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

1)     Fixed Capital

2)     Working Capital

        Every business needs funds for two purposes for its establishment and to carry out its day- to-day
operations. Long terms funds are required to create production facilities through purchase of fixed assets
such as p&m, land, building, furniture, etc. Investments in these assets represent that part of firm’s capital
which is blocked on permanent or fixed basis and is called fixed capital. Funds are also needed for short-
term purposes for the purchase of raw material, payment of wages and other day – to- day expenses etc.

These funds are known as working capital. In simple words, working capital refers to that part of
the firm’s capital which is required for financing short- term or current assets such as cash, marketable
securities, debtors & inventories. Funds, thus, invested in current assts keep revolving fast and are being
constantly converted in to cash and this cash flows out again in exchange for other current assets. Hence, it
is also known as revolving or circulating capital or short term capital.

CONCEPT OF WORKING CAPITAL

There are two concepts of working capital:

1.     Gross working capital

2.     Net working capital

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

Assets which can convert in to cash within a short period normally one accounting year.

CONSTITUENTS OF CURRENT ASSETS

1)     Cash in hand and cash at bank

2)     Bills receivables

3)     Sundry debtors

 4)     Short term loans and advances.

5)     Inventories of stock as:

a.      Raw material

b.     Work in process

c.     Stores and spares

d.     Finished goods

6. Temporary investment of surplus funds.

7. Prepaid expenses

8. Accrued incomes.

9. Marketable securities.

In a narrow sense, the term working capital refers to the net working. Net working capital
is the excess of current assets over current liability, or, say:

NET WORKING CAPITAL = CURRENT ASSETS – CURRENT LIABILITIES.

Net working capital can be positive or negative. When the current assets exceeds the
current liabilities are more than the current assets. Current liabilities are those liabilities,
which are intended to be paid in the ordinary course of business within a short period of
normally one accounting year out of the current assts or the income business.

CONSTITUENTS OF CURRENT LIABILITIES

1.     Accrued or outstanding expenses.

2.     Short term loans, advances and deposits.

3.     Dividends payable.

 4.     Bank overdraft.

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

6.     Bills payable.

7.     Sundry creditors.

The gross working capital concept is financial or going concern concept whereas net working capital is an
accounting concept of working capital. Both the concepts have their own merits.

The gross concept is sometimes preferred to the concept of working capital for the following reasons:

1.     It enables the enterprise to provide correct amount of working capital at

correct time.

2.     Every management is more interested in total current assets with which it has

to operate then the source from where it is made available.

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

enterprise would increase its working capital.

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

working capital. The net working capital concept, however, is also important
for following reasons:

·        It is qualitative concept, which indicates the firm’s ability to meet to its operating
expenses and short-term liabilities.

·        IT indicates the margin of protection available to the short term creditors.

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

·        It suggests the need of financing a part of working capital requirement out of the
permanent sources of funds.
  

CLASSIFICATION OF WORKING CAPITAL

Working capital may be classified in to ways:

o       On the basis of concept.

o        On the basis of time.

On the basis of concept working capital can be classified as gross working capital and net
working capital. On the basis of time, working capital may be classified as:

Ø     Permanent or fixed working capital.

Ø     Temporary or variable working capital

PERMANENT OR FIXED WORKING CAPITAL

Permanent or fixed working capital is minimum amount which is required to ensure effective utilization of
fixed facilities and for maintaining the circulation of current assets. Every firm has to maintain a minimum
level of raw material, work- in-process, finished goods and cash balance. This minimum level of current
assts is called permanent or fixed working capital as this part of working is permanently blocked in current
assets. As the business grow the requirements of working capital also increases due to increase in current
assets.

TEMPORARY OR VARIABLE WORKING CAPITAL

Temporary or variable working capital is the amount of working capital which is required to meet the
seasonal demands and some special exigencies. Variable working capital can further be classified as
seasonal working capital and special working capital. The capital required to meet the seasonal need of the
enterprise is called seasonal working capital. Special working capital is that part of working capital which
is required to meet special exigencies such as launching of extensive marketing for conducting research,
etc.

Temporary working capital differs from permanent working capital in the sense that is required for short
periods and cannot be permanently employed gainfully in the business.
IMPORTANCE OR ADVANTAGE OF ADEQUATE WORKING CAPITAL

Ø    SOLVENCY OF THE BUSINESS: Adequate working capital helps in maintaining the
solvency of the business by providing uninterrupted of production.

Ø     Goodwill: Sufficient amount of working capital enables a firm to make prompt payments
and makes and maintain the goodwill.

Ø     Easy loans: Adequate working capital leads to high solvency and credit standing can
arrange loans from banks and other on easy and favorable terms.

Ø     Cash Discounts: Adequate working capital also enables a concern to avail cash discounts
on the purchases and hence reduces cost.

Ø     Regular Supply of Raw Material: Sufficient working capital ensures regular supply of raw
material and continuous production.

Ø     Regular Payment Of Salaries, Wages And Other Day TO Day Commitments: It leads to the
satisfaction of the employees and raises the morale of its employees, increases their
efficiency, reduces wastage and costs and enhances production and profits.

Ø     Exploitation Of Favorable Market  Conditions: If a firm is having adequate working capital

then it can exploit the favorable market conditions such as purchasing its requirements in
bulk when the prices are lower and holdings its inventories for higher prices.

Ø     Ability To Face Crises: A concern can face the situation during the depression.

Ø     Quick And Regular Return On Investments: Sufficient working capital enables a concern
to pay quick and regular of dividends to its investors and gains confidence of the investors
and can raise more funds in future.

Ø     High Morale: Adequate working capital brings an environment of securities, confidence,
high morale which results in overall efficiency in a business.

EXCESS OR INADEQUATE WORKING CAPITAL

Every business concern should have adequate amount of working capital to run its business
operations. It should have neither redundant or excess working capital nor inadequate nor
shortages of working capital. Both excess as well as short working capital positions are bad for
 any business. However, it is the inadequate working capital which is more dangerous from the
point of view of the firm.

DISADVANTAGES OF REDUNDANT OR EXCESSIVE WORKING CAPITAL

1.     Excessive working capital means ideal funds which earn no profit for the

firm and business cannot earn the required rate of return on its investments.

2.     Redundant working capital leads to unnecessary purchasing and

accumulation of inventories.

3.     Excessive working capital implies excessive debtors and defective credit

policy which causes higher incidence of bad debts.

4.     It may reduce the overall efficiency of the business.

5.     If a firm is having excessive working capital then the relations with banks

and other financial institution may not be maintained.

6.     Due to lower rate of return n investments, the values of shares may also

fall.

7.     The redundant working capital gives rise to speculative transactions

DISADVANTAGES OF INADEQUATE WORKING CAPITAL

Every business needs some amounts of working capital. The need for working capital arises due to the time
gap between production and realization of cash from sales. There is an operating cycle involved in sales
and realization of cash. There are time gaps in purchase of raw material and production; production and
sales; and realization of cash.

Thus working capital is needed for the following purposes:

·       For the purpose of raw material, components and spares.

·       To pay wages and salaries

·       To incur day-to-day expenses and overload costs such as office expenses.

·       To meet the selling costs as packing, advertising, etc.

·       To provide credit facilities to the customer.

·       To maintain the inventories of the raw material, work-in-progress, stores and spares and
finished stock.

For studying the need of working capital in a business, one has to study the business under
varying circumstances such as a new concern requires a lot of funds to meet its initial
requirements such as promotion and formation etc. These expenses are called preliminary
expenses and are capitalized. The amount needed for working capital depends upon the size of
the company and ambitions of its promoters. Greater the size of the business unit, generally
larger will be the requirements of the working capital.

The requirement of the working capital goes on increasing with the growth and expensing of the
business till it gains maturity. At maturity the amount of working capital required is called
normal working capital.

There are others factors also influence the need of working capital in a business.

FACTORS DETERMINING THE WORKING CAPITAL REQUIREMENTS

1.  NATURE OF BUSINESS: The requirements of working is very limited in

public utility undertakings such as electricity, water supply and railways because they
offer cash sale only and supply services not products, and no funds are tied up in
inventories and receivables. On the other hand the trading and financial firms requires
less investment in fixed assets but have to invest large amt. of working capital along
with fixed investments.

2.  SIZE OF THE BUSINESS: Greater the size of the business, greater is the
requirement of working capital.

3.  PRODUCTION POLICY: If the policy is to keep production steady by

accumulating inventories it will require higher working capital.
 4.  LENTH OF PRDUCTION CYCLE: The longer the manufacturing time the
raw material and other supplies have to be carried for a longer in the process with
progressive increment of labor and service costs before the final product is obtained. So
working capital is directly proportional to the length of the manufacturing process.

5.  SEASONALS VARIATIONS: Generally, during the busy season, a firm

requires larger working capital than in slack season.

6.  WORKING CAPITAL CYCLE: The speed with which the working cycle
completes one cycle determines the requirements of working capital. Longer the cycle
larger is the requirement of working capital.

                           DEBTORS

CASH                                 FINISHED GOODS

RAW MATERIAL                        WORK IN PROGRESS

  

7.     RATE OF STOCK TURNOVER: There is an inverse co-relationship between the

question of working capital and the velocity or speed with which the sales are affected.
A firm having a high rate of stock turnover wuill needs lower amt. of working capital as
compared to a firm having a low rate of turnover.

8.     CREDIT POLICY: A concern that purchases its requirements on credit and sales its
product / services on cash requires lesser amt. of working capital and vice-versa.

9.     BUSINESS CYCLE: In period of boom, when the business is prosperous, there is need
for larger amt. of working capital due to rise in sales, rise in prices, optimistic expansion
of business, etc. On the contrary in time of depression, the business contracts, sales
decline, difficulties are faced in collection from debtor and the firm may have a large
amt. of working capital.
10. RATE OF GROWTH OF BUSINESS: In faster growing concern, we shall require large
amt. of working capital.

11. EARNING CAPACITY AND DIVIDEND POLICY: Some firms have more earning
capacity than other due to quality of their products, monopoly conditions, etc. Such
firms may generate cash profits from operations and contribute to their working capital.
The dividend policy also affects the requirement of working capital. A firm maintaining
a steady high rate of cash dividend irrespective of its profits needs working capital than
the firm that retains larger part of its profits and does not pay so high rate of cash
dividend.

12. PRICE LEVEL CHANGES: Changes in the price level also affect the working capital
requirements. Generally rise in prices leads to increase in working capital.

Others FACTORS: These are:

ü     Operating efficiency.

ü     Management ability.

ü     Irregularities of supply.

ü     Import policy.

ü     Asset structure.

ü     Importance of labor.

ü     Banking facilities, etc.

MANAGEMENT OF WORKING CAPITAL

Management of working capital is concerned with the problem that arises in attempting to
manage the current assets, current liabilities. The basic goal of working capital management
is to manage the current assets and current liabilities of a firm in such a way that a
satisfactory level of working capital is maintained, i.e. it is neither adequate nor excessive as
both the situations are bad for any firm. There should be no shortage of funds and also no
working capital should be ideal. WORKING CAPITAL MANAGEMENT POLICES of a
firm has a great on its probability, liquidity and structural health of the organization. So
working capital management is three dimensional in nature as

1.     It concerned with the formulation of policies with regard to profitability,

liquidity and risk.

2.     It is concerned with the decision about the composition and level of

current assets.

3.     It is concerned with the decision about the composition and level of

current liabilities.

  WORKING CAPITAL ANALYSIS

As we know working capital is the life blood and the centre of a business. Adequate amount
of working capital is very much essential for the smooth running of the business. And the
most important part is the efficient management of working capital in right time. The
liquidity position of the firm is totally effected by the management of working capital. So, a
study of changes in the uses and sources of working capital is necessary to evaluate the
efficiency with which the working capital is employed in a business. This involves the need
of working capital analysis.

The analysis of working capital can be conducted through a number of devices, such as:

1.     Ratio analysis.

2.     Fund flow analysis.

3.     Budgeting.

1.    RATIO ANALYSIS

A ratio is a simple arithmetical expression one number to another. The technique of ratio
analysis can be employed for measuring short-term liquidity or working capital position of a
firm. The following ratios can be calculated for these purposes:

1. Current ratio.

2. Quick ratio

3.  Absolute liquid ratio

4.  Inventory turnover.

5.  Receivables turnover.

6.  Payable turnover ratio.

7.  Working capital turnover ratio.

8.  Working capital leverage

9.  Ratio of current liabilities to tangible net worth.

2.    FUND FLOW ANALYSIS

Fund flow analysis is a technical device designated to the study the source from which
additional funds were derived and the use to which these sources were put. The fund flow
analysis consists of:

a.      Preparing schedule of changes of working capital

b.     Statement of sources and application of funds.

It is an effective management tool to study the changes in financial position (working

capital) business enterprise between beginning and ending of the financial dates.

 
3.    WORKING CAPITAL BUDGET

A budget is a financial and / or quantitative expression of business plans and polices to be

pursued in the future period time. Working capital budget as a part of the total budge ting
process of a business is prepared estimating future long term and short term working capital
needs and sources to finance them, and then comparing the budgeted figures with actual
performance for calculating the variances, if any, so that corrective actions may be taken in
future. He objective working capital budget is to ensure availability of funds as and needed,
and to ensure effective utilization of these resources. The successful implementation of
working capital budget involves the preparing of separate budget for each element of
working capital, such as, cash, inventories and receivables etc.  

ANALYSIS OF SHORT – TERM FINANCIAL POSITION OR TEST OF LIQUIDITY

The short –term creditors of a company such as suppliers of goods of credit and
commercial banks short-term loans are primarily interested to know the ability of a firm to
meet its obligations in time. The short term obligations of a firm can be met in time only
when it is having sufficient liquid assets. So to with the confidence of investors, creditors,
the smooth functioning of the firm and the efficient use of fixed assets the liquid position
of the firm must be strong. But a very high degree of liquidity of the firm being tied – up
in current assets. Therefore, it is important proper balance in regard to the liquidity of the
firm. Two types of ratios can be calculated for measuring short-term financial position or
short-term solvency position of the firm.

1.     Liquidity ratios.

2.     Current assets movements ‘ratios.

A)   LIQUIDITY RATIOS

Liquidity refers to the ability of a firm to meet its current obligations as and when these
become due. The short-term obligations are met by realizing amounts from current,
floating or circulating assts. The current assets should either be liquid or near about
 liquidity. These should be convertible in cash for paying obligations of short-term nature.
The sufficiency or insufficiency of current assets should be assessed by comparing them
with short-term liabilities. If current assets can pay off the current liabilities then the
liquidity position is satisfactory. On the other hand, if the current liabilities cannot be met
out of the current assets then the liquidity position is bad. To measure the liquidity of a
firm, the following ratios can be calculated:

1.     CURRENT RATIO

2.     QUICK RATIO

3.     ABSOLUTE LIQUID RATIO

1.   CURRENT RATIO

Current Ratio, also known as working capital ratio is a measure of general liquidity and its
most widely used to make the analysis of short-term financial position or liquidity of a
firm. It is defined as the relation between current assets and current liabilities. Thus,

CURRENT RATIO = CURRENT ASSETS 

                                     CURRENT LIABILITES

The two components of this ratio are:

1)     CURRENT ASSETS

2)     CURRENT LIABILITES

Current assets include cash, marketable securities, bill receivables, sundry debtors,
inventories and work-in-progresses. Current liabilities include outstanding expenses, bill
payable, dividend payable etc.

A relatively high current ratio is an indication that the firm is liquid and has the ability to
pay its current obligations in time. On the hand a low current ratio represents that the
liquidity position of the firm is not good and the firm shall not be able to pay its current
 liabilities in time. A ratio equal or near to the rule of thumb of 2:1 i.e. current assets
double the current liabilities is considered to be satisfactory.

CALCULATION OF CURRENT RATIO

                                                                              (Rupees in crore)

e.g.

Year 2006 2007 2008

Current Assets 81.29 83.12 13,6.57
Current Liabilities 27.42 20.58 33.48
Current Ratio 2.96:1 4.03:1 4.08:1

Interpretation:-

As we know that ideal current ratio for any firm is 2:1. If we see the current ratio of the
company for last three years it has increased from 2006 to 2008. The current ratio of
company is more than the ideal ratio. This depicts that company’s liquidity position is
sound. Its current assets are more than its current liabilities.

2. QUICK RATIO

Quick ratio is a more rigorous test of liquidity than current ratio. Quick ratio may be
defined as the relationship between quick/liquid assets and current or liquid liabilities. An
asset is said to be liquid if it can be converted into cash with a short period without loss of
value. It measures the firms’ capacity to pay off current obligations immediately.

QUICK RATIO = QUICK ASSETS

                               CURRENT LIABILITES

Where Quick Assets are:

1)           Marketable Securities

2)           Cash in hand and Cash at bank.

 3)           Debtors.

A high ratio is an indication that the firm is liquid and has the ability to meet its current
liabilities in time and on the other hand a low quick ratio represents that the firms’
liquidity position is not good.

As a rule of thumb ratio of 1:1 is considered satisfactory. It is generally thought that if

quick assets are equal to the current liabilities then the concern may be able to meet its
short-term obligations. However, a firm having high quick ratio may not have a
satisfactory liquidity position if it has slow paying debtors. On the other hand, a firm
having a low liquidity position if it has fast moving inventories.

CALCULATION OF QUICK RATIO

e.g.                                                              (Rupees in Crore)

Year 2006 2007 2008

Quick Assets 44.14 47.43 61.55
Current Liabilities 27.42 20.58 33.48
Quick Ratio 1.6 : 1 2.3 : 1 1.8 : 1

Interpretation :

       A quick ratio is an indication that the firm is liquid and has the ability to meet its
current liabilities in time. The ideal quick ratio is   1:1. Company’s quick ratio is more
than ideal ratio. This shows company has no liquidity problem.

3. ABSOLUTE LIQUID RATIO

Although receivables, debtors and bills receivable are generally more liquid than
inventories, yet there may be doubts regarding their realization into cash immediately or in
time. So absolute liquid ratio should be calculated together with current ratio and acid test
ratio so as to exclude even receivables from the current assets and find out the absolute
liquid assets. Absolute Liquid Assets includes :

ABSOLUTE LIQUID RATIO =      ABSOLUTE LIQUID ASSETS

                                                       CURRENT LIABILITES

 ABSOLUTE LIQUID ASSETS = CASH & BANK BALANCES.

e.g.                                                          (Rupees in Crore)

Year 2006 2007 2008

Absolute Liquid Assets 4.69 1.79 5.06
Current Liabilities 27.42 20.58 33.48
Absolute Liquid Ratio .17 : 1 .09 : 1 .15 : 1

Interpretation :

       These ratio shows that company carries a small amount of cash. But there is nothing
to be worried about the lack of cash because company has reserve, borrowing power &
long term investment. In India, firms have credit limits sanctioned from banks and can
easily draw cash.

B) CURRENT ASSETS MOVEMENT RATIOS

Funds are invested in various assets in business to make sales and earn profits. The
efficiency with which assets are managed directly affects the volume of sales. The better
the management of assets, large is the amount of sales and profits. Current assets
movement ratios measure the efficiency with which a firm manages its resources. These
ratios are called turnover ratios because they indicate the speed with which assets are
converted or turned over into sales. Depending upon the purpose, a number of turnover
ratios can be calculated. These are :

1.                 Inventory Turnover Ratio

2.                 Debtors Turnover Ratio

3.                 Creditors Turnover Ratio

4.                 Working Capital Turnover Ratio

The current ratio and quick ratio give misleading results if current assets include high
amount of debtors due to slow credit collections and moreover if the assets include high
amount of slow moving inventories. As both the ratios ignore the movement of current
assets, it is important to calculate the turnover ratio.
 1.                 INVENTORY TURNOVER OR STOCK TURNOVER RATIO :

Every firm has to maintain a certain amount of inventory of finished goods so as to

meet the requirements of the business. But the level of inventory should neither be
too high nor too low. Because it is harmful to hold more inventory as some amount
of capital is blocked in it and some cost is involved in it. It will therefore be
advisable to dispose the inventory as soon as possible.

INVENTORY TURNOVER RATIO =      COST OF GOOD SOLD

                                                    AVERAGE INVENTORY

Inventory turnover ratio measures the speed with which the stock is converted into
sales. Usually a high inventory ratio indicates an efficient management of inventory
because more frequently the stocks are sold ; the lesser amount of money is required
to finance the inventory. Where as low inventory turnover ratio indicates the
inefficient management of inventory. A low inventory turnover implies over
investment in inventories, dull business, poor quality of goods, stock accumulations
and slow moving goods and low profits as compared to total investment.

AVERAGE STOCK  =   OPENING STOCK + CLOSING STOCK

                                                                 2

                                                      (Rupees in Crore)

Year 2006 2007 2008

Cost of Goods sold 110.6 103.2 96.8
Average Stock 73.59 36.42 55.35
Inventory Turnover Ratio 1.5 times 2.8 times 1.75 times

Interpretation :

       These ratio shows how rapidly the inventory is turning into receivable through sales.
In 2007 the company has high inventory turnover ratio but in 2008 it has reduced to 1.75
times. This shows that the company’s inventory management technique is less efficient as
compare to last year.

2.                 INVENTORY CONVERSION PERIOD:

 INVENTORY CONVERSION PERIOD =   365 (net working days)

                                                INVENTORY TURNOVER RATIO

e.g.

Year 2006 2007 2008

Days 365 365 365
Inventory Turnover Ratio 1.5 2.8 1.8
Inventory Conversion Period 243 days 130 days 202 days

Interpretation :

       Inventory conversion period shows that how many days inventories takes to convert
from raw material to finished goods. In the company inventory conversion period is
decreasing. This shows the efficiency of management to convert the inventory into cash.

3.                 DEBTORS TURNOVER RATIO :

A concern may sell its goods on cash as well as on credit to increase its sales and a
liberal credit policy may result in tying up substantial funds of a firm in the form of trade
debtors. Trade debtors are expected to be converted into cash within a short period and are
included in current assets. So liquidity position of a concern also depends upon the quality
of trade debtors. Two types of ratio can be calculated to evaluate the quality of debtors.

a)       Debtors Turnover Ratio

b)      Average Collection Period

DEBTORS TURNOVER RATIO = TOTAL SALES (CREDIT)

                                                         AVERAGE DEBTORS

Debtor’s velocity indicates the number of times the debtors are turned over during a
year. Generally higher the value of debtor’s turnover ratio the more efficient is the
management of debtors/sales or more liquid are the debtors. Whereas a low debtors
turnover ratio indicates poor management of debtors/sales and less liquid debtors. This
ratio should be compared with ratios of other firms doing the same business and a trend
may be found to make a better interpretation of the ratio.
AVERAGE DEBTORS= OPENING DEBTOR+CLOSING DEBTOR

                                                        2

e.g.

Year 2006 2007 2008

Sales 166.0 151.5 169.5
Average Debtors 17.33 18.19 22.50
Debtor Turnover Ratio 9.6 times 8.3 times 7.5 times

Interpretation :

       This ratio indicates the speed with which debtors are being converted or turnover into
sales. The higher the values or turnover into sales. The higher the values of debtors
turnover, the more efficient is the management of credit. But in the company the debtor
turnover ratio is decreasing year to year. This shows that company is not utilizing its
debtors efficiency. Now their credit policy become liberal as compare to previous year.

4.                 AVERAGE COLLECTION PERIOD :

Average Collection Period =    No. of Working Days

                                             Debtors Turnover Ratio

The average collection period ratio represents the average number of days for which
a firm has to wait before its receivables are converted into cash. It measures the quality of
debtors. Generally, shorter the average collection period the better is the quality of debtors
as a short collection period implies quick payment by debtors and vice-versa.

Average Collection Period =    365 (Net Working Days) 

                                             Debtors Turnover Ratio

Year 2006 2007 2008

Days 365 365 365
Debtor Turnover Ratio 9.6 8.3 7.5
Average Collection Period 38 days 44 days 49 days
 Interpretation :

          The average collection period measures the quality of debtors and it helps in
analyzing the efficiency of collection efforts. It also helps to analysis the credit policy
adopted by company. In the firm average collection period increasing year to year. It
shows that the firm has Liberal Credit policy. These changes in policy are due to
competitor’s credit policy.

5.                 WORKING CAPITAL TURNOVER RATIO :

Working capital turnover ratio indicates the velocity of utilization of net working
capital. This ratio indicates the number of times the working capital is turned over
in the course of the year. This ratio measures the efficiency with which the
working capital is used by the firm. A higher ratio indicates efficient utilization of
working capital and a low ratio indicates otherwise. But a very high working
capital turnover is not a good situation for any firm.

Working Capital Turnover Ratio =           Cost of Sales

                                                        Net Working Capital

Working Capital Turnover       =                   Sales        

                                                        Networking Capital

e.g.

Year 2006 2007 2008

Sales 166.0 151.5 169.5
Networking Capital 53.87 62.52 103.09
Working Capital Turnover 3.08 2.4 1.64

Interpretation :

          This ratio indicates low much net working capital requires for sales. In 2008,
the reciprocal of this ratio (1/1.64 = .609) shows that for sales of Rs. 1 the company
 requires 60 paisa as working capital. Thus this ratio is helpful to forecast the working
capital requirement on the basis of sale.

INVENTORIES

(Rs. in Crores)

Year 2005-2006 2006-2007 2007-2008

Inventories 37.15 35.69 75.01

Interpretation :

       Inventories is a major part of current assets. If any company wants to manage its
working capital efficiency, it has to manage its inventories efficiently. The graph shows
that inventory in 2005-2006 is 45%, in 2006-2007 is 43% and in 2007-2008 is 54% of
their current assets. The company should try to reduce the inventory upto 10% or 20% of
current assets.

CASH BNAK BALANCE :

(Rs. in Crores)

Year 2005-2006 2006-2007 2007-2008

Cash Bank Balance 4.69 1.79 5.05

Interpretation :

       Cash is basic input or component of working capital. Cash is needed to keep the
business running on a continuous basis. So the organization should have sufficient cash to
meet various requirements. The above graph is indicate that in 2006 the cash is 4.69 crores
but in 2007 it has decrease to 1.79. The result of that it disturb the firms manufacturing
operations. In 2008, it is increased upto approx. 5.1% cash balance. So in 2008, the
company has no problem for meeting its requirement as compare to 2007.

DEBTORS :

(Rs. in Crores)

Year 2005-2006 2006-2007 2007-2008

Debtors 17.33 19.05 25.94
 Interpretation :

       Debtors constitute a substantial portion of total current assets. In India it constitute
one third of current assets. The above graph is depict that there is increase in debtors. It
represents an extension of credit to customers. The reason for increasing credit is
competition and company liberal credit policy.

CURRENT ASSETS :

(Rs. in Crores)

Year 2005-2006 2006-2007 2007-2008

Current Assets 81.29 83.15 136.57

Interpretation :

       This graph shows that there is 64% increase in current assets in 2008. This increase is
arise because there is approx. 50% increase in inventories. Increase in current assets shows
the liquidity soundness of company.

CURRENT LIABILITY :

(Rs. in Crores)

Year 2005-2006 2006-2007 2007-2008

Current Liability 27.42 20.58 33.48

Interpretation :

       Current liabilities shows company short term debts pay to outsiders. In 2008 the
current liabilities of the company increased. But still increase in current assets are more
than its current liabilities.

NET WOKRING CAPITAL :

(Rs. in Crores)
 Year 2005-2006 2006-2007 2007-2008
Net Working Capital 53.87 62.53 103.09

Interpretation :

       Working capital is required to finance day to day operations of a firm. There should
be an optimum level of working capital. It should not be too less or not too excess. In the
company there is increase in working capital. The increase in working capital arises
because the company has expanded its business.

RESEARCH METHODOLOGY

The methodology, I have adopted for my study is the various tools, which basically analyze critically
financial position of to the organization:

             I.               COMMON-SIZE P/L A/C

          II.               COMMON-SIZE BALANCE SHEET

      III.               COMPARTIVE P/L A/C

       IV.               COMPARTIVE BALANCE SHEET

          V.               TREND ANALYSIS

       VI.               RATIO ANALYSIS

The above parameters are used for critical analysis of financial position.  With the evaluation of each
component, the financial position from different angles is tried to be presented in well and systematic
manner. By critical analysis with the help of different tools, it becomes clear how the financial manager
handles the finance matters in profitable manner in the critical challenging atmosphere, the
recommendation are made which would suggest the organization in formulation of a healthy and strong
position financially with proper management system.

I sincerely hope, through the evaluation of various percentage, ratios and comparative analysis, the
organization would be able to conquer its in efficiencies and makes the desired changes.

ANALYSIS OF FINANCIAL STATEMENTS

 

FINANCIAL STATEMENTS:

Financial statement is a collection of data organized according to logical and consistent accounting
procedure to convey an under-standing of some financial aspects of a business firm. It may show position
at a moment in time, as in the case of balance sheet or may reveal a series of activities over a given period
of time, as in the case of an income statement. Thus, the term ‘financial statements’ generally refers to the
two statements

(1) The position statement or Balance sheet.

(2) The income statement or the profit and loss Account.

OBJECTIVES OF FINANCIAL STATEMENTS:

According to accounting Principal Board of America (APB) states

The following objectives of financial statements: -

1. To provide reliable financial information about economic resources and obligation of a business firm.

2. To provide other needed information about charges in such economic resources and obligation.

3. To provide reliable information about change in net resources (recourses less obligations) missing out of
business activities.

4. To provide financial information that assets in estimating the learning potential of the business.

LIMITATIONS OF FINANCIAL STATEMENTS:

Though financial statements are relevant and useful for a concern, still they do not present a final picture a
final picture of a concern. The utility of these statements is dependent upon a number of factors. The
analysis and interpretation of these statements must be done carefully otherwise misleading conclusion may
be drawn.

Financial statements suffer from the following limitations: -

1. Financial statements do not given a final picture of the concern. The data given in these statements is
only approximate. The actual value can only be determined when the business is sold or liquidated.

2. Financial statements have been prepared for different accounting periods, generally one year, during the
life of a concern. The costs and incomes are apportioned to different periods with a view to determine
profits etc. The allocation of expenses and income depends upon the personal judgment of the accountant.
The existence of contingent assets and liabilities also make the statements imprecise. So financial statement
are at the most interim reports rather than the final picture of the firm.

3. The financial statements are expressed in monetary value, so they appear to give final and accurate
position. The value of fixed assets in the balance sheet neither represent the value for which fixed assets
can be sold nor the amount which will be required to replace these assets. The balance sheet is prepared on
the presumption of a going concern. The concern is expected to continue in future. So fixed assets are
shown at cost less accumulated deprecation. Moreover, there are certain assets in the balance sheet which
will realize nothing at the time of liquidation but they are shown in the balance sheets.

4. The financial statements are prepared on the basis of historical costs Or original costs. The value of
assets decreases with the passage of time current price changes are not taken into account. The statement
are not prepared with the keeping in view the economic conditions. the balance sheet loses the significance
of being an index of current economics realities. Similarly, the profitability shown by the income
statements may be represent the earning capacity of the concern.

5. There are certain factors which have a bearing on the financial position and operating result of the
business but they do not become a part of these statements because they cannot be measured in monetary
terms. The basic limitation of the traditional financial statements comprising the balance sheet, profit &
loss A/c is that they do not give all the information regarding the financial operation of the firm.
Nevertheless, they provide some extremely useful information to the extent the balance sheet mirrors the
financial position on a particular data in lines of the structure of assets, liabilities etc. and the profit & loss
A/c shows the result of operation during a certain period in terms revenue obtained and cost incurred
during the year. Thus, the financial position and operation of the firm.

FINANCIAL STATEMENT ANALYSIS

It is the process of identifying the financial strength and weakness of a firm from the available accounting
data and financial statements. The analysis is done

CALCULATIONS OF RATIOS

Ratios are relationship expressed in mathematical terms between figures, which are connected with each
other in some manner.

CLASSIFICATION OF RATIOS

Ratios can be classified in to different categories depending upon the basis of classification

The traditional classification has been on the basis of the financial statement to which the determination of
ratios belongs.

 These are:-

·        Profit & Loss account ratios

·        Balance Sheet ratios

 ·        Composite ratios

Project Description :
Title : Working Capital Management of ____________

Pages : 73

Category : Project Report for MBA

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