able to carry on day-to-day activities without the availability of adequate working capital. Working capital cycle involves conversions and rotation of various constituents/ components of the working capital. Initially cash is converted into raw materials. Subsequently, with the usage of fixed assets resulting in value additions, the raw materials get converted into work in process and then into finished goods. When sold on credit, the finished goods assume the form of debtors who give the business cash on due date. Thus cash assumes its original form again at the end of one such working capital cycle but in the course it passes through various other forms of current assets too. This is how various components of current assets keep on changing their forms due to value addition. As a result, they rotate and business operations continue. Thus, the working capital cycle involves rotation of various constituents of the working capital. While managing the working capital, two characteristics of current assets should be kept in mind viz. (i) short life span, and (ii) swift transformation into other form of current asset. Each constituent of current asset has comparatively very short life span. Investment remains in a particular form of current asset for a short period. The life span of current assets depends upon the time required in the activities of procurement; production, sales and collection and degree of synchronisation among them. A very short life span of current assets results into swift transformation into other form of current assets for a running business. These characteristics have certain implications: i. Decision regarding management of the working capital has to be taken frequently and on a repeat basis. ii. The various components of the working capital are closely related and mismanagement of any one component adversely affects the other components too. iii. The difference between the present value and the book value of profit is not significant. The working capital has the following components, which are in several forms of current assets like Stock of Cash, Stock of Raw Material, Stock of Finished Goods, Value of Debtors, Miscellaneous current assets like short term investment loans & advances According to Hoagland, Working Capital is descriptive of that capital which is not fixed. But the more common use of working capital is to consider the difference between the book value of current assets and current liabilities.

KINDS OF WORKING CAPITAL:

1. Gross Working Capital According to this concept; working capital refers to the firms investment in current assets. The amount of current liabilities is not deducted from the total of current assets. This concept views Working Capital and aggregate of Current Assets as two inter-changeable terms. This concept is also referred to as `Current Capital' or `Circulating Capital'. The proponents of the gross working capital concept advocate this for the following reasons: Profits are earned with the help of assets, which are partly fixed and partly current. To a certain degree, similarity can be observed in fixed and current assets so far as both are partly financed by borrowed funds, and are expected to yield earnings over and above the interest costs. Logic then demands that the aggregate of current assets should be taken to mean the working capital. Management is more concerned with the total current assets as they constitute the total funds available for operating purposes than with the sources from which the funds come. An increase in the overall investment in the enterprise also brings about an increase in the working capital. 2. Net Working Capital The net working capital refers to the difference between current assets and current liabilities. Current liabilities are those claims of outsiders, which are expected to mature for payment within an accounting year and include creditors dues, bills payable, bank overdraft and outstanding expenses. Net working capital can be positive or negative. A negative net working capital occurs when current liabilities are in excess of current assets. "Whenever working capital is mentioned it brings to mind current assets and current liabilities with a general understanding that working capital is the difference between the two". Net working capital is a qualitative concept, which indicates the liquidity position of the firm and the extent to which working capital needs may be financed by permanent sources of finds. This needs some explanation.
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Current assets should be sufficiently in excess of current liabilities to constitute a margin or buffer for obligations maturing within the ordinary operating cycle of a business. A weak liquidity position poses a threat to the solvency of the company and makes it unsafe. Excessive liquidity is also bad. It may be due to mismanagement of current assets. Therefore, prompt and timely action should be taken by management to improve and correct the imbalance in the liquidity position of the firm. 3. Fixed Working Capital The need for current assets is associated with the operating cycle, which, as you know, is a continuous process. As such, the need for current assets is felt constantly. The magnitude of investment in current assets however may not always be the same. The need for investment in current assets may increase or decrease over a period of time according to the level of production. Nevertheless, there is always a certain minimum level of current assets, which is essential for the firm to carry on its business irrespective of the level of operations. This is the irreducible minimum amount necessary for maintaining the circulation of the current assets. This minimum level of investment in current assets is permanently locked up in business and is therefore referred to as permanent or fixed or regular working capital. It is permanent in the same way as investment in the firm's fixed assets is. 4. Fluctuating Working Capital Depending upon the changes in production and sales, the need for working capital, over and above the permanent working capital, will fluctuate. The need for working capital may also vary on account of seasonal changes or abnormal or unanticipated conditions. For example, a rise in the price level may lead to an increase in the amount of funds invested in stock of raw materials as well as finished goods. Additional doses of working capital may be required to face cutthroat competition in the market or other contingencies like strikes and lockouts. Any special advertising campaigns organised for increasing sales or other promotional activities may have to be financed by additional working capital. The extra working capital needed to support the changing business activities is called the fluctuating (variable, seasonal, temporary or special) working capital.

Figure 2 Fixed working capital remaining constant overtime

Figure 3 Fixed working capital increasing over time As seen in Figure 2, that fixed working capital is stable over time, whereas variable working capital is fluctuating-sometimes increasing and sometimes decreasing. The permanent working capital line, however, may not always be horizontal. For a growing firm, permanent working capital may also keep on increasing over time as has been shown in Figure 3. Both these kinds of working capital - permanent and temporary-are required facilitating production and sales through the operating cycle, but temporary working capital is arranged by the firm to meet liquidity requirements that are expected to be temporary.

WORKING CAPITAL CYCLE:

The time between purchase of inventory items (raw material or merchandise) and their conversion into cash is known as operating cycle or working capital cycle. The successive events which are typically involved in an operating cycle are depicted in Figure 16.1. A perusal of the operating cycle would reveal that the funds invested in operations are re-cycled back into cash. The cycle, of course, takes some time to complete. The longer the period of this conversion the longer is the operating cycle. A standard operating cycle may be for any time period but does not generally exceed a financial year. Obviously,

the shorter the operating cycle, the larger will be the turnover of funds invested for various purposes. The channels of the investment are called current assets. Sometimes the available funds may be in excess of the needs for investment in these assets, e.g., inventory, receivables and minimum essential cash balance. Any surplus may be invested in government securities rather than being retained as idle cash balance. The assessment of the working capital should be accurate even in the case of small and micro enterprises where business operation is not very large. We know that working capital has a very close relationship with day-to-day operations of a business. Negligence in proper assessment of the working capital, therefore, can affect the day-to-day operations severely. It may lead to cash crisis and ultimately to liquidation. An inaccurate assessment of the working capital may cause either under-assessment or over-assessment of the working capital and both of them are dangerous.

CONSEQUENCES OF UNDER ASSESSMENT OF WORKING CAPITAL Growth may be stunted. It may become difficult for the enterprise to undertake profitable projects due to non-availability of working capital. Implementation of operating plans may become difficult and consequently the profit goals may not be achieved. Cash crisis may emerge due to paucity of working funds. Optimum capacity utilisation of fixed assets may not be achieved due to non-availability of the working capital. The business may fail to honour its commitment in time, thereby adversely affecting its credibility. This situation may lead to business closure. The business may be compelled to buy raw materials on credit and sell finished goods on cash. In the process it may end up with increasing cost of purchases and reducing selling prices by offering discounts. Both these situations would affect profitability adversely. Non-availability of stocks due to non-availability of funds may result in production stoppage. While underassessment of working capital has disastrous implications on business, overassessment of working capital also has its own dangers.

CONSEQUENCES OF OVER ASSESSMENT OF WORKING CAPITAL Excess of working capital may result in unnecessary accumulation of inventories. It may lead to offer too liberal credit terms to buyers and very poor recovery system and cash management. It may make management complacent leading to its inefficiency. Over-investment in working capital makes capital less productive and may reduce return on investment.

Working capital is very essential for success of a business and, therefore, needs efficient management and control. Each of the components of the working capital needs proper management to optimise profit

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FACTORS INFLUENCING WORKING CAPITAL:

The working capital needs of a business are influenced by numerous factors. The important ones are discussed in brief as given below: i. Nature of Enterprise The nature and the working capital requirements of an enterprise are interlinked. While a manufacturing industry has a long cycle of operation of the working capital, the same would be short in an enterprise involved in providing services. The amount required also varies as per the nature; an enterprise involved in production would require more working capital than a service sector enterprise. ii. Manufacturing/Production Policy Each enterprise in the manufacturing sector has its own production policy, some follow the policy of uniform production even if the demand varies from time to time, and others may follow the principle of 'demand-based production' in which production is based on the demand during that particular phase of time. Accordingly, the working capital requirements vary for both of them. iii. Operations The requirement of working capital fluctuates for seasonal business. The working capital needs of such businesses may increase considerably during the busy season and decrease during the slack season. Ice creams and cold drinks have a great demand during summers, while in winters the sales are negligible. iv. Market Condition If there is high competition in the chosen product category, then one shall need to offer sops like credit, immediate delivery of goods etc. for which the working capital requirement will be high. Otherwise, if there is no competition or less competition in the market then the working capital requirements will be low. v. Availability of Raw Material If raw material is readily available then one need not maintain a large stock of the same, thereby reducing the working capital investment in raw material stock. On the other hand, if raw material is not readily available then a large inventory/stock needs to be maintained, thereby calling for substantial investment in the same. vi. Growth and Expansion Growth and expansion in the volume of business results in enhancement of the working capital requirement. As business grows and expands, it needs a larger amount of working capital. Normally, the need for increased working capital funds precedes growth in business activities. vii. Price Level Changes Generally, rising price level requires a higher investment in the working capital. With increasing prices, the same level of current assets needs enhanced investment.

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viii. Manufacturing Cycle The manufacturing cycle starts with the purchase of raw material and is completed with the production of finished goods. If the manufacturing cycle involves a longer period, the need for working capital would be more. At times, business needs to estimate the requirement of working capital in advance for proper control and management. The factors discussed above influence the quantum of working capital in the business. The assessment of working capital requirement is made keeping these factors in view. Each constituent of working capital retains its form for a certain period and that holding period is determined by the factors discussed above. So for correct assessment of the working capital requirement, the duration at various stages of the working capital cycle is estimated. Thereafter, proper value is assigned to the respective current assets, depending on its level of completion. The basis for assigning value to each component is given below:

Component of Working Capital Stock of raw material Stock of work in process Stock of finished goods Debtors Cash

Basis of Valuation Purchase cost of raw Materials At cost or market value, whichever is lower Cost of production Cost of sales or sales value Working expenses

Each constituent of the working capital is valued on the basis of valuation enumerated above for the holding period estimated. The total of all such valuation becomes the total estimated working capital requirement.

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FINANCING WORKING CAPITAL:

Working capital or current assets are those assets, which unlike fixed assets change their forms rapidly. Due to this nature, they need to be financed through short-term funds. Short-term funds are also called current liabilities. The following are the major sources of raising short-term funds: i. Suppliers Credit At times, business gets raw material on credit from the suppliers. The cost of raw material is paid after some time, i.e. upon completion of the credit period. Thus, without having an outflow of cash the business is in a position to use raw material and continue the activities. The credit given by the suppliers of raw materials is for a short period and is considered current liabilities. These funds should be used for creating current assets like stock of raw material, work in process, finished goods, etc. ii. Bank Loan for Working Capital This is a major source for raising short-term funds. Banks extend loans to businesses to help them create necessary current assets so as to achieve the required business level. The loans are available for creating the following current assets: Stock of Raw Materials Stock of Work in Process Stock of Finished Goods Debtors Banks give short-term loans against these assets, keeping some security margin. The advances given by banks against current assets are short-term in nature and banks have the right to ask for immediate repayment if they consider doing so. Thus bank loans for creation of current assets are also current liabilities. iii. Promoters Fund It is advisable to finance a portion of current assets from the promoters funds.They are long-term funds and, therefore do not require immediate repayment. These funds increase the liquidity of the business.

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PROFORMA OF WORKING CAPITAL:

1. Trading Concern

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2. Manufacturing firm:

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RATIOS RELATING TO WORKING CAPITAL:

1. Current Ratio (CR) CR = Current Assets/Current Liabilities It indicates the ability of a company to manage the current affairs of business. It is useful to study the trend of working capital over a period of time. Though the current ratio of 2:1 is considered ideal, this may have to be modified depending on the peculiar conditions prevailing in a particular trade or industry. It is not only the quantum of current ratio that is important but also its quality, i.e. extent to which assets and liabilities are really current. 2. Quick Ratio (QR) QR = Liquid Assets/Current Liabilities Liquid assets mean current assets minus those, which are not quickly realizable. Inventory and sticky debts are generally treated as non-quick assets. The relationship of 1:1 between quick assets and current liabilities is considered ideal, but, like current ratio, it also varies from industry to industry, depending on the peculiar conditions of a particular industry. 3. Cash to Current Assets If cash alone is a major item of current assets then it may be a good indicator of the profitability of the organisation, as cash by itself does not earn any profit, the propor-tion should usually be kept low. 4. Sales to Cash Ratio Sales to Cash Ratio = Sales/Average cash balance during the period. Cash should be turned over as many times as possible, in order to achieve maximum sales with minimum cash on hand. 5. Average Collection Period (Debtors/Credit Sales) x 365 This ratio explains how many days of credit a company is allowing to its customers to settle their bills. 6. Average Payment Period Average payment period = (Creditors/Credit purchases) x 365 It indicates how many days of credit is being enjoyed by the company from its suppliers.

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7. Inventory Turnover Ratio (ITR) ITR = Sales/Average Inventory It shows how many times inventory has turned over to achieve the sales. Inventory should be maintained at a level, which balances production facilities and sale's needs. 8. Working Capital to Sales Usually expressed in terms of percentage, it signifies that for any amount of sales a relative amount of working capital is needed. If any increase in sales is contemplated it has to be seen that working capital is adequate. Therefore, this ratio helps manage-ment in maintaining working capital, which is adequate for the planned growth in sales. 9. Working Capital to Net Worth Working Capital/Net wroth This ratio shows the relationship between working capital and the funds belonging to the owners. When this ratio is not carefully watched, it may lead to: a) Overtrading when the conditions are in the upswing. Its symptoms being (i) High Inventory Turnover Ratio (ii) Low Current Ratio; or b) Under trading when the conditions of market are not good. Its major symptoms are: Low Inventory Turnover Ratio and High Current Ratio. Efficient working capital management should, therefore, avoid both excess and deficit working capital situations. Efficient working capital management demands proper management of its current assets, as excess of these assets would not yield any returns. Cash and marketable securities being least productive need to be managed even more carefully. Cash denotes the liquidity of a business enterprise and plays an important role in nurturing and improving the profitability of an organisation. It is, therefore, essential to make a proper estimate of the cash need and plan for it so as to avoid technical or legal insolvency. Hence, effective management of cash is necessary to ensure adequate liquidity.

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CONCLUSION:
An enterprise needs funds to operate profitably. The working capital of a business reflects the short-term uses of funds. Apart from the investment in the long-term assets such as buildings, plant and equipment, funds are also needed for meeting day to day operating expenses and for amounts held in current assets. Within the time span of one year there is a continuing cycle or turnover of these assets. Cash is used, to acquire stock, which on being sold results in an inflow of cash, either immediately or after a time lag in case the sales are on credit. The rate of turnover of current assets in relation to total sales of a given time period is of critical importance to the total funds employed in those assets. The amount needed to be invested in current assets is affected by many factors and may fluctuate over a period of time. Manufacturing cycle, production policies, credit terms, growth and expansion needs, and inventory turnover are some of the important factors influencing the determination of working capital. Inflation magnifies the need for working capital. The constant rise in the cost of inputs, if not accompanied with corresponding increase in output prices puts an additional strain on the management. However, by taking several measures on production front and by keeping a strict watch on managed costs and expediting collection of credit sales, etc. the management can contain or at least minimize the upward thrusts for additional working capital. The management should ensure the adequacy and efficiency in the utilization of working capital. For this purpose various ratios can be periodically computed and compared against the norms established in this regard. For efficient management of working capital, management of cash is as important as the management of other items of current assets like receivables and inventories. Too little cash may place the firm in an illiquid position, which may force the creditors and other claimants to stop transacting with the firm. Too much cash results in funds lying idle, thereby lowering the overall return on capital employed below the acceptable level. An adequate amount of cash is always needed for meeting any unforeseen contingencies and also liabilities as well as day-to-day operating expenses of the business.

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WIBLIOGRAPHY:
www.studyfinance.com www.caalley.com www.bizresearchpapers.com www.investopedia.com

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