antima tyagi

8/6/2019 ANTIMA TYAGI

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SUMMER TRAINING PROJECT REPORT

WORKING CAPITAL ANALYSIS OF

DABUR INDIA LTD.

DABUR INDIA LTD.

SUBMITTED IN THE PARTIAL FULFILLMENT OF

THE REQUIREMET OF

BACHELOR OF BUSINESS ADMINISTRATION (BBA)

GURU JAMBHESWAR UNIVERSITY OF SCIENCE AND

TECHNOLOGY, HISAR

Training Supervisor : Submitted By

Mr. Sandeep Gupta ANTIMA TYAGI

Branch Manager 08511242107

SESSION-2008-11

GURU JAMBHESWAR UNIVERSITY OF

SCIENCE AND TECHNOLOGY

HISAR

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ACKNOWLEDGEMENT

With deep sense of pleasure and satisfaction I complete this project on The Working

Capital Management and take this opportunity to thank Mr. sandeep gupta, Branch

manager Dabur India Limited, whose inestimable support rendered it possible.

I also express my deep sense of gratitude to my guide Mr. R Venkatesan, Manager

Accounts, Dabur India Limited, under whose guidance I have been able to complete

this study.

I would like to place on record my sincere gratitude to my facilitator, Mr. D P Sur

Accounts, whose immense support helped me completing this project.

I also wish to thank all the Executives and the staff members of Dabur India Limited,

in particular Mr. Atul Bansal and Mr. Arun gupta, who were immensely co-operative

through out my tenure with them.

Last but not the least, I would like to thank my parents whose blessings, cooperation

and guidance inspired me to complete this task easily.

(ANTIMA TYAGI)

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EXECUTIVE SUMMARY

The management of current assets deals with determination, maintenance, control and

monitoring the level of all the individual current assets. Current assets are referred to

as assets, which can normally be converted into cash within one year therefore

investment in current assets should be just adequate no more no less to the needs of

the business. Excessive investments in current assets should be avoided, because it

impairs firms profitability, as idle investment in current assets and are non-productive

and so they can earn nothing, on the other hand inadequate amount of working capital

can threaten solvency of the firm, if it fails to meet its current obligations.

Thus the working capital is a qualitative concept-

1. It indicates the liquidity position of the firm and

2. It suggests the extent to which working capital needs may be financed by

permanent source of fund. Current assets should be sufficiently in excess of

current liabilities to constitute a margin or buffer for maturing obligation

within the ordinary cycle of business.

The basic learning objective behind the study was-

Computation of Working Capital Management

Operating Cycle of the firm

Financial plan estimated for 2009-2010 and projected for 2010-2011

Working capital credit limits

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Ratio analysis

On the basis of above calculations following conclusions can be made-

Dabur India ltd. has both long term as well as short term sources for current

asset financing. It implies that company follows matching principle for raising

funds.

Right now company is following aggressive policy, which means that company

is maintaining lower ratio of current assets to fixed assets.

Dabur India ltd has high collection period which shows that money has been

unnecessarily blocked with the debtors. So to overcome the above problems

following are the recommendations.

Increase the proportion of current assets over fixed assets to come to proper

proportion of current assets and fixed assets as per the basic norms and

guidelines.

Company should shift from aggressive policy to conservative current assets

policy.

Company should reduce the holiday period else the company will have to pay

high carrying cost.

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Table of content

CHAPTER 1

INTRODUCTION

I.1 HISTORY

I.2 SWOT ANALYSIS

I.3 DABUR AT AGLANCE

I.4 CORPORATE GOVERNENCE

I.5 CERTIFICATION OF QUALITY

CHAPTER 2

COMPANY PROFILE

CHAPTER 3

RESEARCH METHODOLOGY

3.1 RESEARCH OBJECTIVES

3.2 DATA SOUCSES

3.3 DESCRIPTIVE RESEARCH

CHAPTER 4

CONCEPTUAL DISCUSSION

WORKING CAPITAL

4.1 ROTIO ANALYSIS

4.2 RECEIVABLE MGT

4.3 INVENTORY MGT

4. 4 CASH MGT

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CHAPTER 5

DATA ANALYSIS

CHAPTER 6

FINDING AND RECOMMENDATION

CHAPTER 7

CONCLUSION

CHAPTER 8

ANNEXURES

CHAPTER 9

BIBLIOGRAPHY

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CHAPTER-I

I. Introduction

I.IHISTORICAL BACKGROUND OF DABUR

Dabur derives its name from Devanagri rendition of Daktar Burman.

In 1884, the Dabur was bornin a small Calcutta pharmacy, where Dr. S.K. Burman

launches his mission of making health care products.

In 1896, with growing popularity of Dabur products, Dr. Burman expands his

operations by setting up a manufacturing plant for mass production of formulations.

In early 1900s, Dabur enters the specialized area of nature-based Ayurvedic

medicines, for which standardized drugs are not available in the market.

In 1919, the need to develop scientific processes and quality checks for mass

production of traditional Ayurvedic medicines leads to establishment of research

laboratories.

In 1920, Daburexpands further with new manufacturing units at Narendrapur and

Daburgram. The distribution of Dabur products spreads to other states like Bihar and

the North-East.

In 1936, Dabur becomes a full-fledged company - Dabur India (Dr. S. K. Burman)

Pvt. Ltd.

In 1972, Dabur's operations shift to Delhi. A new manufacturing plant is set up in

temporary premises in Faridabad, on the outskirts of Delhi.

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the first time in the history of Dabur, a non-family professional CEO sits at the helm

of the Company.

In 2000, Dabur establishes its market leadership status with a turnover of Rs.1,000

crores. From a small beginning and upholding the values of its founder, Dabur now

enters the august league of large corporate businesses.

2005 - Dabur announces bonus after 12 years

Dabur India announced issue of 1:1 Bonus share to the shareholders of the company,i.e. one share for every one share held. The Board also proposed an increase in the

authorized share capital of the company from existing Rs 50 crore to Rs 125 crore.

2009 - Dabur Red Toothpaste joins 'Billion Rupee Brands' club

Dabur Red Toothpaste becomes the Dabur's ninth Billion Rupee brand. Dabur Red

Toothpaste crosses the billion rupee turnover mark within five years of its launch.

SWOT ANALYSIS

STRENGTHS:

Century Old Company

Established BrandAyurvedic/ herbal Product line

Leader in Herbal Digestives where the product has 90% of

the market share

Innovativeness in Promotions

WEAKNESS:

Profitability is uneven across product line

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OPPORTUNITIES:

Extend Vatika brand to new categories like Skin Care

and body wash segments

Launch several OTC brands

Southern India Market

Exploring new geographical areas- local as well global

Oral Care Segment

Launching new Products like Hair oils, Herbal and Gel

Toothpastes etc

THREATS:

Competition in the FMCG sector from well established

names

Other fields of medicine- Allopathic and Homeopathic

Markets where Herbal products are not recognised

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DABUR AT A GLANCE

Dabur India Limited has marked its presence with significant achievements and today

commands a market leadership status. Our story of success is based on dedication to

nature, corporate and process hygiene, dynamic leadership and commitment to our

partners and stakeholders. The results of our policies and initiatives speak for

themselves.

Leading consumer goods company in India with a turnover of Rs. 2834.11

Crore (FY09)

3 major strategic business units (SBU) - Consumer Care Division (CCD),

Consumer Health Division (CHD) and International Business Division

(IBD)

3 Subsidiary Group companies - Dabur International, Fem Care Pharma

and newuand 8 step down subsidiaries: Dabur Nepal Pvt Ltd (Nepal),

Dabur Egypt Ltd (Egypt), Asian Consumer Care (Bangladesh), AsianConsumer Care (Pakistan), African Consumer Care (Nigeria), Naturelle

LLC (Ras Al Khaimah-UAE), Weikfield International (UAE) and Jaquline

Inc. (USA).

17 ultra-modern manufacturing units spread around the globe

Products marketed in over60 countries

Wide and deep market penetration with 50 C&F agents, more than 5000

distributors and over2.8 million retail outlets all over India

Consumer Care Division (CCD) adresses consumer needs across the entire FMCG

spectrum through four distinct business portfolios of Personal Care, Health Care,

Home Care & Foods

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Master brands:

Dabur - Ayurvedic healthcare products

Vatika - Premium hair care

Hajmola - Tasty digestives

Ral - Fruit juices & beverages

Fem - Fairness bleaches & skin care products

9 Billion-Rupeebrands: Dabur Amla, Dabur

Chyawanprash, Vatika, Ral, Dabur Red Toothpaste,

Dabur Lal Dant Manjan, Babool, Hajmola and Dabur

Honey

Strategic positioning ofHoney as food product, leading

to market leadership (over75%) in branded honey

market

Dabur Chyawanprash the largest selling Ayurvedic

medicine with over 65% market share.

Vatika Shampoo has been the fastest selling shampoo

brand in India for three years in a row

Hajmola tablets in command with 60% market share of

digestive tablets category. About 2.5 crore Hajmola

tablets are consumed in India every day

Leader in herbal digestives with 90% market share

Consumer Health Division (CHD) offers a range of classical Ayurvedic

medicines and Ayurvedic OTC products that deliver the age-old benefits of Ayurveda

in modern ready-to-use formats

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Has more than 300 products sold through prescriptions as

well as over the counter

Major categories in traditional formulations include:

- Asav Arishtas

- Ras Rasayanas

- Churnas

- Medicated Oils

Proprietary Ayurvedic medicines developed by Dabur

include:

- Nature Care Isabgol

- Madhuvaani

- Trifgol

Division also works for promotion of Ayurveda through

organised community of traditional practitioners and

developing fresh batches of students

International Business Division (IBD) caters to the health and personal care needs of

customers across different international markets, spanning the Middle East, North &

West Africa, EU and the US with its brands Dabur & Vatika

Growing at a CAGR of 33% in the last 6 years and contributes to about 20% of

total sales

Leveraging the 'Natural' preference among local consumers to increase share in

perosnal care categories

Focus markets:

- GCC

- Egypt

- Nigeria

- Bangladesh

- Nepal

- US

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High level of localization of manufacturing and sales & marketing

C & F AGENTS, DISRIBUTORS & RETAILERS

The objective of appointment of Carrying and Forwarding Agents ('C&FA') is to

achieve improved service levels in despatches made, order processing, FMFO

issuance of stocks, transportation, efficient and proper maintenance of stocks and

sales return recording procedures. The outsourcing of the C&FA function ensures

smooth and efficient movement of products from the Company to its dealers,

stockists etc. There is a wide market penetration on the part of Dabur through 47

C&F agents, more than 5000 distributors and over1.5 million retail outlets all

over India. The company under restructuring exercise has started focussing on

distribution network. The company has shifted to zonal setup for its sales and

marketing. The company is planning to shift to C&F agents system and has

appointed more than 50 such agents in the market. It has also connected its C&F

agents and its key distributors online for better management of its stock. The

company has also implemented ERP system to cover all its activities. The

company also started its interactive website during the year. It has plans of going

for B2B and B2C transactions

CORPORATE GOVERNENCE

Good corporate governance and transparency in actions of the management is key

to a strong bond of trust with the Companys stakeholders. Dabur understands the

importance of good governance and has constantly avoided an arbitrary decision-

making process. Our initiatives towards this end include:

Professionalization of the board

Lean and active Board(reduced from 16 to 10 members)

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Less number of promoters on the Board

More professionals and independent Directors for better management

Governed through Board committees for Audit, Remuneration, Shareholder

Grievances, Compensation and Nominations

Meets all Corporate Governance Code requirements of SEBI

CERTIFICATION FOR QUALITY

ISO 9002

Dabur India Limited has been awarded the ISO 9002 certification after the

Quality Management Systems of the company were assessed in November

1995. The product areas assessed include Health care Products, Family and

Food Products, Bulk Drugs and Chemicals, Ayurvedic specialities and

Pharmaceutical products. This implies that for Dabur quality is an attitude that

has been translated into action. For the company quality is a culture and not a

stop gap arrangement and believe that quality is a corporate responsibility

towards its customers, employees and the environment in which it operates.

Sustaining consumer confidence for over a century is a true reflection of the

quality of the companys products.

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CRISIL GVC Level 2

CRISIL, the leading rating agency in India, has been assigning top credit

ratings to Dabur India limited for its institutional borrowings. Recently,

CRISIL launched the Governance and Value Creation Rating (GVC) and

Dabur India Limited was one of the first companies to volunteer for getting

itself rated on GVC. Dabur has been assigned `Crisil GVC Level 2 rating

which is the second highest rating on an 8-point scale. The rating indicates that

capability of the Company on wealth creation for all its stakeholders including

shareholders, employees, creditors, suppliers, dealers and society, while

adopting sound corporate governance practices is `high. This takes into

account past track record as well as future expectations of wealth creation by

the company.

Some of the quotes of CRISIL :

(1) The rating reflects Dabur Indias strong wealth management practices,

high disclosure standards, and satisfactory track

record on creating value for its various stakeholders.

(2) The managements long experience and good track record coupled with

Dabur Indias consistent performance in its existing businesses exemplify

its wealth management capabilities.

(3) Dabur India follows good disclosure standards in terms of its financial

performance and ownership pattern.

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CHAPTER-II

RESEARCH METHODOLOGY

II.1 RESEARCH OBJECTIVE

The project is aimed at evaluating the financial status of Dabur India Ltd and

then doing the comparative analysis with its competitors.

Studying the working capital management at Dabur India Ltd. and estimating

the working capital requirements for 2007-2008 and then forecasting for 2008-

2009

To find out if there is any relationship between the working capital, sales and

current assets of DABUR INDIA LTD

II.2 DATA SOURCES:

Primary data

The data that are still needed after that search is completed will have to be developedspecifically for the research project and are known as primary data .

Types Primary data

Interview

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Questionnaire

Survey

Observation

Secondary data

The secondary data that are available are relatively quick and inexpensive to obtain,

especially now that computerized bibliographic search services and databases are

available. The various sources of the secondary data and how they can be obtained and

used are described ahead.

Most secondary data are generated by specialized firms and are sold to marketers to

help them deal with a category of problems. Nielsens television ratings, which

marketers use in making advertising decisions, is the best-known example. Many of

these services, broadly categorized as audits, commercial surveys, and panels, allow

some degree of customization and thus fall between secondary and primary data.

These sources are treated in detail ahead.

Types of Secondary data

News paper

Books

Journals

Fairs and conference

Websites

Any data, which have been gathered earlier for some other purpose, are

secondary data in the hands of researcher. Those data collected first hand, either by the

researcher or by someone else, especially for the purpose of the study is known as

primary data. The data collected for this project has been taken from the secondary

source. Sources of secondary data are:-

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Internet

Magazines

Publications

Newspapers

Broachers

II.3 Descriptive research

This project is based on descriptive research. Descriptive research, also known as

statistical research, describes data and characteristics about the population or

phenomenon being studied. Descriptive research answers the questions who, what,

where, when and how...

Although the data description is factual, accurate and systematic, the research cannot

describe what caused a situation. Thus, Descriptive research cannot be used to create a

causal relationship, where one variable affects another. In other words, descriptive

research can be said to have a low requirement forinternal validity.

The description is used forfrequencies, averages and other statistical calculations.

Often the best approach, prior to writing descriptive research, is to conduct a survey

investigation. Qualitative research often has the aim of description and researchers

may follow-up with examinations of why the observations exist and what the

implications of the findings are.

In short descriptive research deals with everything that can be counted and studied.

But there are always restrictions to that. Your research must have an impact to the

lives of the people around you. For example, finding the most frequent disease that

affects the children of a town. The reader of the research will know what to do to

prevent that disease thus, more people will live a healthy life.

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CHAPTER-III

COMPANY PROFILE

Dabur India Limited (DIL) is an ayurvedic and natural health care company. The

Company is engaged in manufacturing and marketing fast moving consumer goods

and Ayurvedic products. The Company operates its business through three business

units: consumer care division (CCD), international business division (IBD) and

consumer healthcare division (CHD). DIL has manufacturing facilities in eight States

of India. As of March 31, 2010, the Company also had manufacturing facilities in

eight countries: India, Bangladesh, Nepal, Dubai, Sarjah, Ras-Al-Khaima, Egypt and

Nigeria. Major markets of the Company include India, Middle East, Nepal,

Bangladesh, United States and United Kingdom. As of March 31, 2010, the

Company's brands included Dabur Amla, Dabur Chyawanprash, Vatika, Hajmola,

FEM and Real. Its subsidiaries include Dabur Nepal Pvt Ltd, Dabur (UK) Ltd, H&B

Stores Ltd, Weikfield International (UAE) Ltd and Naturelle LLC. On April 1, 2009,

DIL completed the merger of Fem Care Pharma Ltd.

VISION

Vision 2010

After the successful implementation of the 4-year business plan from 2002 to 2006,

Dabur has launched another plan for 2010. The main objectives are:

Doubling of the sales figure from 2006

The new plan will focus on expansion, acquisition and innovation. Although

Daburs international business has done well growing by almost 29 per cent

to Rs.292 crore in 2006-07, plans are to increase it by leaps and bounds.

Growth will be achieved through international business, homecare, healthcare

and foods.

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Southern markets will remain as a focus area to increase its revenue share to 15

per cent.

With smoothly sailing through its previous plans, this vision seems possible. Time and

again, Dabur has made decisions that have led to its present position. However, if

Dabur could be more aggressive in its approach, it can rise to unprecedented levels.

PRINCIPLES

Ownership

This is our Company. We accept personal responsibility and accountability to meet

business needs.

Passion for Winning

We all are leaders in our area of responsibility, with a deep commitment to deliver

results. We are determined to be the best at doing what matters most.

People Development

People are our most important asset. We add value through result driven training and

we encourage & reward excellence.

Consumer Focus

We have superior understanding of consumer needs and develop products to fulfill

them better.

Team Work

We work together on the principle of mutual trust & transparency in a boundaryless

organization. Innovation

Continuous innovation in products & processes is the basis of our success.

PRODUCTS OF DABUR

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1 Amla Hair Oil

2 Amla Lite

3 Baby Olive Oil

4 Back Aid

5 Binaca Toothpowder

6 Chyawanprash

7 Dabur Balm

8 Glucose D

9 Gulabri10 Hajmola

11 Hajmola Candy

12 Hingoli

13 Honey

14 Itch Care

15 Jama Ghunti Honey

16 Lal Dantmanjan17 Lal Oil

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18 Nature Care

19 Pudin Hara

20 Pudin Hara G

21 Ring Ring

22 Sarbyna Strong

23 Sat Isabgol

24 Shilajit

25 Shankha Pushpi

26 Vatika

- Anti Dandruff Shampoo

- Hair oil

- Shampoo

Daburs Departments

1 IT(Information Technology)

2 HR(Human Resource)3 Training

4 Projects

5 Finance

6 CSCC(Central Supply Chain Cell)

7 CPPD(Central Purchase and Procurement Department)

8 Divisions

9 DRF(Dabur Research Foundation)

10 Operations

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11 Corporate Communication

FUTURE PLANS OF DABUR INDIA LIMITED

Speaking to Business Line, Mr. Sunil Duggal, Chief Executive Officer,

Dabur India, said: "The company's biggest growth areas in the current year

will be the personal and healthcare segments. Within the foods segment,

the strategy will be to consolidate existing products.''

The company has projected turnover of Rs. 2834.11 Crore by 2009.Some of

the company's slow-moving brands would be either phased out or divested

progressively as part of its portfolio rationalization. The company proposes

to enter unexplored areas of haircare, and introduce the brand at lower

price points and in sachets. Another category Dabur intends to enter this

year is mass skin care.

Dabur India's ad spends (both above-the-line and below-the-line) average

Rs 140 crore, and this figure could be ramped up by 10 per cent the

following year. They will move toward spending away from non-core to

core brands.

Dabur India Ltd announced the "virtual demerger" of its FMCG business

from its pharmaceutical business. It has restructured its Rs 162.9-crore

pharma business into a separate business unit (SBU). The pharma

business would be led by the Pharma Management Committee headed by

Dr Anand Burman, Vice-Chairman, Dabur India.

New Delhi Dabur India Ltd. has plans to launch an entire range of

Ayurvedic products in the domestic market soon. The company is also

focusing on exports of Ayurvedic products into new markets this year.

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Successful Implementation of Business Risk Management. With the

Business Risk Management Framework, every employee will now be

formally responsible for identifying business risks that surround their

functions and make business risk management as part of their normal

working practice said Mr.Rajan Varma, Chief Financial Officer, Dabur

India.

Dabur India, the fourth largest FMCG Company in the country, has forged

an alliance with FreeMarkets Services, a leading e-procurement consulting

company, for adopting the next level of sourcing practice e-Sourcing, for

reducing costs, providing greater transparencies and optimizing

procurement efficiencies.

We will be fully online and conducting the first few set of reverse

auctions next month i.e. February. Our association with Free-Markets

would give us a head start in terms of market making as they have over

1,50,000 suppliers in their database that will be available to us. Also, Free

Markets would vet suppliers from scratch that would cut lead-time added

Mr. Jude Magima.

CHAPTER - IV

CONCEPTUAL DISCUSSION

WORKING CAPITAL

Working Capital is the excess of Current Assets over Current Liabilities. It is also

called the net Current Assets. It is important from point of view of liquidity and

profitability. More precisely, management of Current Assets includes :

(1) Cash and Bank Balances

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(2) Inventories

(3) Receivables (including Debtors & Bills)

(4) Marketable Securities.

Current Assets can be described as those Assets which can be converted into cash /

equivalent within a year and which are required to meet day to day operations.

Factors determining Working Capital Requirements :

(1) Basic Nature and Size of Business

The quantum of money required for the operations of the business enterprise more

or less depends upon its nature and size. Bigger the size more will be therequirement. Similarly, the complex nature of the business demands for large

amount of working capital.

(2) Business Cycle Fluctuations

The working capital requirements has also been affected by the fluctuations in the

business environment. One of the essentials of any business activity is the element

of risk due to unforeseen future and uncertainty. The business should be well

equipped against such type of uncertainties.

(3) Seasonal Fluctuations

The liquidity of any business is necessary and can be used as a guard against

seasonal fluctuations. Howsoever, it should be remembered that it does not render

the undue blockage of the companys funds. It might be possible that firm will be

in acute shortage of flowing funds during the peak season say for wollens in winter

and blockage of funds in the off season say wollens in summer. So, here comes the

importance of the management of the working capital.

(4) Market Competitiveness

Monopoly situations can be served as an excuse for working capital but in the

current scenario of intense competition highly managed working capital is

essential to take the advantage of any opportunity while serving as a guard against

the possible threats at the same time.

(5) Credit Policy

The credit policy of the company should be such as to comply all of three

mentioned criteria for the optimum results:

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(a) Regarding credit extended by supplier of Raw Materials, Goods etc.

If the credit time allowed by the supplier is sufficient enough for the

company it can relax the operations of the firm as a feasible level and

also serve as a shoat term financing for the current assets.

(b) Similarly, credit extended to the customers determine the actual

requirement of the working capital funds needed by the company. If

the credit allowed by the company is for short period it would result in

the early realization of the funds which then be deployed in the other

potential areas of interest.

(c) Should take care of the monitoring of own credit policies in the

market and it should be in compliance with the prevailing credit

policies and trends in the ongoing market scenario so that there is the

societal acceptance of the company.

(6) Supply Conditions

Again to a large extent the determination of the working capital depends upon the

flow of trade in the actual encountered situations. Rigidity can be automatically

formed just by the insufficient availability of funds. The reason can be understood

on the pretext that matching the supply with the demand can only be the optimal

solution. It is better to stop production rather than to produce inventory.

Need for Adequate Working Capital :

A firm should maintained Optimum level of Working Capital. There should be neither

excessive Working Capital nor inadequate Working Capital.

Excessive Working Capital results in :

(1) Unnecessary accumulation of inventories resulting in wastes, thefts, damages etc.

(2) Delays in collection of receivables resulting in more liberal credit terms to

customers than warranted by the Market conditions.

(3) Adverse influence on the performance of the management.

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If there is Inadequate Working Capital, then it means :

(1) Fixed Assets may not be optimally used.

(2) Firms growth may remain stagnant.

(3) Interruptions in Production schedule may occur ultimately resulting in lowering of

the profit of the firm.

(4) Firm may not be able to take benefit of the opportunity.

(5) Goodwill is affected if not meeting liabilities on time.

Therefore, an Optimum quantum of Working Capital should be maintained as it

provides :

(1) Solvency of the business : Optimum working capital helps in maintaining

solvency of the business concern to make prompt

payments and hence helps in creating and maintaining goodwill.

(2) Goodwill : Sufficient working capital enables a business concern to make prompt

payments and thus, assist in building goodwill.

(3) Easy Loans : A concern having adequate working capital, high solvency and good

credit standing can arrange loans from banks and others on easy and favorable

terms.

(4) Cash Discounts : Adequate working capital also enable a concern to avail cash

discounts on the purchases and hence reduces the costs of procurement.

(5) Regular Supply of Raw material : Sufficient working capital ensures regular

supply of raw materials and uninterrupted production processes.

(6) Regular payment of salaries, wages and other day-to-day commitments : A

company which has ample working capital can make regular payment of salaries,

wages and day-to-day commitments which raises the morale of the employees &

increases their efficiencies.

(7) Exploitation of favorable market conditions : Only concerns with adequate

working capital can exploit favorable market conditions such as purchasing its

requirements in bulk when the prices are lower.

(8) Ability to face crisis : Optimum working capital enables a concern to face

business crisis whether it being financial, behavioral or cultural to certain extent or

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depression periods in the ongoing business cycle as in these time maximum

pressure is on the working capital.

(9) Quick and regular return on the investments : Every individual invest money in

the company with a view to earn returns on his investments. Therefore it is an

obligation on the part of company to reward its investors from time to time & this

regular practice is being facilitated by adequate surplus in the hands of the

company.

(10)High Morale : Optimality of working capital creates an environment of security,

confidence, high morale and overall efficiency of the business enterprises.

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Comparison between Current and Fixed Assets :

(1) Funds required for management of Current Assets are determined under Working

Capital techniques and for management of Fixed Assets are determined under

Capital Budgeting techniques.

(2) Current Assets generally referred to short term period say for one year while Fixed

Assets are concerned with longer tenures say more than one year.

(3) Time Value of money isnt considered in calculating Working Capital

requirements while it is an important part of decision making in any materialCapital investment.

(4) Decisions regarding Current Assets affect the short term liquidity position of the

firm whereas decisions regarding Fixed Assets affect the long term profitability of

the firm.

(5) Lastly, Working Capital Decisions can be modified without much implications

whereas Capital budgeting decisions are irreversible.

In Working Capital Management, a Finance Manager is faced with a decision

involving some of the considerations as follows :

(1) What should be the total investment in Working Capital of the Firm ?

(2) What should be the level of individual Current Assets ?

(3) What should be the relative proportion of different sources to Finance the Working

Capital requirement ?

The extent to which the payments to these Current Liabilities are delayed, the Firm

gets the availability of funds for that period. So, a part of the funds required to

maintain Current Assets is provided by the Current Liabilities.

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THE OPERATING CYCLE AND WORKING CAPITAL NEEDS :

The Operating Cycle may be defined as the time duration starting from the

procurement of goods or raw materials and ending with Sales realization. The length

and nature of the Operating Cycle may differ from one Firm to another depending

upon the size and nature of the Firm.

What is required on the part of a firm is to make adjustments and arrangements so that

the uncertainty and non synchronization of these cash flows can be taken care of.

Operating Cycle of a Firm consists of the time required for :

(1) Procurement of Raw Materials and Services

(2) Conversion of Raw Materials into Work in Progress

(3) Conversion of Work in Progress into Finished Goods

(4) Sale of Finished Goods (Cash or Credit)

(5) Conversion of Receivables into Cash

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Receivable conversion period

(RCP) Raw material storage

Conversion period (RMSCP)

Cash received from debtors ad paid to

Suppliers of

Raw materials Raw material

introduced into process

Goods

Finished Goods

Produced

Work in process

Sales of finished Finished goods

goods conversion

Period (FGCP)

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For calculation of TOCP & NOC, various Conversion Periods may be calculated as

follows :

RMCP = Average Raw Material Stock * 365

Total Raw Material Consumption

WPCP = Average Work in Progress * 365

Total Cost of Production

FGCP = Average Finished Goods * 365

Total Cost of Goods Sold

RCP = Average Receivables * 365

Total Credit Sales

DP = Average Creditors * 365

Total Credit Purchases

Some Important Reminders :

(1) Average Value in Numerator is the average of the Opening & Closing balances.

However, if only Closing balance is given, it can be assumed to be average.

(2) No hard and fast rule of 365 days. We can also take 360 days a year.

(3) In calculation of RMCP, WPCP, FGCP, the denominator is calculated on cost

basis and the profit margin has to be excluded. The reason being that there is no

investment of funds in profits as such.

Approaches to Working Capital Requirements :

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(1) Hedging Approach:

It is also known as Matching Approach. The Hedging Approach guides a firms debtmaturity financing decisions. The Hedging principle states that the financing maturity

should follow the cash flow characteristics of the assets being financed. For example,

an asset that is expected to provide cash flows over a period of say, 5 years, then it

should be financed with a debt having similar pattern of cash flow requirements. The

Hedging Approach involves matching the cash flows generating characteristics of an

asset with the maturity of the source of financing used to finance it.

The general rule is that the length of the finance should match with the life duration of

the assets. That is why the fixed assets are financed by long term sources only. So, the

permanent Working Capital needs are financed by long term sources. On the other

hand, the temporary Working Capital needs are financed by short term sources only.

In other words, the core or fixed working capital is financed by long term sources of

funds while the additional or fluctuating working capital needs are financed by the

short term sources.

(2) Conservative Approach:

Under Conservative Approach, the finance manager doesnt undertake risk. As a

result, all the working capital needs are primarily financed by long term sources and

the use of short term sources may be restricted to unexpected and emergency situation

only. The Working Capital policy of a firm is called a Conservative policy when all or

most of the working capital needs are met by the long term sources and thus the firm

avoids the risk of insolvency.

In case, the firm has no temporary working capital need then the idle long term funds

can be invested in marketable securities. This will help the firm to earn some income.

(3) Aggressive Approach :

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A working Capital policy is called an Aggressive policy if the firm decides to finance

a part of permanent working capital by short term sources. The Aggressive policy

seeks to minimize excess liquidity while meeting the short term requirements. The

firm may accept even greater risk of insolvency in order to save cost of long term

financing and thus in order to earn greater return.

Thus, the Hedging Approach suggests a low cost - high risk situation while the

Conservative Approach attempts at high cost - low risk situation. Neither the Hedging

Approach nor the Conservative Approach can be used by any firm in the strict sense.

Therefore, the financial manager should try to have a trade - off between the Hedging

& the Conservative approach.

Liquidity versus Profitability - A Risk-Return Trade off :

Having a large Working Capital may reduce the liquidity risk faced by the firm, but it

can have a negative effect on the cash flows. Therefore, the net effect on the value of

the firm should be use to determine the optimal amount of the working capital. The

risk return trade off involved in managing the firms working capital is a trade off

between the firms liquidity and its profitability.

The discussion regarding the financing pattern of current assets point out a conflict

between the short term and long term sources of finance. This conflict between the

two arises because of the fact that these sources have different costs of financing and

different risk associated with them. A Financial Manager should therefore strive for a

trade-off between the risk and return associated with the financing mix.

One way of achieving a trade-off is to find out, the average working capital required

(on the basis of maximum and minimum during the period). Then this average

working capital may be financed by long term sources and other requirements, if any,

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arising from time to time may be met from short term sources. For example, a firm

may require a maximum and minimum working capital of Rs. 50000 and Rs. 30000

respectively during a particular year. The firm can have long term sources of Rs.

40000 (i.e. average of Rs. 50000 and Rs. 30000) and any additional requirements

above Rs. 40000 may be met out of short term sources as and when the need arises.

BANK CREDIT FOR WORKING CAPITAL

Credit facility provided by commercial banks to meet the working capital requirement

has been an important source of short term funds to business firms. In India, bank

credit has been the main institutional source of short term financing requirements. This

short term financing to business firm is regarded as self-liquidating in the sense that

the uses to which the borrowing firm is expected to put the funds are ordinarily

expected to generate cash flows adequate to repay the loan within a year. Further, the

banks motive to provide finance is to meet the seasonal demand. In India, banks may

give financial assistance in different shapes and forms. The usual form of bank credit

are as follows :

(1) Overdraft

It is the simplest form of bank credit. In this case, the borrowing firm is allowed to

withdraw more (up to a specified limit) over and above the balance in the current

account. The firm has to pay interest at a predetermined rate only for the period during

which the amount was withdrawn.

(2) Cash Credit

Under the Cash Credit, a loan limit is sanctioned by bank and the borrowing firm can

withdraw any amount at any time, within that limit. The interest is charged at a

specified rate on the amount withdrawn and for the relevant period.

(3) Bills Purchased and Bills Discounting

Commercial banks also provide short term credit by discounting the bill of exchange

emerging out of commercial transactions of sale and purchase. However, if the seller

wants the money before the maturity date of the bill, he can get the bill discounted by

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the bank which will pay the amount of the bill to the seller after charging some

discount.

(4) Letter of Credit

A letter of credit is a guarantee provide by the buyers banker to the seller that in the

case of default or failure of the buyer, the bank shall make the payment to the seller.

So, in fact, the letter of credit becomes a security of the bill and any bank will have no

problem in discounting the bill.

(5) Working Capital Term Loans

Generally, the banks while granting working capital facility to a customer stipulates

that a margin of 25% would be required to be provide by the customers and hence the

bank borrowing remains only limited to 75% of the security offered. The working

Capital Term Loan is to be repaid in a phased manner varying between a period of two

to five years.

(6) Funded Interest Term Loans

Sometimes, a company is unable to pay the interest charges on its working capital cash

credit facility. Such accumulation of unserviced interest makes the cash credit account

irregular and in excess of the sanctioned limit. This unserviced accumulated interest

may transfer by the bank from cash credit account to Funded Interest Term Loan

(FITL). This will enable the firm to operate its cash credit account. The FITL is

considered seprately for repayment.

TRENDS IN FINANCING OF WORKING CAPIATAL BY BANKS

Traditionally, the bank credit has been an easily accessible source of meeting the

working capital needs of the borrowing firms. Convenience in getting the bank credit

has been an important factor for the growth of bank credit in fulfilling the requirement

of industries. However, it also resulted in distortion of allocation of bank resources in

favour of industry. Consequently, the bank credit has been subject to various rules,

regulations and controls. The reserve Bank of India has appointed different study

groups from time to time to suggest ways and means to make the bank credit as an

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effective instrument of industrialization as well as to ensure equitable distribution of

bank resources namely :

(1) Dehejia Committee

(2) Tandon Committee

(3) Chore Committee

(4) Marathe Committee

(5) Nayak Committee

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IV.1 RATIO ANALYSIS

Ratio measures the relationship between two data expressed in mathematical terms in

some logical manner; Male-Female Ratio of the population of a country, Ratio of

students passed among those appeared in an examination a re the two examples.

Absolute comparison between two figures does not carry much sense. When spoken in

terms of ratio, it becomes much more penetrating and meaningful. Not for comparison

only, ratios convert the data in precise form for easy understanding. Ratios can be

expressed as proportion or percentage. The Ratio Analysis has emerged as a principal

technique for analysis of the Financial Statements.

Steps in Ratio Analysis : The Ratio Analysis requires two steps as follows :

(1). Calculation of a ratio and

(2). Comparing the ratio with some predetermined standard. The standard ratio may

be the past ratio of the same firm or industrys average ratio or a projected ratio or the

ratio of the most successful firm in the industry. In interpreting the ratio of a particular

firm, the analyst could not reach any fruitful conclusion unless the calculated ratio is

compared with the standard one. The importance of a correct standard is obvious as

the conclusion is going to be based on the standard itself.

Types of comparisons : The ratios can be compared in three different ways :

(1). Cross Section Analysis : One way of comparing the ratio or ratios of a firm is to

compare them with the ratio or ratios of some other selected firm in the same industry

at the same point of time. The cross section analysis helps the analyst to find out as to

how particular firm has performed in relation to its competitors. It is easy to be

undertaken as most of the data is freely available in the financial statements of the

firms.

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(2). Time Series Analysis : The analysis is called Time Series Analysis when the

performance of the firm is evaluated over a period of time. By comparing the present

performance of a firm with the performance of the same firm over last few years, an

assessment can be made about the trend and the direction of the progress of the firm.

The information generated by the Time Series Analysis can be of immense help to the

firm to make planning for future operations.

(3). Combined Analysis : If the Cross Section and Time Series Analyses, both are

combined together to study the behavior and pattern of the ratios, then meaningful and

comprehensive evaluation of the performance of the firm can definitely be made.

Pre requisite to Ratio Analysis :

(1). The dates of different financial statements from where data is taken must be same.

(2). If possible, only audited financial statements should be considered. Otherwise

there must be sufficient evidence that the data is correct.

(3). Accounting Policies followed by the different firms should be same otherwise the

results will get distorted.

(4). One ratio may not throw light on any area of performance of the firm. Therefore, a

group of ratios must be preferred. This will also be conductive to counter checks.

(5). Last, but not the least, the analyst must find out that the two figures being used to

calculate a ratio must be related to each other, otherwise, there is no purpose of

calculating a ratio.

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Categorization of Ratios :

The ratios can be categorized under different names and different groups depending

upon the purpose they ought to be served. There is no hard and fast rule regarding this

matter. Therefore, it might be possible that a ratio serving a particular purpose in a

company falls under a separate category in comparison to another company or a ratio

of utmost importance for a company comes out to be a wastage for another.

Howsoever, with due respect to all the possible sayings, here the ratios are divided

under six sub-heads namely:

(1). Cash Position Ratios

(2). Short Term Solvency Ratios / Liquidity Ratios

(3). Long Term Solvency Ratios / Capital Structure Ratios

(4). Profitability Ratios

(5). Activity Ratios

(6). Capital Market Ratios

(1). CASH POSITION RATIO :

Cash position ratio show the cash reservoir of the business. Cash is the most liquid

asset; Cash reservoir is constituted of cash in hand and cash in bank (which can be

freely used for the day to day operations) and marketable securities (which can be

disposed of readily). Marketable Securities may also be part of trade investments,

which the business would not dispose of, although readily marketable. So, it is better

to take marketable securities from non-trade investment categories.

(1). Absolute Cash Ratio : The purpose of this ratio is to show how far cash reservoir

is sufficient to meet the current liabilities. Although Provisions do not represent

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current liabilities, some provisions have the characteristics of current liabilities.

Examples are tax provision and proposed dividend. It is almost certain that some

liabilities will arise in the near future.

(2). Cash Interval Ratio : Interval Measure indicates the ability of the cash reservoir

to meet cash expenses. The businessman is interested to know how many days he can

run the business using his cash reservoir if there is no further cash inflow. Higher

reserve gives better protection against unforeseen events for which the business may

have to depend exclusively on its cash reservoir. Average daily cash expenditure is

determined by taking away depreciation and similar other non-cash expenditure from

the total expenses charged to the profit and loss account and dividing the total net

expenses by 365 days.

(3). Cash Position to Total Assets Ratio : This ratio is a measure of liquid layer of

the assets deployed by business. It has been discussed earlier that cash is the most

liquid business asset. How much cash is maintained by others who are in the same

business or how much was maintained in the business earlier may give some idea

about the ideal cash position to total assets ratio.

(2). SHORT TERM SOLVENCY RATIO / LIQUIDITY RATIO :

The Terms liquidity and short term solvency are used synonymously. Liquidity means

ability of the business to pay-off its short term liabilities. Inability to pay short term

liabilities affect the credibility of the business. It also lowers its credit rating. A

continuos default on the part of the business to pay-off its liability may even create

hindrance to its day to day operations.

(1). Current Ratio : Current Ratio is given by current assets as a ratio of current

liabilities. Higher the current ratio better is the liquidity position. The traditional belief

is that 2:1 current ratio is an indicator of good liquidity position. The Chore

Committee recommended that 1.33:1 current ratio should be attained by an enterprise

for a good liquidity position.

(2). Quick Ratio : Very often presence of slow moving inventories make some

portion of current assets illiquid even at a higher degree. Also there are current

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liabilities like bank overdraft, cash credit and short term borrowings which are used as

a means of financing

current assets. So, these short term liabilities (if any) are excluded from current

liabilities while quantifying liquidity.

Thus, if quick ratio is more than current ratio, this is caused by

(a). Low proportion of non-liquid current assets (like inventory).

(b). Low proportion of quick liabilities.

If quick ratio is less than current ratio, this is due to

(a). High proportion of non-liquid current assets.

(b). High proportion of quick liabilities.

Quick Ratio is taken as ultimate test of liquidity.

(3). LONG TERM SOLVENCY RATIO / CAPITAL STRUCTURE RATIO :

Capital Structure of a business consists of long term funds, which are not repayable in

the short run and short term funds, which are repayable in the short run. Here the short

run can be taken as a period of one year or so. Long Term funds are :

(a). Shareholders Funds

(b). Loan Funds excluding cash credit, bank overdraft and other short term loans.

(1). Debt Equity Ratio : Debt Equity ratio is popularly used as Capital Structure

Ratio. It is also called Leverage Ratio. Debt means long term loan funds and Equity

means shareholders funds. It shows the long term solvency of the business. Higher

the debt fund used in the capital structure, greater is the risk. The risk is technically

called financial risk. Debt-equity ratio is also called leverage ratio. This lever operates

favourable if rate of interest is lower than return on capital employed.

(2). Proprietary ratio : Proprietary Ratio is calculated to judge the owners

contribution to total fund applications. This ratio indicates share of proprietary fund

against each rupee of investment. It can be calculated by dividing the Proprietors

funds from the Total Assets

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(3). Capital Gearing Ratio : It gives the proportion of interest bearing fund to non-

interest bearing fund. It is different from debt-equity ratio. Preference Share capital is

fixed dividend bearing fund. Likewise, other long term and short term borrowed funds

carry fixed interest. Equity share capital and reserves and surplus do not carry fixed

dividend. The word gear is used to indicate the proportion of fixed interest /

dividend bearing fund. Higher the proportion of fixed interest / dividend bearing fund

to non interest / dividend bearing fund, higher is the gearing and as a consequence

commitment to pay fixed interest / dividend out of profit is higher. This ratio seems to

be better than the debt equity ratio as debt does not include all interest bearing fund.

Also equity includes redeemable preference shares which carry fixed dividend. There

are two further ways to highlight the respective positions via Financial Leverage and

Operating Leverage.

(4). PROFITABILITY RATIO :

A business is run primarily for profit. So its performance has been measured in terms

of profit. Profitability ratios give some yardsticks to measure profit in relative terms,

either with reference to sales or assets or capital employed.

(1). Gross Profit Ratio : This ratio provides us the proportion of gross profit incurred

with respect to sales. Moreover the percentage of this ratio for any specified industry

remain more or less same as this profit takes into account the direct cost of production

which are in contrast to all the firms in the same industry.

(2). Net Profit Ratio : This ratio reflects the net profit earned by a firm after taking

into consideration all the cash and non cash expenditure for a specified period of time.

Generally this work as a yardstick to measure and compare the respective position of

the firms on the basis of the profitability.

(3). Return on Capital Employed : A popularly used measure of profitability based

on capital employed is Return on Capital Employed. It can be worked out by dividing

the net profit before interest and tax by average capital employed during the year.

Through this ratio, one is in a position to know the results reaping out from the

respective quantum of the capital employed.

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(4). Return on Shareholders fund : This ratio reflects the proportion of profit which

is left out with the firm, after payment of interest, tax and preference dividend to the

shareholders fund. Shareholders want the maximum possible dividend while the

management wants to withhold with the entire lot of funds and earnings. Therefore, an

eye should be regularly kept on the prevailing proportion.

(5). Operating Ratio : This ratio is a good indicator of the operational efficiency of

the firm. It takes into account the operating cost which is sum total of Cost of goods

sold and Selling & Administration costs; and not the total cost. The ratio of this

operating cost with the net sales gives a fair view of the operational efficiency of the

firm.

(6). Operating Profit Ratio : This ratio takes into consideration operating profit

which is the difference between the sales figure and operating costs. This provides the

Firm, an idea about how efficiently and effectively, its resources are being used in the

respective areas over a specified period of time.

(5). ACTIVITY RATIO :

Activity Turnover Ratios generally indicate relationship between sales and assets and

these are indicators of efficiency of asset use. However, sometimes, turnover ratios are

expressed in relation to cost of goods sold. Current Liabilities are also often linked

with turnover or cost of goods sold.

(1).Working Capital Turnover Ratio : Working Capital Turnover Ratio can be

provided by dividing Sales from the average working capital employed by the firm

during a specified period of time. Thus, a relative status can be judged for the working

capital employed in order to achieve the respective sales figure. The higher the ratio,

the lower is the investment in the working capital and higher would be the

profitability.

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(2).Capital Turnover Ratio : Capital Turnover Ratio reflects the relationship of Sales

with the average capital employed by the firm. It can be helpful in determining the

excessive or inadequate amount of capital employed as far as sales are concerned. The

higher the ratio, the greater is the sales made per rupee of capital employed.

(3).Fixed Assets Turnover Ratio : Again the sales figure achieved by the respective

average fixed assets employed by the firm is being reflected by this ratio. The

contribution of fixed assets can be judged in respect of the sales figure achieved by the

firm.

(4).Total Assets Turnover Ratio : The proportion of quantum of Sales with respect to

average total assets i.e. sum of fixed and current assets is being called as Total Assets

turnover Ratio.

(5).Inventory Turnover Ratio : Inventory Turnover Ratio reflects the proportion of

total sales with the average inventory maintained by the firm during a specified time

period. Difference in the inventory ratios of the different industries may result from

the different characteristics of various industries. Since this ratio is a test of efficient

inventory management, the higher the ratio, the better it is.

(6).Debtors Turnover Ratio : Debtors turnover ratio is calculated to judge the credit

policy of the firm. Higher is the Debtor Turnover, lower is the credit period offered to

customers. It can be calculated by dividing annual net credit sales with the average

debtors.

(7).Average Collection Period : This ratio provides the number of days in which the

debtors of the company are expected to be realized. In other words, a high receivable

turnover ratio or a low average collection period depicts highly liquid position on one

hand and a very restrictive credit policy on the other.

(8).Creditors Turnover Ratio : Like Debtors turnover ratio, this ratio indicates the

credit period enjoyed by the firm from its suppliers. Since trade credit is a popularly

used financing source of working capital, it is important to look at this ratio. It shows

the velocity of debt payment by a firm.

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(9).Average Payment Period : This ratio reflects the period in which the company

ought to pay its creditors during a specified period of time. To the extent possible, a

firm should try to maintain the average payment period which is approximately equal

to the credit terms of the supplier.

(6). CAPITAL MARKET RATIO :

Capital Market Ratios are used to reflect the market position of the company. It works

as a yardstick for the company to compare its various aspects with the prevailing

market trends, competitors share and also with its own previous performance.

(1). Earning Per Share : Earning Per Share can be calculated by dividing the net

profit after interest, tax and preference dividend with the number of equity shares. It

measures the profitability in terms of the total funds and explain the return as a

percentage of the funds.

(2). Earning Yield Ratio : This ratio reflects the proportion of the earnings of a

shareholder in respect of the prevailing market price. The Yield is defined as the rate

of return on the amount invested. It can be observed that Earning Yield is the inverse

of the Price Earning ratio.

(3). Price Earning Ratio : Price earning ratio can be obtained by dividing the market

price with the earning per share. The PE Ratio indicates the expectations of the equity

investors about the earnings of the firm. The investors expectations are reflected in

the market price of the share and therefore the PE Ratio gives an idea of investors

perception of the EPS.

(4). Dividend Pay-Out Ratio : This ratio provides the proportion of Dividend per

share with respect to Earning per share in the prevailing market trends. It refers to the

proportion of the Earning Per Share which has been distributed by the company as

dividends.

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(5). Dividend Yield Ratio : This ratio can be obtained by dividing the Dividend per

share with the prevailing market price per share for a specified period of time. Both

the Earning Yield and the Dividend Yield evaluate the profitability of the firm in

terms of the market price of the share and hence are useful measures from the point of

view of a prospective investor who is evaluating a share worth to take a buy or not to

buy decision.

IV.2RECEIVABLE MANAGEMENT

Receivables are almost certain and inevitable to arise in the ordinary course ofbusiness. They represent extension of credit and investment of funds and must be

carefully managed. Every firm must develop a credit policy that includes setting credit

standards, defining credit terms and employing methods for timely collection of

receivables. The Receivables (including the debtors and the bills) constitute a

significant portion of the working capital and is an important element of it. Since

credit sales assumes a sizeable proportion of total sales in any firm, the receivable

management becomes an area of attention. Higher credit sales at more liberal terms

will no doubt increase the profit of the firm, but simultaneously also increases the risk

of bad debts as well as results in more and more funds blocking in the receivables. The

term RM may be defined as collection of steps and procedure required to properly

weigh the costs and benefits attached with the credit policies. The RM consists of

matching the costs of increasing sales (particularly credit sales) with the benefits

arising out of increased sales with the objective of maximizing the return on

investment of the firm.

COSTS OF RECEIVABLES :

(1). Cost of Financing : The credit sales delays the time of sales realization and

therefore the time gap between the cost and the sales realization is extended. This

results in the blocking of the funds for a longer period. The firm on the other hand, has

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to arrange funds to meets its own obligation at some explicit or implicit costs. This is

known as the cost of financing the Receivables.

(2). Administrative Costs : A firm will also be required to incur various costs in order

to maintain the record of credit customers both before the credit sales as well as after

the credit sales.

(3). Delinquency Costs : Over and above the normal administrative cost of

maintaining and collection of receivables, the firm may have to incur the additional

delinquency costs, if there is delay in payment by a customer; in the form of

reminders, phone calls, postage, legal notices etc. Moreover, there is always an

opportunity cost of the funds tied up in the receivables due to delay in the payment.

(4). Cost of Default by Customers : If there is a default by a customer and the

receivable becomes, partly or wholly, unrealizable, then this amount, known as bad

debt, also becomes a cost to the firms. This cost does not appear in the case of cash

sales.

BENEFITS OF RECEIVABLES :

(1). Increase in Sales : Almost all the firms are required to sell goods on credit, either

because of trade customs or other conditions. The sales can further be increased by

liberalizing the credit terms. This will attract more customers to the firm resulting in

higher sales and growth of the firm.

(2). Increase in Profits : Increase in sales will help the firm to easily recover the fixed

expenses & attaining the break even level, and increase the operating profit of the

firm.

(3). Extra Profits : Sometimes, the firms make the credit sales at a price which is

higher than the usual cash selling price. This brings an opportunity to the firm to make

extra profit over and above the normal profit.

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TRADE-OFF ON RECEIVABLES :

Firms offer credit to customer for a number of reasons, but the ultimate objective is to

generate sales that would not have occurred otherwise. The costs associated with

offering credit are twofold: Firstly, granting credit exposes the firm to the possibility

that the customer will default. Secondly, the foregone interest between the time of

sales and the sales realization. This cost can however be partially or wholly set off by

charging customers interest cost for buying goods on credit. In fact, in cases where

the firm can charge higher interest rate from the customer, such interest income

becomes a profit instead of a cost to the firm.

The trade-off on receivables can be applied to find out whether to liberalize the credit

terms or not. When a firm adopts more liberal credit policies, the sales increase

resulting in higher profits. However, the chances of bad debts will also increase and

there will be a decrease in liquidity of the firm. On the other hand, a stringent credit

policy reduces the profitability but increases the liquidity of the firm. The opposite

forces of profitability and liquidity have an inverse relationship. Thus, a firm should

try to frame its credit policy in such a way as to attain the best possible combination of

profitability and liquidity.

Therefore, the receivables management must be attempted by adopting a systematic

approach and considering the following aspects of the receivable management :

(1). The Credit Policy.

(2). The Credit Evaluation.

(3). The Credit Control.

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CREDIT POLICY :

A firm makes significant investment by extending credit to its customers and thus

requires a suitable and effective credit policy to control the level of total investment in

the receivables. The basic decision to be made regarding receivables is to decide how

much credit to be extended to a customer and on what terms. This is what is known as

credit policy. The credit policy may be defined as the set of parameters and principles

that govern the extension of credit to the customers. This requires the determination of

the credit standard i.e. the conditions that the customer must meet before being granted

credit, and the credit terms i.e. the terms and conditions on which the credit is

extended to the customers.

(1). Credit Standards : When a firm sells on credit, it takes a risk about the paying

capacity of the customers. Therefore, the problem is to balance the benefits of

additional sales against the cost of increasing bad debts. Effect of the credit standard

on the sales volume, total bad debts of the firm and on the total collection costs are

worth noting. The credit standard will help setting the level which must be satisfied by

a customer before being selected for making credit sales. However, even after

selecting the customers, all of them need not necessarily be offered the same terms and

conditions.

(2). Credit Terms : The credit terms refer to the set of stipulations under which the

credit is extended to the customers. The credit terms specify how the credit will be

offered, including the length of the period for which the credit will be offered, the

interest rate on the credit and the cost of default. The credit terms may relate to the

following :

Credit Period : It refers to the length of the time over which the customers are

allowed to delay the payment. There is no hard and fast rule regarding the credit

period and it may differ from one market to another. Customary practices are

important factor in deciding the credit period.

Discount Terms : The customers are generally offered cash discount to induce

them to make prompt payments. Different discount rates are offered for different

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periods e.g. 5% discount if payment made within 10 days; 3% discount if payment

made within 20 days etc.

When a firm offers a cash discount, its intention is to accelerate the flow of cash into

the firm to improve its cash position. The length of cash discount affects the collection

period. Some customers, who were not paying promptly, may be tempted to avail the

discount and may pay earlier. This will result in shortening of the average collection

period.

However, there is always a cost of cash discount. If a firm has an average collection

period of 40 days, and in order to reduce the average collection period, it offers a cash

discount of 3% if payment is made in 10 days. A customer having a balance of Rs.100,

who was paying in 40 days, now avails the discount of 3% and pays Rs.97 on the 10th

day.

So, firm will be having Rs.97 for a period of 30 days (40-10), and the cost is Rs.3. The

annual cost of this discount can be calculated as follows :

Annual financing cost = Rs. 3 * 365 * 100 = 37.6%

Rs. 97 30

So, the annual cost of offering cash discount is 37.6%. This may be compared with the

cost of financing from other sources to decide whether to offer discount to customers

or not. The annual financing cost may be ascertained as follows :

Annual financing cost = % Discount * 365 * 100

100-% Discount Credit Period - Discount Period

Increase in discount rate will tantamount to reducing the ultimate selling price

resulting in increase in sales. Increasing the collection period results in increasing the

amount of receivables and hence the higher cost of receivables. Therefore, any change

in the discount terms should be evaluated in terms of costs and benefits of such

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change. The competition requires that the credit terms should match the credit terms of

other firms.

CREDIT EVALUATION :

The receivables are generally considered a relatively low risk asset. Under normal

circumstances, the total bad debts losses a firm will experience can be forecast with

reasonable accuracy, especially if the firm sells to a large number of customers and

does not change its credit policies. These normal losses can be considered purely a

cost of extending credit.

Credit Evaluation involves determination of the type of the customers who are going

to qualify for the trade credit. Several costs are associated with extending credit to less

credit-worthy customers. When more time is spent investigating the less credit-worthy

customers, the cost of credit investigation increases. As the customers credit rating

declines, the chance that the amount will not be paid on time increases. Collection

costs also increase as the quality of the customer declines.

There are three basic factor of credit worthiness of a customer. First, the character i.e.

the willingness and the practice of the customer to honor his obligations by paying as

agreed. Second, the capacity i.e. the financial ability of the customer to pay as agreed,

and third, the collateral i.e. the security offered by the customer against the credit.

Evaluation of credit worthiness of a customer is a two step procedure (1). collection of

information, and (2). analysis of information.

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(1). Collection of Information :

In order to make better decisions, the firm may collect information from various

sources on the prospective credit customers. Some of the sources are listed below :

(a). Bank Reference

(b). Credit Agency Report

(c). Published Information

(d). Credit Scoring

Information collection is often costly and therefore, the firms also weigh the benefits

of gathering information against its costs.

(2). Analysis of Information :

The five well known Cs of credit : Character, Capacity, Capital, Collateral and

Conditions provide a framework for the evaluation of a customer. These

characteristics can throw light on the credit worthiness or default-risk of the customer.

The difficulty arises in case of those customer who are marginally credit worthy. In

such a situation, the financial manager must attempt to balance the potential

profitability against the potential loss from the default.

CONTROLS OF RECEIVABLES :

Since the credit has been extended to a customer as per the credit policy, the next

important step in the management of receivables is the control of these receivables. In

this reference, the efforts may be required in the following directions :

(1). The Collection Procedure :

Once a firm decides to extend credit and defines the terms of credit sales; it must

develop a policy for dealing with delinquent or slow paying customers. There is a

cost of both : Delinquent customers create bad debts and other costs associated

with repossession of goods, whereas the slow paying customer cause more cash

being tied up in receivables and the increased interest costs. A strict collection

policy can affect the goodwill and damage the growth prospects of the sales. If a

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firm has a lenient credit policy, the customers with a natural tendency towards

slow payments, may become even slower to settle his accounts. Overly aggressive

collection policy may offend good customers who inadvertently have failed to pay

in time. One possible way of ensuring early payments from customers may be to

charge interest on over due balances. But this penal interest and the rate thereof

must be agreed in advance and better written in sales document. Thus, the

objective of collection procedure and policies should be to speed up the slow

paying customer and reduce the incidence of bad debts.

(2). Monitoring of Receivables :

In order to control the level of receivables, the firm should apply regular

checks and there should be a continuous monitoring system. For the purpose,

number of measures are available as follows :

(a). A common method to monitor the receivables is the collection period or

number of days outstanding receivables. The average collection period may be

found by dividing the average receivables by the amount of credit sales per day

i.e.,

Average collection period = Average Receivables

Credit Sales per day

(b). Another technique available for monitoring the receivables is known as

AgingSchedule. The quality of the receivables of a firm can be measured by

looking at the age of receivables. The older the receivable, the lower is the

quality and higher or greater the likelihood of a default.

(3). Lines of Credit :

Another control measure for receivables management is the line of credit

which refers to the maximum amount a particular customer may have as due to

the firm at any time. However, if a new order is going to increase the

indebtedness of a customer beyond his line of credit, then the case must be

taken for an approval for a temporary increase in the line of credit.

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(4). Accounting Ratios :

Accounting information may be of good help in order to control the

receivables. Though, several ratios may be calculated in this regard, two

accounting ratios, in particular may be calculated to find out the changing

patterns of receivables. These are (a). Receivables Turnover Ratio, and (b).

Average Collection Period.

FACORING AND RECEIVABLES MANAGEMENT :

Factoring may be defined as the relationship between the seller of goods and a

financial firm, the factor, whereby the latter purchases the receivables of the former

and also administer the receivables of the former. Factoring involves sale of

receivables of a firm to another firm under an already existing agreement between the

firm and the factor. So, the factoring is a tool to release the working capital tied up in

credit extended to the customers, for more profitable uses and thereby relieving the

management from sales collection chores so that they can concentrate on other

important activities. There are two types of Factoring : (1). Non-recourse factoring

(Full Factoring) where factor firm purchases the receivables from the selling firm and

(2). Recourse Factoring (Pure Factoring) where factor firm does only collection work

of receivables & thus does not bear any risk of default by the receivable.

IV.3 INVENTORY MANAGEMENT

The Inventory absorbs a major part of Working Capital funds; the key of efficient

working capital management lies in inventory management. Inventories are assets of

the firm and require investment and hence involve the commitment of firms

resources. If the inventories are too big, they become a strain on the resources,

however if they are too small, the firm may loose the sales. Therefore, the firm must

have an optimum level of inventories. Managing the level of inventories is like

maintaining the level of water in a bath tub with an open drain. The water is flowing

out continuously. If water is let in too slowly, the tub is soon empty. If water is let in

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too fast, the tub over flows. Like the water in the tub, the particular item in the

inventory keeps changing, but level may remain the same.

TYPES OF INVENTORIES :

(1). RAW MATERIAL : This consists of basic materials that have been committed to

the production in a manufacturing concern. The purposes of maintaining raw material

inventory is to uncouple the purchase function from the production so that delays in

the shipment of raw material do not cause production delays. Carrying extra inventory

means tying up money in the resources. When money is converted into inventories, it

leads to additional costs in the form of storage, security, supervision, insurance,

obsolescence etc. in addition to loss of an opportunity to earn a return on money.

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(2). WORK IN PROGRESS : This Category includes those materials, which have

been committed to the production process but have not been completed. The more

complex and lengthy production process the larger will be the investment in the work

in process inventory. Work in Progress refers to the raw materials engaged in various

phases of production schedule. The degree of completion may be varying for different

units. The value of Work in Progress includes the raw material costs, the direct wages

and expenses already incurred and the overheads, if any. So, the Work in Progress

inventory consists of partially produced / completed goods.

(3). FINISHED GOODS : These are the goods which are either being purchased by

the firm or are being produced or processed in the firm. These are completed products

awaiting sales. The purpose of finished goods inventory is to uncouple the production

and the sale function so that it is not necessary to produce the goods before the sales

can occur and therefore sales can be made directly out of inventory. It is necessary to

decide on the safety stock of finished goods to be carried to meet the fluctuations in

the demand as well as other uncertainties that are present in the nature of business.

PURPOSE OF MAINTAINING INVENTORY :

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We have seen that the purpose of carrying inventory is to uncouple the operations of

the firm i.e. to make each function of the firm independent of other functions so that

delays in one area do not affect the production and sales activities. Any firm will like

hold higher levels of inventory. This will enable the firm to be more flexible in

supplying to the customers and will find ease in its production schedule. Given the

benefits of holding inventories and costs of stock-outs, a firm will be tempted to hold

maximum possible inventories. But this is costly too, because the funds blocked in

inventory always have an opportunity costs. Thus, the objective of inventory

management is to determine the optimal level of inventory i.e. the level at which the

interest of all the departments are taken care of. The motives for holding inventory

may be enumerated as follows :

(1). Transactionary Motive :

Every firm has to maintain some level of inventory to meet the day to day

requirements of sales, production process, customer demand etc. This motive makes

the firm to keep the inventory of finished goods as well as raw materials.

(2). Precautionary Motive :

A firm should keep some inventory for unforeseen circumstances also. For example

the fresh supply of the raw material may not reach the factory due to strike by the

transporters or due to natural calamities in a particular area. There may be labor

problem in the factory and the production process may halt. So, the firm must have

inventory of raw materials as well as finished goods for meeting such emergencies.

(3). Speculative Motive :

The firm may be tempted to keep some inventory in order to capitalize an opportunity

to make profit e.g. sufficient level of inventory may help the firm to earn extra profit

in case of expected shortage in the market.

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COSTS OF INVENTORY :

(1). Carrying Costs :

This is the cost incurred in keeping or maintaining an inventory of one unit of raw

material or work in progress or finished goods. Two costs associated with it are: (a).

Cost of storage: This

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